American Economic Review: Vol. 92 No. 1 (March 2002)
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Endogenous Federal Grants and Crowd-out of State Government Spending: Theory and Evidence from the Federal Highway Aid Program
Knight, Brian. 2002. "Endogenous Federal Grants and Crowd-out of State Government Spending: Theory and Evidence from the Federal Highway Aid Program ." American Economic Review, 92(1): 71-92.
Contrary to simple theoretical predictions, existing evidence suggests that federal grants do not crowd out state government spending. A legislative bargaining model with endogenous grants documents a positive correlation between grant receipts and preferences for public goods; this correlation has likely biased existing work against measuring crowd-out. To correct for such endogeneity, the model motivates instruments based on the political power of state congressional delegations. Exploiting this exogenous variation in grants, the instrumental variables estimator reports crowd-out that is statistically and economically significant. This endogeneity may explain the flypaper effect, a nonequivalence between grant receipts and private income. (JEL D70, H40, H77)
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Knight, Brian (Federal Reserve Board, Washington DC, 20551, US)