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Intergovernmental Grants

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Published in: Political Science
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Intergovernmental Grants are used in many countries however their implementation is complex. This presentation aims to break down those complexities.

Vatsala K / Delhi

7 years of teaching experience

Qualification: B. A. Honors - Economics

Teaches: English, Mathematics, Science, Business Studies, Economics

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  1. INTERGOVERNMENTAL GRANTS PUBLIC ECONOMICS Vatsala Khurana Economics Honors: B 1 30806
  2. INTRODUCTION "Intergovernmental grants are used in many countries to finance spending and to implement national policies. However, the governance of grants is complex, and practices vary widely across countries." • Intergovernmental Grants are grants/funds that flow from the central (federal) government to local authorities. • Grants are used for the purposes of financing and subsidization of services and for equalization of tax or service capacity. • The design of these transfers is of critical importance for efficiency and equity of local service provision and fiscal health of subnational governments. • What form should the grant take? This decision will be made by predicting the response of local authority to different kinds of grants. • Assumption: A local authority maximizes a utility function in the same way as would an individual in neoclassical microeconomic theory.
  3. INITIAL CASE PRIOR TO ANY GRANT ASSISTANCE Units of Y ICC 2 Units of X The relevant indifference curve would be that of a representative voter. To avoid any problem in cases of heterogeneous society, 'Majority of Rule' applies and we use the preferences of the median voter. This figure shows the initial budget constraint prior to any grant assistance. It limits possibilities between the good X and all other goods Y. The local authority seeks to maximize utility at E where IC is tangential to Budget Constraint and passes through ICC. In this diagram: On horizontal axis: Units of good X On vertical axis: Units of good Y IC I: Indifference Curve of the representative voter ICC: Income Consumption Curve of the representative voter
  4. TYPES OF INTERGOVERNMENTAL GRANTS Matching Grants Open-Ended Closed-Ended Conditional Non-Matching Grants Unconditonal
  5. NON MATCHING GRANTS Non Matching Grants: Grants that offer a given amount of funds without local matching. Non-matching grants may be either conditional (selective) or unconditional (general). • Conditional Non-matching Grants offer a given amount of funds without local matching, provided they are spent for a particular purpose. conditionality ensures that the recipient government's spending on the specified category will be at least equal to the amount of grant monies. • If the recipient is already spending an amount equal to grant funds, some or all of the grant funds may be diverted to other uses. In practice it is possible that the lumpiness of investments in areas such as infrastructure may result in increases in expenditures exceeding grants. In Unconditional Non-matching Grant, no constraints are put on how it is spent and no minimum expenditure in any area is expected. Since the grant can be spent on any combination of public goods or services or to provide tax relief to residents, general non- matching assistance does not modify relative prices Least stimulating of local spending.
  6. UNCONDITIONAL NON-MATCHING GRANT Unit* 3 7 Cc .6 Initially, the local authority with no grant aid chooses to be at 8. It pays taxes of 15 (in units of Y) and provides OXO of the publicly provided good. Lets say authority receives a grant of 3 1 . This will increase the total provision of the publicly available good. ICC: Income Consumption Curve is the locus of points showing the consumption bundles chosen at each of various levels of income. At the increased income The Budget constraint shifts to 34 and new equilibrium is established at El More of X is consumed but consumption of Y has also increased by the amount 57. The welfare has increased from 10 to Il 2 Units of X
  7. CONDITIONAL NON-MATCHING GRANT Units jcc Total amount received by the local authority must be spent on the consumption of good x. So the budget line becomes 154. Thus the maximum utility will be at point 5 Local authority would have shifted to El had there been no conditions The welfare is less than the previous case because 5 is on a lower Indifference Curve than 12 This is a result of spending more than the state would otherwise choose to spend on X Of X Figure 12.7 Conditional atching grant-
