Fiscal equalization and lobbying

Abstract

Inter-regional redistribution through tax-base equalization transfers is examined in a setting in which taxpayers, organized as lobby groups, influence policy making. With lobbying only at the local level on tax rates, social welfare maximization implies, ceteris paribus, high (low) equalization rates on the tax bases backed by the strong (weak) lobby groups. With lobbying also at the central level, equalization is distorted downward on all tax bases if the pressure groups are similar in terms of lobbying power. It is instead distorted downward (upward) on the bases backed by strong (weak) groups if they are highly heterogeneous. In the latter situation, a uniform equalization structure may perform better than a differentiated one.