Redistributing income under fiscal vertical imbalance

From the literature on decentralization, it appears that the fiscal vertical imbalance (i.e. the dependence of sub-national governments on national government revenues to support their expenditures) is somehow inherent to multi-level governments. Using a stylized model we show that this leads to a reduction of the extent of redistributive fiscal policies if the maximal size of government has been reached. To test for this empirically, we use some high quality data from the LIS dataset on individual incomes. The results are highly significant and point in the direction of our theoretical predictions. (C) 2008 Elsevier B.V. All rights reserved.