Fiscal Illusion and the Grantor Government in Canada

Abstract

Recent work on the U.S. concludes that one or more illusions are responsible for the empirically observed “flypaper effect.” Using annual Canadian data for the period 1962–84, we test the “single‐illusion” and “dual‐illusion” specifications currently in the literature. While the empirical results support the dual‐illusion specification, it is not the unambiguous choice over single‐illusion specifications as previously found. Further, the nature of the grant system in Canada raises questions about whether illusions or real factors produce the empirical results.

The marginal cost of public funds and the flypaper effect

“…While Logan's estimate of the reduction in grantor government spending exceeds the amount predicted by our model, Hammes and Wills (1987) found that a one dollar increase in the Canadian federal government's transfers to the provinces reduced its spending in its own areas by 0.81 to 1.33, depending on the specification of the model. Similarly, Dollery and Worthington (1995) and Stewart (1996) found that increases in grants to the state governments in Australia reduced the Commonwealth government's expenditures on its own services.…”

Fiscal decentralization and government size: An extension

“…The existing theory of the impact of grants on recipient government expenditures argues that a 3 > 0 (see Gramlich, 1977, for a review of the literature and empirical evidence), while the literature on the impact of grants on grantor government expenditures suggests that a 3 < 0 (see Hammes and Wills, 1987;Hewitt, 1986;and Logan, 1986). As to the overall impact of grants, Grossman (1987) argues that an interest group theory of governments suggests a 3 > 0.…”

FISCAL ILLUSION AT THE LOCAL SPHERE: AN EMPIRICAL TEST OF THE FLYPAPER EFFECT USING SOUTH AFRICAN MUNICIPAL DATA1

“…Using the expenditure behaviour model of Logan (1986), Hammes and Wills (1987) argue that expansions in public expenditure caused by lump‐sum grant transfers reflects the spending behaviour of both recipient and grantor governments. Where lump sum transfers raise the perceived price of grantor government expenditures and lower the perceived price of recipient government expenditures, then such price changes will encourage individuals “over‐buying” of recipient government expenditures and “under‐buying” grantor government expenditures.…”