I consider a heterogeneous federal system in which policy coordination is desirable but underprovided in the absence of a federal intervention. To improve policy coordination, the federal layer can intervene by imposing bounds on local policies. These federal bounds define a restricted policy space within which local jurisdictions have residual discretion. I analyze a voting game in which the federal bounds are determined directly by the citizens via federal majority rule.
The voting equilibrium exhibits various forms of inefficiencies. When the distribution of voters' ideal policy is skewed in one direction, the federal bounds are biased in the opposite direction. When the gains from policy coordination are negligible, local discretion is too limited, and a majority of voters are worse-off with the federal intervention than without. When policy coordination is more important, the federal intervention is supported by a majority of voters, but contrary to the received wisdom, it is socially worse than no intervention. Hence, the model shows that inadequate and excessively rigid federal interventions can emerge in a democratic federation without agency costs or informational imperfections.