Interregional Reditribution through Tax Surcharge

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Abstract
This paper considers a utilitarian federal government that attempts to effect some revenue sharing or to finance through taxation some national public good. For reason of asymmetric information, this financing cannot be based on actual regional income nor on regional preferences, as it should be in a first-best setting. The only information available at no cost to federal authorities is the amount of regional public spending. In this setting with two imperfectly observable characteristics, regional income and regional preferences, we derive an optimal tax surcharge that can be viewed as a non linear matching grant scheme. This is done first without and second with the possibility of using costly auditors to acquire more information on regional income.
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