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The Marginal Cost of Public Funds and the Flypaper Effect

  • Dahlby, Bev

    ()

    (University of Alberta, Department of Economics)

A lump-sum intergovernmental transfer has a "price effect", as well as an "income effect", because it allows the recipient government to reduce its tax rate, which lowers its marginal cost of public funds, while still providing the same level of public service. This reduction in the effective price of providing the public service helps to explain the "flypaper effect" - the empirical observation that a lump-sum grant has a much larger effect on spending than an increase in personal income. Contrary to the assertions of Mieszkowski (1994) and Hines and Thaler (1995), a model of a benevolent local government financing its expenditures with a distortionary tax predicts flypaper effects from lump-sum grants that are similar to those observed in many econometric studies

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File URL: http://www.ualberta.ca/~econwps/2009/wp2009-17.pdf
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Paper provided by University of Alberta, Department of Economics in its series Working Papers with number 2009-17.

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Length: 31 pages
Date of creation: Jan 2009
Date of revision: 01 Jun 2010
Handle: RePEc:ris:albaec:2009_017
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  1. Andrew Haughwout & Robert Inman & Steven Craig & Thomas Luce, 2004. "Local Revenue Hills: Evidence from Four U.S. Cities," The Review of Economics and Statistics, MIT Press, vol. 86(2), pages 570-585, May.
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  3. Craig Volden, 2007. "Intergovernmental Grants: A Formal Model of Interrelated National and Subnational Political Decisions," Publius: The Journal of Federalism, Oxford University Press, vol. 37(2), pages 209-243, Spring.
  4. Bailey, Stephen J & Connolly, Stephen, 1998. " The Flypaper Effect: Identifying Areas for Further Research," Public Choice, Springer, vol. 95(3-4), pages 335-61, June.
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  9. Peter C. Coyte & Stuart Landon, 1990. "Cost-Sharing versus Block-Funding in a Federal System: A Demand Systems Approach," Canadian Journal of Economics, Canadian Economics Association, vol. 23(4), pages 817-38, November.
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  12. Gary S. Becker & Casey B. Mulligan, 1998. "Deadweight Costs and the Size of Government," NBER Working Papers 6789, National Bureau of Economic Research, Inc.
  13. Lars-Erik Borge, 1995. "Lump-Sum Intergovernmental Grants Have Price Effects: a Note," Public Finance Review, , vol. 23(2), pages 271-274, April.
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  15. Roemer, John E & Silvestre, Joaquim, 2002. " The "Flypaper Effect" Is Not an Anomaly," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 4(1), pages 1-17.
  16. Bev Dahlby, 2008. "The Marginal Cost of Public Funds: Theory and Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262042509, June.
  17. Baker, Michael & Payne, A. Abigail & Smart, Michael, 1999. "An empirical study of matching grants: the 'cap on CAP'," Journal of Public Economics, Elsevier, vol. 72(2), pages 269-288, May.
  18. 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.
  19. Stewart, Mark F, 1996. "Fiscal Illusion (the Flypaper Effect) and Government Spending in Australia," Australian Economic Papers, Wiley Blackwell, vol. 35(67), pages 390-96, December.
  20. Michael Smart, 1998. "Taxation and Deadweight Loss in a System of Intergovernmental Transfers," Canadian Journal of Economics, Canadian Economics Association, vol. 31(1), pages 189-206, February.
  21. Dahlby, Bev, 2009. "The Optimal Taxation Approach to Intergovernmental Grants," Working Papers 2009-16, University of Alberta, Department of Economics.
  22. Dollery, Brian E & Worthington, Andrew C, 1996. " The Empirical Analysis of Fiscal Illusion," Journal of Economic Surveys, Wiley Blackwell, vol. 10(3), pages 261-97, September.
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