Redistribution and provision of public goods in an economic federation

This paper concerns redistribution and public good provision in an economic federation with two levels of government: a local government in each locality and a (first mover) central government. Each locality is characterized by two ability-types, and the ability-distribution differs across localities. The central government redistributes via a nonlinear income tax and a lump-sum transfer to each local government, while the local governments use proportional income taxes and provide local public goods. We show how the redistributive role of taxation is combined with a corrective role, and how the central government can implement the second best resource allocation.