Sharing budgetary austerity under free mobility and asymmetric information: An optimal regulation approach to fiscal federalism

In the present article, Tiebout meets Laffont and Tirole in the land of fiscal federalism. A non-trivial Principal-Multi-Agent model is used to characterize the optimal intergovernmental grant schedule, when the cost of local public goods depends on hidden characteristics and actions of local governments, and under citizen free mobility. We show how informational rents, landlords' interests, and citizen mobility interact to produce distortions at both ends of the type space: in particular the most efficient jurisdictions should overproduce and overtax in second-best optimum. Informational asymmetries decrease the average production of public goods and increase the inter-jurisdictional variance of taxes and public-good production.