Interregional Rural/Urban Fiscal Competition: A Political-Economy General Equilibrium Approach

The aim of this paper is to analyze the general equilibrium welfare effects of taxation and subsidy changes in a multi-regional model that has inter-government strategic interactions. The focus is specifically on issues that arise among rural regions linked to an urban region. While, national and regional governments react to the policies of one another by implementing counter strategies to maximize their own welfare, to date, few conventional regional CGE models implement welfare theory illustrating this optimal economic decision-making by governments. This paper overcomes this limitation by analyzing a three-region GE model exhibiting maximizing behavior by both regional and federal governments. This paper extends the Groenewold, Hagger, and Madden (2000) regional political-economy general equilibrium (PEGE) model. The model is first constructed considering only regional governments. A rudimentary federal government is then introduced and several different scenarios considered; in the first case, the federal government carries out a lump-sum transfer of resources from the rural regional governments to the urban one then, it imposes lump-sum income taxes on households and uses this revenue to make transfers to the rural regional governments, and finally, the federal government imposes additional program costs on all the regional governments. The results are then used to examine the implications of federal government transfers, the resulting optimizing schemes as regional governments change their own tax rates to offset the effects on their citizens of the federal government action, and finally the effects on Rural/Urban factor transfers and competition resulting from the differing focus of federal action. ∗