Local fiscal crises and intergovernmental grants: A suggested hypothesis

This paper seeks to relate the secular increase in intergovernmental grants to localities and the increasing appearance of actual, or potential, local fiscal crises. The hypothesis is that in a world of interpersonal benevolence both within and across jurisdictional boundaries where intergovernmental grants are made on the basis of need, individual governmental units rationally seek to reduce their production of services in order to obtain more increased fiscal aid. This may be accomplished, for example, by a locality overspending relative to its revenue resulting in future budget deficits and fiscal crises. The subsequent cutback in services and public employment then becomes the basis for increased aid. Such strategic behavior generates a non-optimal allocation of resources. Optimality can be restored by requiring that any increase in aid based on a locality's ‘need’ be divided equally over all localities. This policy also introduces an element of fiscal symmetry at the federal level. Copyright Martinus Nijhoff Publishers b.v. 1979