The Effects of Grants and the Marginal Cost of Public Funds: Evidence from Brazilian States
AbstractThe flypaper effect is the empirical anomaly by which intergovernmental grants tend to be transformed by recipient authorities into public expenditures at a considerably higher rate than local private resources. The objective of this research is to detect the existence and investigate the causes of the flypaper effect in the Brazilian states. Panel data evidence from 27 Brazilian states from 1985 to 2010 indicates the existence of a large flypaper effect, with an estimated impact of grants on public expenditures. Considering there are some ways to calculate MCF proxies, first, an autonomous index was used as a proxy of the marginal cost of public funds (MCF), because it represents how much the municipality can survive by itself, representing the municipalities’ independency to federal grants. Second, the MCF was calculated by the derivation of Proper Tax Revenue to the Total Revenues. The results show that the stimulative effect of grants on public spending increases with the MCF in both proxies, but it was stronger in the autonomous index proxy, in convergence to results of  to Canadian provincial data.
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