• KDI Journal of Economic Policy
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• v.31 no.1
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• pp.27-69
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• 2009

This paper studies the logic of fiscal constraints and fiscal autonomy in a political agency model with both moral hazard and adverse selection. The electoral process not only disciplines incumbents who may act against the public interest but also opts in politicians who are most likely to act along voters' interests. We characterize perfect Bayesian equilibria under shared tax system and fiscal autonomy with fiscal constraints for local public good provision. It is shown that the local voters' expected welfare under fiscal autonomy is higher than under shared tax system if the same fiscal constraints are applied. In order to examine the effects of party's candidate selection processes on the behavior of local politician and national politician, we extend the model to an environment where local politician can compete for the candidacy of national assembly with incumbent national politician. If local politician wins majority of votes against incumbent national politician, then he can move on to serve as a national politician. Otherwise, his political career will end as a local politician. It is the gist of this primary system portrayed by this setup that local politician and national politician compete to garner more votes. Therefore, primary system as a candidate selection mechanism enhances local residents' welfare compared to top-down candidate selection processes.