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Equalization Transfers and the Pattern of Municipal Spending: An Investigation of the Flypaper Effect in Germany

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  • Sebastian Langer

    (Leibniz Institute of Ecological Urban and Regional Development (IOER)
    Technische Universit¨at Dresden, Faculty of Business and Economics)

  • Artem Korzhenevych

    (Leibniz Institute of Ecological Urban and Regional Development
    Technische Universitat Dresden, Faculty of Business and Economics)

Abstract

We investigate how lump-sum equalization transfers affect expenditures and taxes in the municipalities of the largest German state North RhineWestphalia. In general, those general-purpose transfers cannot be treated as exogenous variables. Thus, for the identification of causal effects, two exogenous adjustments in the transfer allocation formula are used as instrumental variables. Findings suggest the existence of the "flypaper effect" - municipalities use transfers to increase expenditures but do not reduce tax rates. Extra money from transfers is mainly used to finance social expenditures and public facilities. A set of robustness checks, including a spatial dependence model, confirm the results.

Suggested Citation

  • Sebastian Langer & Artem Korzhenevych, 2019. "Equalization Transfers and the Pattern of Municipal Spending: An Investigation of the Flypaper Effect in Germany," Annals of Economics and Finance, Society for AEF, vol. 20(2), pages 737-765, November.
    • Handle: RePEc:cuf:journl:y:2019:v:20:i:2:langerkorzhenevych
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    Cited by:

    1. Becker, Johannes & Hopp, Daniel & Kriebel, Michael, 2020. "Mental accounting of public funds – The flypaper effect in the lab," Journal of Economic Behavior & Organization, Elsevier, vol. 176(C), pages 321-336.
    2. Manuel E. Lago & Santiago Lago-Peñas & Jorge Martinez-Vazquez, 2022. "On the effects of intergovernmental grants: a survey," Working Papers. Collection A: Public economics, governance and decentralization 2204, Universidade de Vigo, GEN - Governance and Economics research Network.
    3. Kaur, Amandeep & Mohanty, Ranjan & Chakraborty, Lekha S & Rangan, Divy, 2021. "Ecological Fiscal Transfers and State-level Budgetary Spending in India: Analysing The Flypaper Effects," MPRA Paper 111947, University Library of Munich, Germany.
    4. Kaur, Amandeep & Mohanty, Ranjan Kumar & Chakraborty, Lekha & Rangan, Divy, 2021. "Ecological Fiscal Transfers and State-level Budgetary Spending in India: Analysing The Flypaper Effects in India," Working Papers 21/332, National Institute of Public Finance and Policy.

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    More about this item

    Keywords

    Flypaper effect; Local government expenditure; Transfers; Local taxation;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H70 - Public Economics - - State and Local Government; Intergovernmental Relations - - - General
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue
    • 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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