Asymmetric Information and Regional Transfers: Federalism versus Devolution

Intergovernmental transfers under asymmetric information have been analyzed basically through adverse selection models. This setting fits well in the stylized facts of consolidated federalism, though it is unsatisfactory to analyze the recent devolution of fiscal powers. In the latter case, the fundamental informational asymmetry between central and local governments is related to the imperfect verifiability of local policies. The paper shows that, whatever the institutional setting, asymmetric information reduces the scope for interregional equalization. However, the sign of optimal distortion that grants bring about on regional fiscal policy may differ between federalism (adverse selection) and devolution (pure moral hazard).