Do Fiscal Transfers Stick under Fiscal Stress? Evidence of the Flypaper Effect from Manipur, North-Eastern Region of India

This paper investigates the flypaper effect in India s North-Eastern Region (NER), focusing on Manipur, a state marked by persistent structural dependence on central fiscal transfers due to geographic isolation, a narrow tax base, ethnic diversity, and historically embedded arrangements such as Special Category Status and concessional plan assistance. Despite successive fiscal reforms, the NER remains heavily reliant on intergovernmental transfers, raising concerns about fiscal autonomy and expenditure incentives. Drawing on fiscal federalism theory, the study tests whether subnational expenditure responds more strongly to central transfers than to equivalent increases in own revenue (the flypaper effect) and examines whether this asymmetry reflects costly local taxation as hypothesised by Hamilton (1986). The analysis uses annual data from 1987 2023 drawn from the Reserve Bank of India, Union Budget documents, and the Ministry of Statistics and Programme Implementation. Augmented Dickey Fuller and Engle Granger tests indicate that all variables are integrated of order one with no evidence of cointegration, justifying first-difference estimation. The first-difference log-linear Ordinary Least Square models reveal a pronounced and robust flypaper effect: central grants exhibit significantly larger expenditure response than own revenue across aggregate and disaggregated spending categories. Tax devolution also stimulates expenditure but with smaller magnitudes than untied grants, particularly for capital outlays. Fiscal deficits positively supplement expenditure, suggesting borrowing finances both current and investment spending. Extending the empirical specification to include fiscal effort as a proxy for Hamilton s (1986) costly taxation hypothesis yields statistically insignificant coefficients in the first-difference log log estimations, indicating the absence of disciplining effect of local tax mobilisation on expenditure growth. However, grant dependence negatively affects total expenditure growth, suggesting that entrenched reliance on transfers constrains long-run fiscal flexibility despite short-run stimulative effects from grant inflows. These findings highlight institutional constraints in fragile regions: while transfers sustain public provision amid weak own-revenue capacity, they crowd out incentives for mobilisation and perpetuate dependence, with implications for fiscal sustainability and decentralisation efficacy in developing federations. The pronounced flypaper effect in capital spending underscores transfers role in infrastructure financing but raises concerns about discretionary autonomy in politically complex settings.