IDEAS home Printed from https://ideas.repec.org/a/taf/rjapxx/v30y2025i1p243-264.html
   My bibliography  Save this article

Federal transfers and sub-national spending in India: an analysis of the stimulatory effect

Author

Listed:
  • A. M. Suha
  • P. S. Renjith

Abstract

This study empirically examines the stimulatory effect of federal transfers in India using a panel dataset of 21 states for the period 2005–06 to 2019–20. In mapping the stimulus effect, we test the validity of the ‘extended flypaper effect’, where lumpsum federal transfers tend to increase the state’s public spending more than a corresponding increase in its own revenue and borrowing resources. The results suggest that the marginal effects of state own-source revenues and borrowing on India’s sub-national non-capital expenditure outweigh those of federal transfers. Therefore, the existence of flypaper effects at the sub-national level in India cannot be ruled out. However, at the disaggregate level, 10 of 21 states report a stimulatory effect of lumpsum federal transfers on state spending. Of these, nine states are mapped to the capital expenditure account and one state to the revenue account. The empirical results also reveal the presence of fiscal illusion i.e., the systematic misperception of fiscal parameters. While the fiscal illusion produced by federal transfers is not a concern, the debt-driven fiscal illusion is worrisome in India as most states’ non-development revenue expenditure is fuelled by borrowed money. Hence corrective action is needed to find a strategy of optimal mix of three stimulus factors for these states namely states’ own revenue, federal transfers and state borrowing.