  8. MATCHING GRANTS Matching Grants: In the case of a matching grant the central government agrees to match a certain proportion of • • the expenditures of the local authority. The recipient must match the funds to some degree. Example: Government may pay X percent of the total cost of providing the service at the local level. Matching grants may be either open or closed Open ended Grants: There is no upper limit of the grant beyond which the central government will go. Closed ended Grants: Grants with a closed limit are called Closed ended Grants
  9. MATCHING OPEN ENDED GRANTS Other services Al 00 DAO PO P* For every unit spent by the state, a specified sum is spent by central authority. This makes the grant act like a subsidy for X. The slope of Budget Line changes and pivots As a result of Movement along the PCC Equilibrium shifts from AO to Al . OBI goods are now demanded. Bl Prioritized service
  10. MATCHING CLOSED ENDED GRANTS Ltnits I'CC Continuing from the previous case, an additional assumption here is that the government makes the upper limit of the grant depicted in the diagram as 25(in units So the budget line is 165. The budget line is kinked. The individual will choose to move from EO to El along ICC. Had the grant been equal to 28, the budget line becomes 1 78 and the consumer would have moved along PCC. 2 3
  11. INFERENCES • • Matching grant is generally more successful than a non matching grant in stimulating local expenditure on a particular service or good. However is general welfare has to be increased, non matching grant will be more successful.
  12. THE CASE OF INTERGOVERNMENTAL GRANTS • • • • • INTER-JURISDICTIONAL SPILLOVERS: These are external benefits for neighboring localities as a result of any jurisdiction's expenditures. The local authority takes no account in its decision making. If region R undertakes a program that creates spillover for region S, then optimal decision is set the provision of the good at the quantity when Marginal Benefit to residents of R + Marginal Benefit to residents of S = Marginal Cost of the program If spillovers are not included, then MBr = MC. In this case a subsidy provided at the rate MBr I(MBr+MBs) gives us the optimal point. Marginal Cost of expansion to R -MBs/(MBr+MBs)] PROMOTING A MERIT GOOD: On merit grounds the govt. may want to provide some particular service. For this it should choose open matching grants. Lump-sum grant can be used if it felt desirable. REVENUE SHARING: Central government may collect tax revenue on behalf of the local government and then return the revenue over to them. In this an unconditional grant would seem appropriate.
  13. • THE CASE OF INTERGOVERNMENTAL GRANTS Equalization: Some authorities may be unable to finance programs even though there would be an overall fiscal balance. The objective here is to close the fiscal gap between Wt revenue resources and expenditure responsibilities between different authorities. The reason could be based on considerations of equity or efficiency. Horizontal Equity: Individuals residing in high income state will gain more than the ones who aren't. Horizontal equity can be achieved by inter state transfers. Whether central government chooses to do so depends on value judgements. Efficiency: With labor mobility, inefficiency can arise from fiscal spending in different localities. Assume R is high income locality and S is low income locality. Marginal Rate of Product Mr & Ms On horizontal axis: total labor supply. If initially there is efficient allocation of resources, OrLO is labor in locality R and OsL0 in locality S. Marginal Products of labor equal at l. Now R revenue raised by taxes trshared to people by Ir.ln S there is nosuch revenue. The wage rate is Mr+ (tr/lr) Mr+ (tr/lr) Mt 2 3 Migration is there to the extent of LO to Ll . This leads to output loss by triangle 1 23 In locality s wages increase to compensate. But there is an equilibrium where marginal products of labor is unequal. Output is less than it should be and there is efficiency cost.
  14. THERE MAYBEA GOOD REASON TO UTILIZE INTERGOVERNMENTAL GRANTS AND THAT IN ORDER TO CHOOSEAPPROPRIATE GRANT IT IS NECESSARY TO SEE BOTH THE OBJECTIVEAND THE LIKELY RESPONSE OF THE LOCAL AUTHORITY TO THE GRANT. THANK YOU,
  15. COMPARISON BETWEEN UNCONDITIONAL NON-MATCHING GRANT & MATCHING OPEN ENDED GRANTS Units 4 1 The matching open ended grant will always lead the local authority to consume more of the publicly available good than in case of non matching closed ended grant. Unconditional Non matching grant acts as a lump-sum subsidy but Matching open ended is like a subsidy at every unit spent. For enabling the consumption of OX' , an unconditional grant of amount 14 must be given. The new equilibrium would be at E2. Unconditional Non-matching Grant has an income effect and shifts the budget constraint outward along the ICC. 2 5 3 Figure 12.8 Matching open-ended vent.

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