Political competition and fiscal equalisation

Most federations, including Australia, have systems of fiscal equalisation which transfer income between States. Economists have long studied the economic efficiency and equity arguments for and against such transfers. This paper concentrates instead on the political aspect; namely, it asks whether federal political parties wishing to maximise their expected votes at election time would ever support a system of equalisation, particularly one which mandates efficient transfers of the type studied by economists. The answer, found using a two-State model of a federation in which voters are mobile, is in the affirmative: the political process delivers an efficient and equitable system of equalisation. However, the result depends on certain assumptions. The implications of these assumptions are explored.