The effects of vertical fiscal transfers on the location of economic activity across a country regions: theory and evidence for Argentina

Buenos Aires

Congreso; XLV Reunión de la Asociación Argentina de Economía Política; 2010

AAEP

Argentina is constitutionally organised as a federal country, with both national and state levels of government sharing tax and expenditure powers. For a long time now, state governments have authorised the national government to raise taxes and to distribute them among local governments according to some fixed criteria, including the target of achieving a convergence in development and growth among sub-national regions. Despite this compensatory aim, it is still possible to observe a great level of asymmetries among the country provinces, asymmetries that in some cases have even increased in recent times. Extending Martin and Rogers? Footloose Capital Model to include the production of non-tradable goods and public employment, we analyse the effect on the location of economic activity that follows to changes on how vertical fiscal transfers from the national to state governments are distributed. Our results show that an increase in the share of transfers a region receives has a positive effect on the production of footloose activities (i.e. manufactures) the higher are: i) transaction costs of goods produced under increasing returns to scale; ii) the share of transfers that goes directly to consumers instead of local governments; iii) the elasticity of substitution between differentiated goods; and iv) the share of consumers? expenditure on manufactures via-as-vis on non-traded goods.