Unsticking the Flypaper Effect Using Distortionary Taxation

38 Pages Posted: 7 Jun 2016

See all articles by Carlos A. Vegh

Carlos A. Vegh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS); University of Maryland - Department of Economics; University of California at Los Angeles; National Bureau of Economic Research (NBER)

Guillermo Vuletin

Brookings Institution

Date Written: June 2016

Abstract

The flypaper effect is a widely-documented puzzle whereby the propensity of sub-national governmental units to spend out of unconditional transfers is higher than the propensity to spend out of private income. Building on previous insights in the literature that rationalize this puzzle using costly taxation, we develop a simple optimal fiscal policy model with distortionary taxation that generates two novel and testable implications: (i) there should be a positive association between the size of the flypaper effect and the level of the tax rate, and (ii) the flypaper effect should be larger the lower the elasticity of substitution between private and public spending and, in fact, should vanish for very high degrees of substitution. We show that these hypotheses hold for Argentinean provinces and Brazilian states.

Suggested Citation

Vegh, Carlos A. and Vuletin, Guillermo, Unsticking the Flypaper Effect Using Distortionary Taxation (June 2016). NBER Working Paper No. w22304, Available at SSRN: https://ssrn.com/abstract=2790701

Carlos A. Vegh (Contact Author)

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS) ( email )

1740 Massachusetts Avenue, NW
Washington, DC 20036-1984
United States

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States

University of California at Los Angeles ( email )

Box 951477
Los Angeles, CA 90095-1477
United States
310-825-7371 (Phone)
310-825-9528 (Fax)

HOME PAGE: http://vegh.sscnet.ucla.edu

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Guillermo Vuletin

Brookings Institution ( email )

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
6
Abstract Views
189
PlumX Metrics