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Endogenous Federal Grants and Crowd-out of State Government Spending: Theory and Evidence from the Federal Highway Aid Program

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  • Brian Knight

Abstract

Contrary to simple theoretical predictions, existing evidence suggests that federal grants do not crowd out state government spending. A legislative bargaining model with endogenous grants documents a positive correlation between grant receipts and preferences for public goods; this correlation has likely biased existing work against measuring crowd-out. To correct for such endogeneity, the model motivates instruments based on the political power of state congressional delegations. Exploiting this exogenous variation in grants, the instrumental variables estimator reports crowd-out that is statistically and economically significant. This endogeneity may explain the flypaper effect, a nonequivalence between grant receipts and private income. (JEL D70, H40, H77)

Suggested Citation

  • Brian Knight, 2002. "Endogenous Federal Grants and Crowd-out of State Government Spending: Theory and Evidence from the Federal Highway Aid Program," American Economic Review, American Economic Association, vol. 92(1), pages 71-92, March.
  • Handle: RePEc:aea:aecrev:v:92:y:2002:i:1:p:71-92
    Note: DOI: 10.1257/000282802760015612
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D70 - Microeconomics - - Analysis of Collective Decision-Making - - - General
    • H40 - Public Economics - - Publicly Provided Goods - - - General
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism

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    1. Endogenous Federal Grants and Crowd-Out of State Government Spending: Theory and Evidence from the Federal Highway Aid Program (AER 2002) in ReplicationWiki

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