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An empirical study of matching grants: The "cap on CAP"

Funding mechanisms for social expenditures are currently being reformed in many countries. While the theoretical implications of these changes are often easily identified, their empirical magnitude is not always as clear. For example, in federal systems social expenditure is often funded by matching grants, and estimates of the effect of varying matching rates on expenditures by sub-national governments vary widely. The ambiguity is due in part to inherent difficulties identifying price and income effects of federal grants given the structure of the funding mechanisms in most countries. In this paper, we examine a recent reform in Canada, in which federal grants for welfare expenditures were `capped' (converted from an open-ended to a closed-ended matching grant). Importantly, the cap applied to only three of ten provincial governments. Our empirical strategy exploits the time series-cross section variation in the funding mechanism provided by the differential application of the reform. This approach potentially surmounts some of the difficulties which have beset earlier studies. We find that the affected provinces did respond to the reform by reducing the growth rate of expenditures. They were 6 to 8 percentage points lower than predicted in the absence of the cap over the medium term.

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File URL: http://www.economics.utoronto.ca/public/workingPapers/UT-ECIPA-MSMART-98-03.ps
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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number msmart-98-03.

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Length: 30 pages
Date of creation: 11 Jun 1998
Date of revision:
Handle: RePEc:tor:tecipa:msmart-98-03
Contact details of provider: Postal: 150 St. George Street, Toronto, Ontario
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  1. James R. Hines & Richard H. Thaler, 1995. "The Flypaper Effect," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 217-226, Fall.
  2. Edward M. Gramlich & Henry J. Aaron & Michael C. Lovell, 1982. "An Econometric Examination of the New Federalism," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 13(2), pages 327-370.
  3. Moffitt, Robert A., 1984. "The effects of grants-in-aid on state and local expenditures : The case of AFDC," Journal of Public Economics, Elsevier, vol. 23(3), pages 279-305, April.
  4. Peltzman, Sam, 1992. "Voters as Fiscal Conservatives," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 327-61, May.
  5. Howard Chernick, 1998. "Fiscal Effects of Block Grants for the Needy: An Interpretation of the Evidence," International Tax and Public Finance, Springer, vol. 5(2), pages 205-233, May.
  6. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  7. Moffitt, Robert, 1990. "Has State Redistribution Policy Grown More Conservative?," National Tax Journal, National Tax Association, vol. 43(2), pages 123-42, June.
  8. Lindert, Peter H., 1996. "What Limits Social Spending?," Explorations in Economic History, Elsevier, vol. 33(1), pages 1-34, January.
  9. Edward M. Gramlich & Deborah S. Laren, 1984. "Migration and Income Redistribution Responsibilities," Journal of Human Resources, University of Wisconsin Press, vol. 19(4), pages 489-511.
  10. Becker, Gary S, 1983. "A Theory of Competition among Pressure Groups for Political Influence," The Quarterly Journal of Economics, MIT Press, vol. 98(3), pages 371-400, August.
  11. Borcherding, Thomas E., 1985. "The causes of government expenditure growth: A survey of the U.S. evidence," Journal of Public Economics, Elsevier, vol. 28(3), pages 359-382, December.
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