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

Listed author(s):
  • Bev Dahlby
  • Ergete Ferede

    ()

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

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File URL: http://hdl.handle.net/10.1007/s10797-015-9352-5
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Article provided by Springer & International Institute of Public Finance in its journal International Tax and Public Finance.

Volume (Year): 23 (2016)
Issue (Month): 1 (February)
Pages: 114-139

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Handle: RePEc:kap:itaxpf:v:23:y:2016:i:1:p:114-139
DOI: 10.1007/s10797-015-9352-5
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