Exploring the Sub-state Intergovernmental Game

Abstract

This paper presents a model of fiscal federalism where state and local officials jointly fund a local public good that produces regional externalities. The model examines the implications of diverging budgetary priorities at the state and local level for the sustainability of cooperative funding arrangements. Local government dependence on intergovernmental aid is shown to negatively affect the likelihood of receiving state bailouts. Additionally, the termination of joint funding agreements is predicted to precede increased government fragmentation through the formation of new special purpose districts. The analysis is illustrated using flood control infrastructure finance and school district fragmentation.