Content area
Full text
Abstract
This paper estimates causal effects of intergovernmental grants on local expenditure and tax revenue. This is done by utilizing a rule-based grant distribution scheme in the Philippines. The results provide evidence of a flypaper effect among both municipalities and cities in the Philippines, i.e., grants create a large stimulative effect on local spending but have no effect on the reduction of local taxation. The result is robust to a noticeable self-selection bias in the Philippine local governance, where a municipality can opt to convert to a city to receive more grants once it meets conversion criteria.
Keywords: intergovernmental grants, instrumental variable, self-selection, public finance, flypaper effect
JEL Classification Codes: C26, H71, H72, H77, R51
(ProQuest: ... denotes formulae omited.)
I.Introduction
In many countries, central governments provide unconditional grants to lower-tier governments, which allows for recipients' discretion in allocating funds. Intergovernmental grants finance about one-third of subnational expenditure in OECD countries, and about 60 percent in developing countries (Shah, 2007). Grants help to preserve local autonomy and fund public goods provision, given that local governments better understand the needs of their localities and have an advantage in service delivery.1 Knowledge about whether and to what extent grants do stimulate local governments to provide the desired level of public goods is, therefore, crucial for the appropriate design of fiscal decentralization.
Starting from Bradford and Oates' (1971) seminal work, economic theory suggests that a lump-sum grant to a local government induces a pure income effect and thus affects its public goods expenditure according to the median voter's marginal propensity to spend on local public goods, i.e., 5 to 10 percent of income (Hines and Thaler, 1995).2 Because a median voter perceives grants and private income to be fungible, receiving a one-dollar grant transfer should have an effect on total spending no different from a one-dollar increase in private income. In other words, intergovernmental grants are expected to result in a small stimulating effect on local public spending and a large effect on private goods in the form of tax reduction. The phenomenon that grants crowd out private income is also referred to in the literature as the crowding-out effect. Most empirical studies, however, find that grants have a larger stimulating effect on public expenditure than predicted...