SFB 303 Discussion Paper No. A - 499
Author: Janeba, Eckhard, and Horst Raff
Title: Should Income Redistribution be (De-) Centralized? The Role of Risk
Aversion and Income Inequality
Abstract: Consider a system of regions populated by heterogeneous individuals.
Suppose that these individuals are mobile across regions and that they must
decide, by majority rule, on what kind of redistributive tax policy, if any,
to implement. Should such a policy be voted on and imposed on a system-wide
(i.e., centralized) basis or on a region-by-region (i.e., decentralized) basis? Using the concept of a
veil of ignorance, we construct a benchmark case in which a decentralized
political system dominates a centralized one in expected value terms. In
this benchmark scenario, individuals are riskneutral or nearly so, and tax
competition among regions in a decentralized system reduces the
inefficiencies inherent in the redistribution process. In numerical
examples, we show that for a certain income distributions in society a large
enough degree of risk aversion may lead to centralization becoming the
preferred solution; however, there does not exist a monotone relationship
between risk aversion and the advantage of decentralized and centralized
systems. Risk aversion interacts with the distribution of gross incomes in a
non-trivial way.
Keywords: income redistribution, mobility, majority voting, fiscal federalism
JEL-Classification-Number: D7, H1, H7
Creation-Date: October 1995
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