Resource Fungibility, the Flypaper Effect, and the Expenditure Impact of Grants-in-Aid

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Abstract
The typical assumption that intergovernmental grants-in-aid alter a recipient's budget constraint according to the legal provisions of grant programs was first challenged by McGuire (1975, 1978) in a model where local officials are able to convert some fraction of conditional aid into pure fungible resources. This paper develops a model of local government expenditure decisions based on McGuire's original work and applies it to data for large U.S. city governments. The results lend strong support to the fungibility hypothesis. Additionally, and importantly, the results provide very little evidence in support of the so-called "flypaper effect" of unconditional grants. This is due to a more appropriate specification of the unconditional aid variable.

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