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Local Public Expenditure with Piecewise-Linear Nonconvex Budget Constraints

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  • F Revelli

    (Department of Economics, University College London, Gower Street, London WC1E 6BT, England)

Abstract

The author analyses local authority expenditure decisions under the Block Grant system, that is, the grant distribution scheme that was in place in Britain from 1981 to 1990. The Block Grant system creates a piecewise-linear, and potentially nonconvex, budget constraint. As the choice of segment is endogenous—cither as a result of unobserved preference heterogeneity or as a result of random optimisation error—a demand function for local public expenditure cannot be consistently estimated by ordinary least squares (OLS). Instead, a two-error maximum likelihood (ML) estimation procedure is used. The results show a positive income effect and a negative price effect, both of high significance. The OLS estimate of the price coefficient is underestimated relative to its ML counterpart—because of spurious positive correlation between expenditure and price—but the OLS estimate of the income coefficient does not show a substantial bias. The two-error ML estimation results show significant evidence of unobserved preference heterogeneity and some weaker evidence of random optimisation error.

Suggested Citation

  • F Revelli, 1999. "Local Public Expenditure with Piecewise-Linear Nonconvex Budget Constraints," Environment and Planning C, , vol. 17(2), pages 195-209, April.
    • Handle: RePEc:sae:envirc:v:17:y:1999:i:2:p:195-209
    DOI: 10.1068/c170195
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    References listed on IDEAS

    as
    1. Alan Duncan & Peter Smith, 1995. "Modelling local government budgetary choices under expenditure limitation," Fiscal Studies, Institute for Fiscal Studies, vol. 16(4), pages 95-110, November.
    2. Barnett, Richard R & Levaggi, Rosella & Smith, Peter, 1991. "Does the Flypaper Model Stick? A Test of the Relative Performance of the Flypaper and Conventional Models of Local Government Budgetary Behaviour," Public Choice, Springer, vol. 69(1), pages 1-18, February.
    3. Burtless, Gary & Hausman, Jerry A, 1978. "The Effect of Taxation on Labor Supply: Evaluating the Gary Negative Income Tax Experiments," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1103-1130, December.
    4. Barnett, Richard R & Levaggi, Rosella & Smith, Peter, 1992. "Local Authority Expenditure Decisions: A Maximum Likelihood Analysis of Budget Setting in the Face of Piecewise Linear Budget Constraints," Oxford Economic Papers, Oxford University Press, vol. 44(1), pages 113-134, January.
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