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Granting public or private consumption? Effects of grants on local public spending and income taxes

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  • Heléne Lundqvist

Abstract

Most of the early empirical estimates on effects of intergovernmental grants contradict theoretical predictions. In the more recent literature that emphasizes the importance of convincing empirical strategies, the results are more mixed. This paper contributes to this literature by estimating causal effects on local expenditures and income taxes of general, unconditional grants. This is done in a difference-in-difference model utilizing policy-induced increases in grants to a group of remotely populated municipalities in Finland. The finding is that increased grants have a statistically and economically significant positive immediate effect on local expenditures. The effect on local income taxes, while statistically significant, is considerably smaller in magnitude. Furthermore, there is no evidence of dynamic crowding-out—i.e., that the immediate response in expenditures is reversed in later years. Copyright Springer Science+Business Media New York 2015

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  • Heléne Lundqvist, 2015. "Granting public or private consumption? Effects of grants on local public spending and income taxes," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 22(1), pages 41-72, February.
  • Handle: RePEc:kap:itaxpf:v:22:y:2015:i:1:p:41-72
    DOI: 10.1007/s10797-013-9279-7
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    More about this item

    Keywords

    Intergovernmental grants; Difference-in-difference model; Flypaper effect; C23; H71; H72; H77; R51;
    All these keywords.

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • 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
    • R51 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Regional Government Analysis - - - Finance in Urban and Rural Economies

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