Local Government Responses to Permanent vs. Transitory Grant Revenue: Evidence from Indonesia

Abstract

I exploit unusual policy variation in Indonesia to examine how local responses to intergovernmental grants depend on their persistence. A national reform produced permanent increases in the general grant that were larger for less densely populated districts. Hydrocarbon-rich districts experienced transitory shocks to shared resource revenue. Public service delivery strongly responded to the permanent shock, but not to the transitory shocks, consistent with districts providing lumpy public services as a function of lifetime fiscal resources. I provide supporting evidence for this mechanism and rule out other potential mechanisms. I discuss implications for decentralization policy and research on taxation and accountability.