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The marginal cost of public funds and the flypaper effect

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  • Bev Dahlby

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Abstract

A lump-sum intergovernmental transfer has a "price effect", as well as an "income effect", because it allows the recipient government to reduce its tax rate, which lowers its marginal cost of public funds, while still providing the same level of public service. This reduction in the effective price of providing the public service helps to explain the "flypaper effect" - the empirical observation that a lump-sum grant has a much larger effect on spending than an increase in personal income. Contrary to the assertions of Mieszkowski (1994) and Hines and Thaler (1995), a model of a benevolent local government financing its expenditures with a distortionary tax predicts flypaper effects from lump-sum grants that are similar to those observed in many econometric studies

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Article provided by Springer in its journal International Tax and Public Finance.

Volume (Year): 18 (2011)
Issue (Month): 3 (June)
Pages: 304-321

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Handle: RePEc:kap:itaxpf:v:18:y:2011:i:3:p:304-321

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Web page: http://www.springerlink.com/link.asp?id=102915

Related research

Keywords: Flypaper effect; Intergovernmental grants; Intergovernmental transfers; Fiscal federalism; Marginal cost of public funds; H77;

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  1. Roemer, John E & Silvestre, Joaquim, 2002. " The "Flypaper Effect" Is Not an Anomaly," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 4(1), pages 1-17.
  2. Stewart, Mark F, 1996. "Fiscal Illusion (the Flypaper Effect) and Government Spending in Australia," Australian Economic Papers, Wiley Blackwell, vol. 35(67), pages 390-96, December.
  3. James R. Hines & Richard H. Thaler, 1995. "The Flypaper Effect," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 217-226, Fall.
  4. Dollery, Brian E & Worthington, Andrew C, 1996. " The Empirical Analysis of Fiscal Illusion," Journal of Economic Surveys, Wiley Blackwell, vol. 10(3), pages 261-97, September.
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  6. Craig Volden, 2007. "Intergovernmental Grants: A Formal Model of Interrelated National and Subnational Political Decisions," Publius: The Journal of Federalism, Oxford University Press, vol. 37(2), pages 209-243, Spring.
  7. Gary S. Becker & Casey B. Mulligan, 1998. "Deadweight Costs and the Size of Government," NBER Working Papers 6789, National Bureau of Economic Research, Inc.
  8. Hamilton, Jonathan H., 1986. "The flypaper effect and the deadweight loss from taxation," Journal of Urban Economics, Elsevier, vol. 19(2), pages 148-155, March.
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  10. Hammes, David L & Wills, Douglas T, 1987. "Fiscal Illusion and the Grantor Government in Canada," Economic Inquiry, Western Economic Association International, vol. 25(4), pages 707-13, October.
  11. Lars-Erik Borge, 1995. "Lump-Sum Intergovernmental Grants Have Price Effects: a Note," Public Finance Review, , vol. 23(2), pages 271-274, April.
  12. Buettner, Thiess & Wildasin, David E., 2006. "The dynamics of municipal fiscal adjustment," Journal of Public Economics, Elsevier, vol. 90(6-7), pages 1115-1132, August.
  13. Michael Smart, 2007. "Raising taxes through equalization," Canadian Journal of Economics, Canadian Economics Association, vol. 40(4), pages 1188-1212, November.
  14. Michael Smart, 1998. "Taxation and Deadweight Loss in a System of Intergovernmental Transfers," Canadian Journal of Economics, Canadian Economics Association, vol. 31(1), pages 189-206, February.
  15. Andrew F. Haughwout & Robert P. Inman & Steven Craig & Thomas Luce, 2003. "Local Revenue Hills: Evidence from Four U.S. Cities," NBER Working Papers 9686, National Bureau of Economic Research, Inc.
  16. Winer, Stanley L, 1983. "Some Evidence on the Effect of the Separation of Spending and Taxing Decisions," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 126-40, February.
  17. Baker, Michael & Payne, A. Abigail & Smart, Michael, 1999. "An empirical study of matching grants: the 'cap on CAP'," Journal of Public Economics, Elsevier, vol. 72(2), pages 269-288, May.
  18. Peter C. Coyte & Stuart Landon, 1990. "Cost-Sharing versus Block-Funding in a Federal System: A Demand Systems Approach," Canadian Journal of Economics, Canadian Economics Association, vol. 23(4), pages 817-38, November.
  19. Dahlby, Bev, 2009. "The Optimal Taxation Approach to Intergovernmental Grants," Working Papers 2009-16, University of Alberta, Department of Economics.
  20. Bailey, Stephen J & Connolly, Stephen, 1998. " The Flypaper Effect: Identifying Areas for Further Research," Public Choice, Springer, vol. 95(3-4), pages 335-61, June.
  21. Bradford, David F & Oates, Wallace E, 1971. "An Analysis of Revenue Sharing in a New Approach to Collective Fiscal Decisions," The Quarterly Journal of Economics, MIT Press, vol. 85(3), pages 416-39, August.
  22. Bev Dahlby, 2008. "The Marginal Cost of Public Funds: Theory and Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262042509, December.
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Citations

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Cited by:
  1. Bev Dahlby & Ergete Ferede, 2012. "The Stimulative Effects of Intergovernmental Grants and the Marginal Cost of Public Funds," CESifo Working Paper Series 3863, CESifo Group Munich.
  2. repec:spa:wpaper:2014wpecon03 is not listed on IDEAS
  3. Lauro Carnicelli & Fernando Antonio Slaibe Postali, 2014. "Oil windfalls and local fiscal effort: a propensity score analysis," Working Papers, Department of Economics 2014_03, University of São Paulo (FEA-USP).

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