Cooperative Federalism

Cooperative Federalism

This item is an extension of Lawi's courses and guides. It offers facts, commentary, and analysis on this topic.

The objective of cooperative federalism is to guarantee the right to uniform living conditions in all jurisdictions. The peculiarity of this institutional organization is the strong interconnection between the functions and prerogatives of the central government and those of lower-level governments (whose typical examples are Germany and, to a lesser extent, Canada). The objective of social cohesion underlined in the literature on cooperative federalism can be analyzed with reference to the two principles of equalization: horizontal and vertical equity.

With a flat federal tax rate, disparities in per capita income between jurisdictions cause the "residual net tax" (the difference between taxes paid and benefits received) to be different for individuals with equal income since taxes are based on the income of each individual, while the benefits depend on the different endowments of resources in each jurisdiction.

The adoption of the horizontal equity principle at the federation level addresses this differentiated tax treatment given to individuals with equal income in lower-level jurisdictions.

The literature on cooperative federalism deals with the application of the objective of horizontal equalization through horizontal and vertical transfers, the latter both downward (from central government to lower-level "poor" jurisdictions) and upward (from lower-tier "rich" jurisdictions to central government). An Informative Guide On Cooperative Federalism

Depending on the magnitude of disparities in the balance between rich and poor lower-tier jurisdictions,

both in terms of resources and population needs, the equalization of cross-jurisdictional grants when transfers are decided based on per capita income may even result in a redistribution from the poor in the rich jurisdiction to the rich in the backward jurisdiction.

Jurisdictions that produce public goods that are also enjoyed by other jurisdictions are entitled to “conditional” matching grants (countervailing subsidies linked to the fulfillment of certain conditions).In the case of positive externalities, the principle of horizontal equity (same net fiscal residual for individuals with the same income) implies that the amount of the transfers must correspond to the equalization between the marginal cost and the marginal benefit.

The literature on cooperative federalism is also concerned with the goal of vertical equity. Income disparities between individuals, which are not caused by their market decisions (their leisure/work or effort choices) but by the conditions of the jurisdiction in which they live, must be compensated. Pervasive interdependencies within a federation make Pareto improvements relevant from both equity and efficiency standpoints (examine more on all of these aspects in this social sciences and humanities online platform). 

Under a flat federal tax rate, the suboptimal Pareto equilibrium position on the utility possibilities frontier may be due to the differential merit and public goods enjoyed by individuals of equal talent. The greater the disparities between lower-tier jurisdictions in terms of resource endowment and public responsibilities deriving from the different needs of the population (infrastructure, education, health care, etc.), the more tax equalization is justified through subsidies of compensation on the basis that with an equal federal tax rate, the same level of public services should be provided throughout the federation. Improved social cohesion and efficiency can be expected by correcting resource imbalances between jurisdictions.