Suggested Citation

  • A. M. Suha & P. S. Renjith, 2025. "Federal transfers and sub-national spending in India: an analysis of the stimulatory effect," Journal of the Asia Pacific Economy, Taylor & Francis Journals, vol. 30(1), pages 243-264, January.
    • Handle: RePEc:taf:rjapxx:v:30:y:2025:i:1:p:243-264
    DOI: 10.1080/13547860.2023.2199620
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1080/13547860.2023.2199620
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1080/13547860.2023.2199620?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Hamilton, Jonathan H., 1986. "The flypaper effect and the deadweight loss from taxation," Journal of Urban Economics, Elsevier, vol. 19(2), pages 148-155, March.
    2. Bruno Heyndels, 2001. "Asymmetries in the flypaper effect: empirical evidence for the Flemish municipalities," Applied Economics, Taylor & Francis Journals, vol. 33(10), pages 1329-1334.
    3. Asharani Samal, 2020. "An Empirical Analysis of Asymmetry and Threshold Effect of Intergovernmental Grants in India: A Panel Data Analysis," Global Business Review, International Management Institute, vol. 21(2), pages 458-472, April.
    4. Hazarika, Bhabesh & Nayak, Dinesh Kumar, 2022. "Fiscal Illusion and Wagner's Law: Evidence from Indian Subnational Finances," Working Papers 22/367, National Institute of Public Finance and Policy.
    5. Worthington, Andrew C & Dollery, Brian E, 1999. "Fiscal Illusion and the Australian Local Government Grants Process: How Sticky Is the Flypaper Effect?," Public Choice, Springer, vol. 99(1-2), pages 1-13, April.
    6. Turnbull, Geoffrey K. & Niho, Yoshio, 1986. "The optimal property tax with mobile nonresidential capital," Journal of Public Economics, Elsevier, vol. 29(2), pages 223-239, March.
    7. Steven C. Deller & Craig S. Maher, 2006. "A Model of Asymmetries in the Flypaper Effect," Publius: The Journal of Federalism, CSF Associates Inc., vol. 36(2), pages 213-229.
    8. Heyndels, Bruno & Smolders, Carine, 1994. "Fiscal Illusion at the Local Level: Empirical Evidence for the Flemish Municipalities," Public Choice, Springer, vol. 80(3-4), pages 325-338, September.
    9. Gamkhar, Shama & Oates, Wallace E., 1996. "Asymmetries in the Response to Increases and Decreases in Intergovernmental Grants: Some Empirical Findings," National Tax Journal, National Tax Association, vol. 49(4), pages 501-12, December.
    10. Ergete Ferede, 2014. "The Incentive Effects of Equalization Grants on Fiscal Policy," SPP Research Papers, The School of Public Policy, University of Calgary, vol. 7(23), September.
    11. Shama Gamkhar & Wallace Oates & Shama Gamkhar & Wallace Oates, 2004. "Asymmetries in the Response to Increases and Decreases in Intergovernmental Grants: Some Empirical Findings," Chapters, in: Environmental Policy and Fiscal Federalism, chapter 15, pages 261-272, Edward Elgar Publishing.
    12. Lekha Chakraborty & Pinaki Chakraborty, 2018. "Federalism, fiscal asymmetries and economic convergence: evidence from Indian States," Asia-Pacific Journal of Regional Science, Springer, vol. 2(1), pages 83-113, April.
    13. Prasant Kumar Panda & Velan Nirmala, 2013. "Central Fiscal Transfers and States' Spending In India: An Analysis of Incentive Effect," Economics Bulletin, AccessEcon, vol. 33(2), pages 1229-1246.
    14. Becker, Elizabeth, 1996. "The Illusion of Fiscal Illusion: Unsticking the Flypaper Effect," Public Choice, Springer, vol. 86(1-2), pages 85-102, January.
    15. Singh, Nirvikar, 2008. "Decentralization and Public Delivery of Health Care Services in India," MPRA Paper 7869, University Library of Munich, Germany.
    16. Melo, Ligia, 2002. "The Flypaper Effect under Different Institutional Contexts: The Colombian Case," Public Choice, Springer, vol. 111(3-4), pages 317-345, June.
    17. Shah, Anwar, 2004. "Fiscal decentralization in developing and transition economies: progress, problems, and the promise," Policy Research Working Paper Series 3282, The World Bank.
    18. Pedro Henrique Martins Prado & Cleomar Gomes da Silva, 2020. "Wagner’s Law and Fiscal Illusion: An analysis of state government finances in Brazil," Review of Development Economics, Wiley Blackwell, vol. 24(2), pages 628-643, May.
    19. Rodden, Jonathan, 2003. "Reviving Leviathan: Fiscal Federalism and the Growth of Government," International Organization, Cambridge University Press, vol. 57(4), pages 695-729, October.
    20. Mark Schneider & Byung Ji, 1987. "The flypaper effect and competition in the local market for public goods," Public Choice, Springer, vol. 54(1), pages 27-39, January.
    21. Korzhenevych, Artem & Langer, Sebastian, 2016. "The Flypaper Effect in Germany: An East-West Comparison," CEPIE Working Papers 10/16, Technische Universität Dresden, Center of Public and International Economics (CEPIE).
    22. Ajit Karnik & Mala Lalvani, 2005. "Urban Local Governments and the Flypaper Effect: Evidence from Maharashtra, India," Publius: The Journal of Federalism, CSF Associates Inc., vol. 35(2), pages 273-295, Spring.
    23. Olmsted, George M. & Denzau, Arthur T. & Roberts, Judith A., 1993. "We voted for this? : Institutions and educational spending," Journal of Public Economics, Elsevier, vol. 52(3), pages 363-376, October.
    24. Deller, Steven C. & Walzer, Norman, 1995. "Structural Shifts in the Treatment of Intergovernmental Aid: The Case of Rural Roads," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 27(2), pages 522-535, December.
