Unsticking the Flypaper Effect Using Distortionary Taxation

Carlos Vegh and Guillermo Vuletin

No 22304, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The flypaper effect is a widely-documented puzzle whereby the propensity of sub-national governmental units to spend out of unconditional transfers is higher than the propensity to spend out of private income. Building on previous insights in the literature that rationalize this puzzle using costly taxation, we develop a simple optimal fiscal policy model with distortionary taxation that generates two novel and testable implications: (i) there should be a positive association between the size of the flypaper effect and the level of the tax rate, and (ii) the flypaper effect should be larger the lower the elasticity of substitution between private and public spending and, in fact, should vanish for very high degrees of substitution. We show that these hypotheses hold for Argentinean provinces and Brazilian states.

JEL-codes: H21 H22 H41 H42 H62 H77 (search for similar items in EconPapers)
Date: 2016-06
New Economics Papers: this item is included in nep-pbe and nep-pub
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Published as Carlos A. Vegh y Guillermo Vuletin, 2016. "Unsticking the flypaper effect using distortionary taxation," Económica, Departamento de Economía, Facultad de Ciencias Económicas, Universidad Nacional de La Plata, vol. 62, pages 185-237, January-D.

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Journal Article: Unsticking the flypaper effect using distortionary taxation (2016)
Journal Article: Unsticking the flypaper effect using distortionary taxation (2016)
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