Intergovernmental Grants Impact on Tax Policy, Fiscal Stability and Political Economy

Intergovernmental grants are an important financial tool for funding subnational governments at the local, intermediate, and regional levels. These grants serve three main purposes: financing public services and investments, subsidizing services that may not be optimally provided, and equalizing public services with similar tax efforts. The upper tiers of government may provide grants to the lower tiers to help bridge the gap between tax and expenditure. Additionally, central governments may subsidize services in order to improve effectiveness, boost spending in priority areas, and/or address inter-jurisdictional externalities.

A paper On the Effects of Intergovernmental Grants provides an updated review of the impact of intergovernmental grants on tax policy, expenditure decisions, fiscal stability, behavioral choices, and the political economy, focusing on existing literature findings. The review analyzes the influence of intergovernmental grants on subnational budget constraints, incentive systems, and institutional settings. It emphasizes the important policy consequences of these grants on the effectiveness and fairness of decentralized fiscal systems. These findings can aid policymakers in comprehending the possible indirect effects of grant design, thus avoiding shortcomings and unforeseen issues. By categorizing grants based on funding sources and intended purposes, the paper provides a comprehensive analysis of how these grants impact government decision-making. Through case studies and examples, the paper also illustrates the consequences of the immediate spending of grant funds on tax and spending decisions, highlighting the need for balanced reactions. Furthermore, it explores how intergovernmental grants influence accountability and subnational autonomy within political institutions.

Read the full article (Open Access funding provided by the IReL Consortium): This work has been supported by the Spanish Ministry of Science and Innovation. On the Effects of Intergovernmental Grants. Manuel E. Lago, Santiago Lago-Peñas, and Jorge Martinez-Vazquez.