    25. Laura Sour, 2013. "The flypaper effect in Mexican local government," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 28(1), pages 165-186.
    26. Quigley, John M & Smolensky, Eugene, 1992. "Conflicts among Levels of Government in a Federal System," Public Finance = Finances publiques, , vol. 47(Supplemen), pages 202-215.
    27. Hammed Amusa & Robert Mabunda & Ramos Mabugu, 2008. "Fiscal Illusion At The Local Sphere: An Empirical Test Of The Flypaper Effect Using South African Municipal Data1," South African Journal of Economics, Economic Society of South Africa, vol. 76(3), pages 443-465, September.
    28. Oates, Wallace E., 2008. "On the Evolution of Fiscal Federalism: Theory and Institutions," National Tax Journal, National Tax Association;National Tax Journal, vol. 61(2), pages 313-334, June.
    29. Levaggi, Rosella & Zanola, Roberto, 2003. "Flypaper Effect and Sluggishness: Evidence from Regional Health Expenditure in Italy," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 10(5), pages 535-547, September.
    30. Bruno Heyndels & Frank Van Driessche, 1998. "Mental Accounting in Local Public Sector Budgeting: An Empirical Analysis for the Flemish Municipalities," Eastern Economic Journal, Eastern Economic Association, vol. 24(4), pages 381-394, Fall.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Manuel E. Lago & Santiago Lago-Peñas & Jorge Martinez-Vazquez, 2024. "On the effects of intergovernmental grants: a survey," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 31(3), pages 856-908, June.
    2. Leonel Muinelo-Gallo, 2021. "Testing regional intergovernmental transfers effects in Uruguay," Sobre México. Revista de Economía, Sobre México. Temas en economía, vol. 2(4), pages 6-38.
    3. Laura Sour, 2013. "The flypaper effect in Mexican local government," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 28(1), pages 165-186.
    4. 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.
    5. Phuong Nguyen-Hoang & Yilin Hou, 2014. "Local Fiscal Responses to Procyclical Changes in State Aid," Publius: The Journal of Federalism, CSF Associates Inc., vol. 44(4), pages 587-608.
    6. Steven C. Deller & Craig S. Maher, 2006. "A Model of Asymmetries in the Flypaper Effect," Publius: The Journal of Federalism, CSF Associates Inc., vol. 36(2), pages 213-229.
    7. Luiz de Mello, 2007. "Local Government Finances: The Link between Intergovernmental Transfers and Net Worth," OECD Economics Department Working Papers 581, OECD Publishing.
    8. Juan González Alegre, 2012. "An evaluation of EU regional policy. Do structural actions crowd out public spending?," Public Choice, Springer, vol. 151(1), pages 1-21, April.
    9. Muinelo-Gallo, Leonel & Azar, Paola, 2018. "Testing regional intergovernmental transfers asymmetries in Uruguay," MPRA Paper 90245, University Library of Munich, Germany.
    10. Asharani Samal, 2020. "An Empirical Analysis of Asymmetry and Threshold Effect of Intergovernmental Grants in India: A Panel Data Analysis," Global Business Review, International Management Institute, vol. 21(2), pages 458-472, April.
    11. Pablo Acosta, 2010. "The “flypaper effect” in presence of spatial interdependence: evidence from Argentinean municipalities," The Annals of Regional Science, Springer;Western Regional Science Association, vol. 44(3), pages 453-466, June.
    12. Ines Helm & Jan Stuhler, 2024. "The Dynamic Response of Municipal Budgets to Revenue Shocks," American Economic Journal: Applied Economics, American Economic Association, vol. 16(4), pages 484-527, October.
    13. Santiago Lago-Peñas, 2008. "Local Governments' Asymmetric Reactions to Grants," Public Finance Review, , vol. 36(2), pages 219-242, March.
    14. Vittoria Idrisova & Lev Freinkman, 2010. "Impact of Federal Transfers over Regional Authorities Behavior," Research Paper Series, Gaidar Institute for Economic Policy, issue 137P.
    15. Sangsoo Lim & Sanghoon Lee & Pilhyun Kim, 2017. "Asymmetry in the fly-paper effect of the national subsidy in Korea," Journal of the Asia Pacific Economy, Taylor & Francis Journals, vol. 22(4), pages 560-574, October.
    16. Thushyanthan Baskaran, 2016. "Intergovernmental Transfers, Local Fiscal Policy, and the Flypaper Effect: Evidence from a German State," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 72(1), pages 1-40, March.
    17. Elena Gennari & Giovanna Messina, 2014. "How sticky are local expenditures in Italy? Assessing the relevance of the flypaper effect through municipal data," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 21(2), pages 324-344, April.
    18. Cristian F. Sepúlveda, 2017. "Flypaper effect, intergovernmental transfers, income and substitution effects, marginal cost of public funds," Hacienda Pública Española / Review of Public Economics, IEF, vol. 222(3), pages 91-108, September.
    19. José Marcelo Torres Ortega & Jorge Mario Ortega De la Rosa, 2022. "Flypaper Effect: The Colombian Municipalities Case for 2000-2017," Lecturas de Economía, Universidad de Antioquia, Departamento de Economía, issue 97, pages 79-111, July-Dece.
    20. 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.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:taf:rjapxx:v:30:y:2025:i:1:p:243-264. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Longhurst (email available below). General contact details of provider: http://www.tandfonline.com/rjap .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.