Theories of Grant Utilization
Economic theory can help illuminate when and where a specific characteristic of a grant is most useful and appropriate. Lump-sum and matching grants tend to produce different incentives for grant recipients. The effects of lump-sum and matching intergovernmental grants on the recipient government's decision making are influenced by two factors: the income effect and the substitution effect. The additional income from a lump-sum grant will cause the demand curve to shift out as shown in Figure 2.3. The price of additional goods or services remains at P1, but the additional funds from the lump-sum grant increase the amount of the good or service from E0 to E1. The additional funds allow the government to provide more of the good or service than it could otherwise and is referred to as the income effect.
A jurisdiction will find that a matching grant will reduce the marginal price of the good or service resulting in a new price, P2, and the amount of goods or services demanded will increase from E0 to E2. Like the lump-sum grant, the matching grant also has an income effect. That is, the cost of providing
- Figure 2.3 Income and substitution effects of a grant.
the good or service is reduced by the grant's matching portion and thus the income effect is realized. However, as Figure 2.3 shows, matching grants tend to be more stimulative than lump-sum grants. This is due to the substitution effect that accompanies a matching grant. The substitution effect results when the price of one good or service is reduced relative to other goods and services. As the price falls relative to other prices, there is an incentive to shift expenditures of other more expensive goods and services to the now less expensive good or service subsidized by the matching grant. Hence, grants utilizing matching funds tend to be more stimulative than lump-sum grants.
When grants are utilized to correct for inefficiencies because of an externality or spillover, conditional matching grants in the amount of the externality are generally considered the most appropriate means to correct the inefficiency. However, before resorting to grants, using a voluntary collective action should be explored. Often both positive and negative externality issues can be resolved voluntarily through contractual arrangements (Coase, 1960).
As discussed previously, grants also are utilized to correct for fiscal inequalities across jurisdictions. Thus, matching grants can be utilized to equalize revenue capacity. By applying matching grants to revenues raised by poorer jurisdictions, a central government can equalize revenue capacity (Feldstein, 1975; Nechyba, 1996).
Still, lump-sum grants from the central government to decentralized jurisdictions generally are the preferred approach for creating equalization across fiscally diverse jurisdictions. Although the United States does not make extensive use of lump-sum grants for equalization purposes, many other countries (including Canada, Germany, and Australia) utilize these grants as a major component of their intergovernmental finances (Oates, 1999). Often the question asked is whether these central government grants actually enhance the recipient jurisdiction's service or merely lower that jurisdiction's tax rate by using the grant to offset taxes. This logic is referred to as the "veil hypothesis," which argues that a grant from a central government to a local government is really nothing more than a veil for a central government tax cut. However, current evidence has found that an additional $1 lump-sum grant has a greater expenditure effect than a $1 increase in individual incomes. This has been referred to as the "flypaper effect" in that grant money tends to stick in the public sector.
Whether a grant is conditional or unconditional may have less impact than expected. One study has shown that welfare and educational grants do increase expenditures in those areas, but also have the effect of increasing expenditures in other areas — including a decrease in state taxes (Craig and Inman, 1985). This is due to the "leakage" of grant monies from the targeted area to other areas. When jurisdictions receive lump-sum grants, they often allocate fewer funds to the targeted area than they would have without the grant. Conditional grants are indeed fungible, with a high likelihood that funds will be shifted away from areas with grant receipts and toward areas without them.
Average user rating: 5 stars out of 1 votes
Post a comment