Vertical externalities with lump-sum taxes: how much difference does unemployment make?

Abstract

This paper analyses how the existence of unemployment affects the conventional approach to vertical externalities. We discuss the optimality rule for the provision of public inputs both in an unitary and a federal country. Our findings show that decentralizing the spending responsability on public inputs can bring its optimality rule closer to the production efficiency condition. Moreover, we describe the inability of the federal government, behaving as Stackelberg leader, to replicate the unitary outcome, unless to have new policy instruments at government’s disposal.