Horizontal Versus Vertical Fiscal Equalization

We analyze a model in which the provision of regional public goods by regional governments leads to spillover effects and in whi ch the central government can establish a vertical equalization scheme while the regional governments can set up a horizontal equalization scheme. The two levels of government decide in different chronological order. It turns out that, regardless of the ti ming, the central government always prevails. Horizontal equalization does not take place – nor is it necessary in order to achieve constrain ed Pareto efficiency. Moreover, if in the model economy the goal of achieving equality in living conditions across the regions is pursued, the only suitable candidate for reaching this goal is vertical equalization.