Testing the Exogeneity of Grants to Local Governments

Muhammed N. Islam and Saud A. Choudhury

Canadian Journal of Economics, 1990, vol. 23, issue 3, 676-92

Abstract: This paper examines the issue of exogeneity of grants, both conditional and unconditional, with respect to local expenditures. The exogeneity (" weak," "strong," and "super") tests show that these grants are not exogenous. A model of fiscal response to endogenously determined grants is derived and tested on a pooled time-series and cross-section sample of forty-nine upper-tier municipalities in Ontario, 1977-84. The OLS and 2SLS estimates of reduced-form coefficients differ significantly, indicating a simultaneity between grants and expenditures. The estimated grant coefficients are negative significant and less than one, which implies a substitution of grant funds for own expenditures. Coefficient estimates of other socio-economic factors conform to standard results.

Date: 1990
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