The Effects of Federal Inter-Regional Transfers with Optimizing Regional Governments

Abstract

This paper analyses a simple inter-governmental transfer within a two-regional federal model with optimising regional governments and an exogenous federal government. Regions are linked by inter-regional migration of labour and households migrate from one region to the other in response to inter-regional differences in utility. Regional governments determined their tax and expenditure settings in order to maximise the welfare of the region's representative household. The federal government exists solely to transfer resources from one region to another. The model is solved numerically, after linearlisation and calibration using data for the Australian states. We find that the federal government transfers have only trivial effects on welfare, ie that the welfare effects of the transfer are undone by the migration response of households and the tax and expenditure changes of regional governments. Most of the 'undoing' comes from inter-regional migration.