Fiscal-capacity equalization-grants with taxpayers' lobbying

The economic analysis of tax-base equalization-grants from central to local governments suggests that the transfer mechanism distorts fiscal policies by providing incentives to local governments to set excessively high tax rates. In this paper, we extend the analysis by allowing taxpayers to lobby the policy makers for reductions of their own tax burdens. In principle, the distortions spurring from the lobbying activity should mitigate those caused by the equalization program. In contrast, we show that taxpayers lobbying amplifi es the distortions of the equalization mechanism. The degree of fiscal equalization can then be adjusted to alleviate the efficiency costs of lobbying.