Intergovernmental Grants and Public Input Provision: Theory and Evidence from Germany

Abstract

This paper uses a simple model of fiscal competition between local jurisdictions to analyse the impact of intergovernmental grants on the composition of public spending. We find that a higher degree of redistribution within a system of fiscal equalisation coincides with a smaller overall share of spending on productivity-enhancing public inputs. Furthermore, in order to test the theoretical predictions, we carry out an empirical analysis based on a panel of German states. The results are consistent with the theoretical findings and support the existence of an incentive effect of intergovernmental grants on state expenditure policies.

Keywords: Fiscal competition, Fiscal equalisation, Intergovernmental grants, Public expenditure, Germany

JEL Classification: H72, H77