(Non)equivalence in a federalism: Dual tax shares, flypaper effects and Leviathan

Abstract

Among the best-known theorems of fiscal federalism is the presumed allocative and dis- tributive equivalence between a lump-sum grant to a collectivity and a set of lump sum grants to the members of a collectivity. Interestingly, the simple elegance of the theorem is at odds with ob- served behavior. Grants to governments produce greater public spending than does tax reduction. Explanations of this "flypaper effect" range from misspecified econometric modeling to pre- sumed behavior based on fiscal illusion. In this paper we show that theoretical equivalence exists in a model that recognizes only one tax share, the citizen voter's local tax share. When the model is expanded to include voters' federal tax shares as well as local taxes, non-equivalence and the flypaper effect become the rule, not the exception.