Tax competition and effectiveness of public service delegation

Abstract

The paper analyses the consequences of fiscal competition on the efficiency of the delegation of local public services. Efficiency is determined by the expected status of the budget constraint, that is soft (a bailout occurs in financial distress) or hard (no bailout). We first stress that delegation contracts are prone to renegotiation. Then, in a theoretical setting, we show that tax competition in a decentralized economy may be welfare improving as it enhances local authorities' commitment capacity. Firms to which the provision of local public services is delegated do not expect bailout anymore and restructure.