61 Rethinking local government: Essays on municipal reform - VATT

Chapter 2Fiscal federalism: International experiencesand the Nordic response 1Lars-Erik BorgeJørn RattsøDepartment of EconomicsNorwegian University of Science and Technology2.1 IntroductionThe standard theory of fiscal federalism prescribes major fiscaloperations at the central <strong>government</strong> level. Given a benevolent plannerat the center, the theory develops arguments for decentralization.Since the gain of decentralization relates to the heterogeneity ofpreferences for <strong>local</strong> public goods, the main tasks of <strong>government</strong> areassumed centralized. The optimal size structure of <strong>local</strong> <strong>government</strong>sis determined by the cost conditions and heterogeneity of preferencesfor <strong>local</strong> public goods. The expanded case for the <strong>local</strong> public sectoradds arguments for the handling of individual redistributive welfareservices (such as schooling and health care) at the <strong>local</strong> level. Thefiscal federalism relevant for the Nordic countries represents animportant role of decentralized <strong>government</strong> in the welfare state, andwe will discuss the challenges that follow.The alternative view of fiscal federalism is more decentralist innature. The advantages of fiscal competition represent a case fordecentralized <strong>government</strong>. Brennan and Buchanan (1980) suggesteda competitive federalism where decentralization is a mechanismto control inefficient central <strong>government</strong>. In this setting, the role1 We appreciate discussions with Antti Moisio.15