Fiscal Federalism As a Constraint on States (Iii. Federalism and Interstate Competition‪)‬

Federalism--by which I mean more than federal-state relationships, and in particular mean all relationships between relatively centralized governments and their relatively decentralized subdivisions--allows different jurisdictions to compete for residents, both firms and individuals. Those who embrace federalism point to the benefits it confers by allowing jurisdictions to vary the bundle of goods and services they offer when the contents of that bundle generate only intrajurisdictional effects. The underlying assumption is that federalism induces subnational jurisdictions to attract residents by offering a preferred public good at a particular tax price. (1) The resulting competition, in theory, has many benefits. It maximizes preference satisfaction, as individuals migrate to jurisdictions that offer the public goods that they desire. It allows efficient delivery of local public goods as competitive markets for residents both drive down monopoly tax prices that public entities might otherwise be able to demand and provide public officials signals of desired services. It reduces the size of government because the resulting homogeneity (1) reduces the costs of monitoring officials who are charged with providing public goods consistent with residents' preferences and (2) represses logrolling among groups with diverse interests that might otherwise divert public resources to private use. And it diminishes corruption within government because that same homogeneity causes expenditures for illicit activity--which almost by definition deviates from majoritarian preferences--to be more salient. A corollary of these characteristics of federalism, and perhaps the primary objective of federalism itself, is that interjurisdictional competition simultaneously acts as a bulwark against strong centralized governments. (2) Allowing potential residents to migrate to jurisdictions that offer desired goods and services and that are motivated to limit expenditures on rent-seeking activities obviously serves liberty interests that otherwise could be quashed by centralized governments that dictated expenditures over a broader jurisdictional scope. (3)