Fiscal illusion and the Australian local government grants process: How sticky is the flypaper effect?

Abstract

It has been argued that evidence supporting the widely documented flypaper effect is a statistical artefact; more specifically that previous studies are compromised by the use of inappropriate functional forms and the endogeneity of intergovernmental grant programs. Whilst the first issue may be resolved with careful econometric testing, the second requires the incorporation of institutional constraints into governmental expenditure equations. Combining Australian local government expenditure equations and intergovernmental grant parameters, the flypaper controversy is analysed. Empirical results confirm the sensitivity of the flypaper effect to specification, and tests of fit unambiguously favour one functional form. That specification yields no evidence of a flypaper effect in the Australian institutional milieu.