Vertical fiscal externality in public education inputs: When federal and state governments have different time perspectives

Abstract

This study investigates how equilibrium under a unitary nation can be achieved through fiscal transfer from (to) the federal government to (from) the state government when both levels of government supply public education to immobile residents under a simple endogenous growth framework fueled by human capital accumulation. We introduce the different time perspectives of both levels of government as a key consideration. Although both levels of government are interested in both the utility level of the present generation and the growth rate that can be attained by accumulating human capital through education, they place different weight on the value of these objectives. We first show that the federal government can replicate the equilibrium outcome that can be achieved under a unitary nation by implementing fiscal transfer between the different levels of government. Second, if the federal government places a large weight on the growth rate, or has a more long-run perspective than the state government, the federal tax rate becomes positive. Third, as the federal government has a stronger long-run perspective, fiscal transfer from the federal government to the state government increases.