Social Weights and the Regional Allocation of Inter-Governmental Transfers

Abstract We develop an optimal theory of intergovernmental transfers and a simulation analysis that provides estimates of the optimal shares of resources to be allocated to state governments in Mexico. Our models provide several insights: First, the best fit of our model to observed data suggests that the best predictor of the share of intergovernmental transfers to states is the density of population in Mexico. Second, our analysis provides recommendations of economic policy design by estimating the optimal shares of intergovernmental transfers to states in Mexico. Our analysis is the first to develop estimates of intergovernmental transfers by using Paretian distribution functions of the interregional distribution of income and the interregional distribution of preferences for local public spending. Our estimates help to understand advantages and shortcomings of the current system of allocation of intergovernmental transfers and propose an alternative way to allocate intergovernmental transfers that couldimprove the welfare associated with local public spending in Mexico.