Local public goods, risk sharing, and private information in federal systems

We examine the implications of information asymmetries for the optimal design of interregional insurance schemes and the allocation of local public goods. We have good and bad news. The good news is that the presence of informational asymmetries is not in itself sufficient to deny federations the attainment of either efficiency or egalitarian goals. The bad news is that not only the first best may not be incentive compatible but also the incentive compatible optimum may violate participation constraints. Federations may have to content themselves with "fourth best" allocations as a result of strategic manipulation of information by privately informed jurisdictions. (C) 2000 Academic Press.