Precommitment and State and Local Policy Coordination

Local government tax and service policies, for reasons including tax competition, spillovers of service benefits, and a limited choice of tax instruments, may not be globally efficient. Policies used by state governments to remedy these inefficiencies include matching grants, mandates, and tax subsidies. We consider an additional strategy the state government may employ to influence local policies -choosing or "precommitting" to its policies before the local governments choose their policies. We argue that the conditions necessary for the state government to credibly precommit to its policies with respect to local government policies do exist. The unlikelihood of the state government being able to alter its policies after local governments have chosen their policies reduces problems associated with time-inconsistency. We first derive the general conditions necessary for precommitment to improve social welfare. Essentially we find that precommitment can increase social welfare if the state government does not have "sufficient" policy instruments to eliminate any change in welfare in one locality from a change in another locality's government policies and if the state government's policies influence the local government policies that create the uncompensated externality. We then illustrate the conditions when precommitment can improve social welfare using two examples from the `tax competition' literature.