Abstract
A three-level governmental world (federal, state, and local) where the local government engages in a positive externality-producing activity is examined. At each level, each (identical) governmental unit is presumed to maximize the benefits minus costs internal to its jurisdiction. The relationship between federal and state rates of subsidy (their respective decision variables) is developed and the equilibrium rate of subsidies found. The analysis is extended to the situation where a significant portion of the taxes which finance the subsidy comes from each particular subgovernment and to a situation where tax exporting exists. Last, alternative assumptions and optimizing rules are suggested.
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