Economics 151 The Economics of the Public Sector: Expenditure

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Economics 151 The Economics of the Public
SectorExpenditure

• Professor Nora Gordon
• Fall 2004
• Lecture 21

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Outline for today

• Intergovernmental grants
• Matching grants
• Block grants
• Conditional block grants
• How do grants affect spending?
• The flypaper effect

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Towns budget constraint with and without
matching grants
Exp on pvt goods
Y total income in the town
Y
BC with no matching grant
Exp on educ
Y
1.5Y
BC with 50 match
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Income and substitution effects of matching grants
Exp on pvt goods
Y total income in the town
Y
BC with no matching grant
BC with 300 match
Exp on educ
Y
4Y
5
Block grants
Exp on pvt goods
Y total income in the town
YBG
Y
Exp on educ
E1
E2
Y
YBG
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Conditional block grants
Exp on pvt goods
Y total income in the town
YBG
Y
Exp on educ
E1
Y
YBG
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The flypaper effect
Exp on pvt goods
Y total income in the town
YBG
Y
Exp on educ
E1
E2
Y
YBG
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The flypaper effect

• We expect to see new education spending E2
• Much research finds levels closer to E3 than to
  E2
• The grant disproportionately sticks to
  education spending.

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Source Hines and Thaler (1995).
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Why are grants so sticky?

• Bureaucrats vs. median voter?
• Requires information asymmetry
• Voters are not economists!
• They do not think of money as fungible
• They care about direct costs more than
  opportunity costs
• Grants disproportionately go to places that want
  to spend them

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Source Hines and Thaler (1995).
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Is the flypaper effect real?

• Depends if the size of the grant is correlated
  with preferences for public spending
• Knight (1999) looks at this with federal highway
  aid to states
• Looks like highway grants transfer into highway
  spending dollar for dollar
• But states with randomly larger highway grants
  spend only about 0.10 of a 1 grant on highways