Laboratory Federalism with Public Funds Sharing

The theory of laboratory federalism hypothesizes that, in a decentralized multi-jurisdictional system, policies follow an evolutionary learning process with innova-tion and imitation. This paper studies the role of public funds sharing in such a setting. As a guiding framework we consider a model of decentralized, rich-to-poor redistribution with labor mobility. Uncorrected learning dynamics here lead to a drastic erosion of the welfare state. Suitably designed public funds sharing can correct this failure and may even restore e?ciency. Surprisingly, the necessary properties of the sharing scheme for e?ciency in the learning model are the same as those that make decentralized Nash play e?cient (and vice versa).Public funds sharing, thus, is a powerful corrective device in ?scally decentralizedsettings for a variety of behavioral modes of government interaction.