CHAPTER

24
The Federal System of
Government
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe

The Federal System of

Government
Federal

system of government

Government

Federal
Top

made up of many levels

government

level in federal system

Economics

of federal system:

Desirability

of a federal system
Economic interactions among governments
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe

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The Theoretical Foundations

of Federalism
Economies

of Scale
Coordination of Large Programs
Public Goods
Externalities
Optimal Sharing Group

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

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Intergovernmental Competition
and Consumer Choice
Different

governments can supply of

variety of publicly provided goods
Better satisfy demands of a
heterogeneous population
Many local governments satisfies varied
demand for local public goods

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

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Intergovernmental Competition
and Consumer Choice

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

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Mobility and Intergovernmental

Competition
Many

governments allow citizens to vote

with their feet
In

other words, free to move to another

jurisdiction that better satisfies their
preferences

Tiebout

model

Local

governments compete for residents

Helps reveal preferences for public sector
output
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe

24-6

Other Governments as a Basis

for Comparison
Government

officials must satisfy

constituents to stay in office
Many local governments allow for
comparison
Provides useful information given
incentives for rational ignorance

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

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Other Governments as a Basis

for Comparison
Capitalization

in real estate prices

creates incentives to monitor government
officials
Many local governments create
laboratories of democracy

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

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The Roles of Different Levels

of Government
Education

is largest portion of state and

local spending
Public welfare is second highest
Gradual

(but steady) rise in public welfare

spending

Highways

have fallen in importance

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

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The Roles of Different Levels of

Government
Table 24.1 The Percentage of State and Local Government
Expenditures in Various Categories for Selected Years
Category

Percentage of Total
Expenditures
1970
1980 1990
2000
40.4% 36.1% 34.5% 34.6%
12.6%
9.0% 7.3% 6.7%
11.3% 12.8% 13.2% 15.4%

Education
Highways
Public welfare
Insurance trust expenditures
5.5%
6.7% 6.5% 8.2%
(retirement and unemployment)
Health and hospitals
7.4%
8.7% 8.9% 8.5%
Utility and liquor stores
7.2%
8.4% 8.0% 7.8%
Natural resources
3.6%
3.3% 1.5% 1.3%
Housing and community
1.6%
1.7% 1.9% 1.8%
development
Interest on debt
3.4%
4.0% 6.0% 5.5%
Other
7.1%
9.4% 12.2% 10.2%
Source: Author's calculations from data in the Statistical Abstract
of the United States , various editions.

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Special Interests and

Government Size
Special

Interest Influence the activities of

government
Federalism can limit special interests
Concentrates

costs
Increases incentives to become informed

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe

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Centralization and the

Cartelization of Government
Government

monitors anticompetitive
behavior in private sector
Anticompetitive behavior in government
is justified as:
Eliminating

wasteful duplication
Enforcing uniform standards

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Competition in the Public

Sector
Intergovernmental

competition important
in public sector but has declined in
recent decades
Standardization decreases
intergovernmental competition
Consolidation has reduce number of local
government units
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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The Number of Governments

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Regulations and Grants

Method

for centralizing government

activity
State governments free to impose
regulations on local governments
Federal government limited by
Constitution
However, imposes

rules as a condition for

receiving grant funding

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Regulations and Grants

Grants

provide a method for federal

government to regulate state and
localities
Lessen intergovernmental competition
Creates more homogenous local
governments

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Intergovernmental Revenue
Significant

source of local government

revenue
Occur because:
Local

government does not have incentive to

undertake the project
Local government does not have funds to
undertake the project

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Intergovernmental Revenue

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Intergovernmental Revenue
Can

lead to cartelization of local

governments
Two distinct types of intergovernmental
grants:
General

grants
Categorical grants

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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General Grants
Tax

revenues collected by higher-level

government
Given

to lower-level government to spend

how they see fit

Two

justifications:

Higher-level

governments have more revenue

generating ability
Equalization of revenues among governments
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Categorical Grants
Grants

made for a specific purpose

Give granting government some control
over expenditure
How much depends on the circumstances
How

much would the local government have

spent without the grant?

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Categorical Grants

A Categorical
Grant That Differs
from a General
Grant
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Matching Grants
Categorical

grant that requires a local

contribution before the government
matches it
Grant can be fixed or limitless

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Matching Grants

Matching Grants of
a Fixed Amount

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Matching Grants

Matching Grants
with No Grant Limit

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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The Flypaper Effect

Empirically, grants

appear to stick where

they land
Possible explanations:
Budget

maximizing bureaucrats
Creates incentive to pursue additional grants

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holcombe
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Tax Issues and Local

Governments
Individual

and business mobility has tax

policy implications
Taxes paid by immobile factors
Explains

property taxation

Capitalization

of debt
Capitalization of public goods
Deductibility of state and local taxes
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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