Fiscal Federalism and Grant-in-Aid Design for the Provision of Impure Public Goods

The traditional fiscal federalism theory shows that the devolution of functions for the supply of local public goods may increase welfare. However, most services offered at local level are impure local public goods with spillovers. These goods have specific characteristics that may prevent devolution to be the best solution in this context. In this paper we develop a model that studies fiscal federalism and we provide grants-in-aid distribution formulae in an environment charaterized by asymmetry of information and coordination problems.We show the set of rules for determining when devolution is a superior alternative to decentralization