Another argument against negotiated grants: how the bill for local corruption is distributed

The objective of this paper is to indicate another argument against negotiated grants (NGs): the possibility of local leaders seeking NGs in order to transfer the bill for local corruption to the whole country. Our argument is that local leaders cause this movement in their attempt to avoid corruption having a negative impact on their re-election chances when voters observe the corruption that exists. Since revenues and corruption have problems of reverse causality, we use random auditing (i.e., audits conducted by the Controladoria Geral da União [Office of the Federal Controller General]) as an IV of corruption to overcome this problem. Moreover, we reinforce the mechanism described with two placebos showing that both the audit per se and non-observed corruption (i.e., corruption of the next term considered in the current term) does not modify statistically the mix of revenue in the budget. We also observe that governors facing elections that are more competitive allow for an increase in transfers that are negotiated with corrupt local leaders. We performed our investigation on the years between 2005 and 2011 using Brazilian local governments where the local leaders (mayors) are elected in a competitive system, have autonomy to define the budget, and the municipal accounting system offers data about NGs with higher levels of government.