The Crowding-in Effect of Simple Unconditional Central Grants on Local Own-Source Revenue: The Case of Benin

The design of grants from central government to local government is an important issue in developing countries. In these countries the decentralisation process involves a vertical gap, i.e. an imbalance between the cost of local public competences and local governments' revenue-raising powers. Our analysis considers the crowding-in (or crowding-out) effect of simple unconditional central grants on local own-source revenue. We demonstrate a theoretical ambiguity concerning the nature of this effect by taking into account the collection costs of local governments' own revenue. Our empirical analysis focuses on Benin. We study the impact of a very simple grant that is collected at the border by Customs and is allocated to local governments through a fixed rule (based on population). Our empirical analysis covers panel data for the seventy-seven Benin communes (local governments) from 2003 to 2008, and addresses the potential endogeneity issues of transfer from the centre. We conclude unambiguously that there is a positive impact of this grant on local own-source revenue. This effect is contingent on a minimum level of wealth of the commune and is stronger for local governments that do not share the same political affiliation as the president in office. Our result emphasises a neglected property of those unconditional transfers whose allocation rule is solely population based: their complementarity with local own-source revenue. Such transfers are not only simpler than other formula-based equalisation transfers, but they may also have an incentive effect on local own-source revenue.