Social Weights and the Regional Allocation of Inter-Governmental Transfers

Abstract

We develop a theory and simulation analysis to calculate optimal transfers from the central government to state governments in Mexico. Our results are: First, our models show that the best predictor of intergovernmental transfers in Mexico is population density. Second, we provide estimates of optimal intergovernmental transfers to states in Mexico. Our analysis suggests using the inequality of income distribution in the social welfare function as an instrument of public policy and our estimates help to understand the advantages and disadvantages of the current transfer system. The main limitation of our work is that it does not consider political factors in the calculation of transfers. Our analysis is the first to develop estimates of intergovernmental transfers using Paretian parametric functions of regional income distribution and interregional preferences for local public spending. Our work proposes an alternative allocation of intergovernmental transfers that could improve the welfare associated with local public spending in Mexico.