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The Impact of Intergovernmental Grants on Cost Efficiency: Theory and Evidence from German Municipalities

Author(s): Alexander Kalb

Journal: Economic Analysis and Policy
ISSN 0313-5926

Volume: 40;
Issue: 1;
Start page: 21;
Date: 2010;
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Keywords: Cost efficiency | Fiscal equalisation | Intergovernmental grants | Bureaucracy | Stochastic frontier analysis | German municipalities

In this paper we use a simple bureaucracy model of fiscal illusion to analyse the impact of intergovernmental grants on the cost efficiency of local jurisdictions. We find that a higher degree of redistribution within a system of fiscal equalisation or an increase in the amount of grants received by a local jurisdiction leads to an extension of organisational slack or X-inefficiency in that jurisdiction. This theoretical prediction is tested by conducting an empirical analysis using a broad panel of German municipalities. The results of the empirical analysis are consistent with the theoretical findings and therefore support the existence of a negative incentive effect of intergovernmental grants on local authorities' cost efficiency.
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