Uncertain income and redistribution in a federal system

Abstract

This paper considers income redistribution in a federal system where regions experience random shocks. Federal redistribution serves as insurance against jurisdiction-specific shocks, but provides a uniform assistance to the poor and cannot suit individual jurisdictions' demands for redistribution. Consequently, whether the federal government should redistribute depends on the advantage of pooling the risk and the disadvantage of compromising different preferences for redistribution. With mobile individuals, federal redistribution loses its advantage, because migration ensures the equalization of factor incomes between regions, and because even local redistribution serves as insurance. However, local redistribution creates fiscal externalities and distorts the allocation of labor.