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The stimulative effects of intergovernmental grants and the marginal cost of public funds

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  • Bev Dahlby
  • Ergete Ferede

Abstract

This paper tests the hypothesis that the stimulative effects of intergovernmental grants increase with the marginal cost of public funds of the recipient government. We present a simple theoretical framework that shows how a lump-sum transfer stimulates the marginal expenditures of a recipient government through an income effect and a price effect. We then test the prediction of this model using Canadian provincial data and exploit the discontinuity in the equalization grants allocation formula to identify the effects of grants. Our results indicate that the stimulative effects of lump-sum grants on spending increase with the provincial government’s marginal cost of public funds (MCF). One policy implication of our results is that higher intergovernmental transfers may be welfare improving if the federal government has a lower MCF than the provinces. Copyright Springer Science+Business Media New York 2016

Suggested Citation

  • Bev Dahlby & Ergete Ferede, 2016. "The stimulative effects of intergovernmental grants and the marginal cost of public funds," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 23(1), pages 114-139, February.
    • Handle: RePEc:kap:itaxpf:v:23:y:2016:i:1:p:114-139
    DOI: 10.1007/s10797-015-9352-5
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    Cited by:

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    2. Robin Boadway & Katherine Cuff, 2017. "The impressive contribution of Canadian economists to fiscal federalism theory and policy," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 50(5), pages 1348-1380, December.
    3. Cristian F. Sepúlveda, 2017. "Flypaper effect, intergovernmental transfers, income and substitution effects, marginal cost of public funds," Hacienda Pública Española / Review of Public Economics, IEF, vol. 222(3), pages 91-108, September.
    4. Saeid Mahdavi & Joakim Westerlund, 2017. "Are state–local government expenditures converging? New evidence based on sequential unit root tests," Empirical Economics, Springer, vol. 53(2), pages 373-403, September.
    5. Cassidy, Traviss, 2017. "How Forward-Looking Are Local Governments? Evidence from Indonesia," MPRA Paper 97776, University Library of Munich, Germany, revised 01 Jun 2019.
    6. Ana-Isabel Guerra & Laura Varela-Candamio & Jesús López-Rodríguez, 2022. "Tax reforms in Spain: efficiency levels and distributional patterns," Economic Systems Research, Taylor & Francis Journals, vol. 34(1), pages 41-68, January.
    7. Thiess Büttner, 2021. "Land Use and Fiscal Competition," CESifo Working Paper Series 8958, CESifo.
    8. Cassidy, Traviss, 2017. "Revenue Persistence and Public Service Delivery," MPRA Paper 114464, University Library of Munich, Germany, revised 06 Sep 2022.
    9. Antti Saastamoinen & Mika Kortelainen, 2020. "When Does Money Stick in Education? Evidence from A Kinked Grant Rule," Education Finance and Policy, MIT Press, vol. 15(4), pages 708-735, Fall.
    10. Yarlina Yacoub, 2019. "Flypaper Effect in Indonesia: The Case of Kalimantan," GATR Journals jfbr164, Global Academy of Training and Research (GATR) Enterprise.
    11. M. Rose Olfert, 2016. "Regional Inequality and Decentralized Governance: Canada's Provinces," The Review of Regional Studies, Southern Regional Science Association, vol. 46(3), pages 201-222, Winter.
    12. Momi Dahan, 2022. "The Effects of Intergovernmental Transfers on Municipalities' Budgets," Israel Economic Review, Bank of Israel, vol. 20(1), pages 1-25.

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    More about this item

    Keywords

    Intergovernmental grants; Marginal cost of public funds; Flypaper effect; Fiscal federalism; H71; H72; H77;
    All these keywords.

    JEL classification:

    • H72 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Budget and Expenditures
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism

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