Unsticking the Flypaper Effect Using Distortionary Taxation

Abstract

El efecto "flypaper" es un enigma ampliamente documentado que se refiere al hecho de que los gobiernos sub-nacionales poseen una propensión al gasto de transferencias no condicionales que es mayor que la propensión al gasto de los ingresos privados. Basándonos en enfoques de la literatura previa que racionalizan este enigma a partir de la existencia de costos asociados con la recaudacion impositiva, desarrollamos un modelo simple de política fiscal óptima con impuestos distorsionantes que genera dos implicancias novedosas y testeables: (i) debería existir una asociación positiva entre el grado del efecto "flypaper" y el nivel de la tasa impositiva; y (ii) el efecto "flypaper" debería ser mayor cuanto menor sea la elasticidad de sustitución entre el gasto público y privado y, de hecho, debería desaparecer para altos grados de sustitución. Mostramos que estas hipótesis se cumplen tanto para las provincias argentinas como para los estados brasileños. Clasificación JEL: H62, H77, H21, H22, H41, H42. Palabras clave: efecto "flypaper", impuestos distorsionantes, tasas impositivas, sustituibilidad entre gasto privado y público, congestión de bienes públicos. ABSTRACTThe flypaper effect is a widely-documented puzzle whereby the propensity of subnational 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 policymodel with distortionary taxation that generates two novel and testable implications: (i) there should be a positive association between the degree 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. JEL Classification: H62, H77, H21, H22, H41, H42. Keywords: flypaper effect, distortionary taxation, tax rates, substitutability between private and public spending, congestion of public goods.

The stimulative effects of intergovernmental grants and the marginal cost of public funds

“…They use differences in local employment as a proxy to the MCF. Végh and Vuletin (2010) also test whether the flypaper effects are larger when the recipient governments' taxes are more distortionary using data on gross receipts tax rates and residential property tax rates for Argentinean provinces and 28 American cities. They split their samples into provinces/cities with tax rates above and below the median and they find that the flypaper effect is about 40 percent larger in the provinces/cities with higher tax rates.…”

The flypaper sticks even when aid travels overseas

“…Among the many theories proposed, one class suggests that the flypaper effect arises from inefficiencies related to government revenue collections (Dahlby 2011;Dahlby and Ferede 2016;Hamilton 1986;Sepulveda 2012;Vegh and Vuletin 2016). 2 Within the contributions to that strand of the literature, we use the general results in Dahlby (2011) as the basis for our model, and we include a simple representation of possible political regimes.…”

Political budget cycles and voting within a federal country: The influence of political alignment

“…Provinces that on average receive more federal funds might have less incentives to spend in the margin than the rest. In this regard, Végh and Vuletin (2014) explain the flypaper effect (by which the propensity to spend out of unconditional federal transfers is much larger than the propensity to spend out of local income) through distortionary taxation. They find that this effect is larger for spending categories that are pure public goods and non-existent for T A B L E 4 Budget balance as a share of potential GGP Chi−2 (df) 503.9 (12) 281.1 (11) 494.4 (13) 537.0 (15) Note: We report estimations of Equation (18).…”