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The stimulative effects of intergovernmental grants and the marginal cost of public funds

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  • Bev Dahlby
  • Ergete Ferede

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Abstract

This paper tests the hypothesis that the stimulative effects of intergovernmental grants increase with the marginal cost of public funds of the recipient government. We present a simple theoretical framework that shows how a lump-sum transfer stimulates the marginal expenditures of a recipient government through an income effect and a price effect. We then test the prediction of this model using Canadian provincial data and exploit the discontinuity in the equalization grants allocation formula to identify the effects of grants. Our results indicate that the stimulative effects of lump-sum grants on spending increase with the provincial government’s marginal cost of public funds (MCF). One policy implication of our results is that higher intergovernmental transfers may be welfare improving if the federal government has a lower MCF than the provinces. Copyright Springer Science+Business Media New York 2016

Suggested Citation

  • Bev Dahlby & Ergete Ferede, 2016. "The stimulative effects of intergovernmental grants and the marginal cost of public funds," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 23(1), pages 114-139, February.
  • Handle: RePEc:kap:itaxpf:v:23:y:2016:i:1:p:114-139 DOI: 10.1007/s10797-015-9352-5
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    Cited by:

    1. Yihua Yu & Jing Wang & Xi Tian, 2016. "Identifying the Flypaper Effect in the Presence of Spatial Dependence: Evidence from Education in China's Counties," Growth and Change, Wiley Blackwell, vol. 47(1), pages 93-110, March.
    2. repec:spr:empeco:v:53:y:2017:i:2:d:10.1007_s00181-016-1123-3 is not listed on IDEAS
    3. M. Rose Olfert, 2016. "Regional Inequality and Decentralized Governance: Canada's Provinces," The Review of Regional Studies, Southern Regional Science Association, pages 201-222.

    More about this item

    Keywords

    Intergovernmental grants; Marginal cost of public funds; Flypaper effect; Fiscal federalism; H71; H72; H77;

    JEL classification:

    • 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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