The flypaper effect: evidence from a natural experiment in Hesse

Baskaran, Thushyanthan (2012): The flypaper effect: evidence from a natural experiment in Hesse.

Abstract

Theory suggests that transfers should have an effect on local fiscal policy that is similar to an equivalent increase in local incomes. Yet much of the empirical literature shows that local governments use transfers primarily to increase expenditures. Recent contributions have revisited this so called flypaper effect by using quasi-experimental methods, and some have found that the evidence for the flypaper effect dissipates once endogeneity of transfer receipts is accounted for. This paper contributes to the growing body of quasi-experimental research on the flypaper effect by exploiting a natural experiment in the German state of Hesse. Using discontinuities in the Hessian municipal transfer allocation formula to construct a set of instruments for municipal transfer receipts during the 2001-2010 period, it provides strong evidence in favor of the flypaper effect.

• Item Type: MPRA Paper
• Language: English
• Keywords: Equalization transfers, Local fiscal policy, Population thresholds
• Subjects: H - Public Economics > H7 - State and Local Government ; Intergovernmental Relations > H70 - General; H - Public Economics > H7 - State and Local Government ; Intergovernmental Relations > H72 - State and Local Budget and Expenditures; H - Public Economics > H7 - State and Local Government ; Intergovernmental Relations > H71 - State and Local Taxation, Subsidies, and Revenue

References

Altonji, J., T. Elder, and C. Taber (2005a). An evaluation of instrumental variables strategies for estimating the effects of Catholic schools. Journal of Human Resources 40, 791–821.

Altonji, J., T. Elder, and C. Taber (2005b). Selection on observed and unobserved: assessing the effectiveness of Catholic schools. Journal of Political Economy 113, 151–184.

Angrist, J. D. and J.-S. Pischke (2009). Mostly harmless econometrics: an empiricist’s companion. Princeton University Press.

Baum, C. F., M. E. Schaffer, and S. Stillman (2002). IVREG2: Stata module for extended instrumental variables/2SLS and GMM estimation. Boston College Statistical Software Components S425401.

Bradford, D. and W. Oates (1971). Toward a predictive theory of intergovernmental grants. American Economic Review 61, 440–448.

Bucovetsky, S. (1998). Federalism, equalization and risk aversion. Journal of Public Eco- nomics 67, 301–328.

Buettner, T. (2006). The incentive effect of fiscal equalization transfers on tax policy. Journal of Public Economics 90(3), 477–497.

Dahlberg, M., E. Mörk, J. Rattso, and H. Agren (2008). Using a discontinous grant rule to identify the effect of grants on local taxes and spending. Journal of Public Economics 92, 2320–2335.

Egger, P., M. Köthenbürger, and M. Smart (2010). Do fiscal transfers alleviate business tax competition? Evidence from Germany. Journal of Public Economics 94, 235–246.

Gordon, N. (2004). Do federal grants boost school spending? Evidence from title I. Journal of Public Economics 88, 1771–1792.

Hadi, A. S. (1992). Identifying multiple outliers in multivariate data. Journal of the Royal Statistical Society, Series B 54, 761–771.

Hines, J. R. and R. H. Thaler (1995). Anomalies: the Flypaper Effect. The Journal of Economic Perspectives 9(4), 217–226.

Knight, B. (2002). Endogenous federal grants and crowd-out of state government spending: theory and evidence from the federal highway aid program. American Economic Review 92, 71–92.

Lenk, T. and H.-J. Rudolph (2003). Die kommunalen Finanzausgleichssysteme in der Bundesrepublik Deutschland. Mimeo (University of Leipzig).

Nickell, S. J. (1981). Biases in dynamic models with fixed effects. Econometrica 49(6), 1417–1426.