The Dynamic Response of Municipal Budgets to Revenue Shocks
American Economic Journal: Applied Economics (Forthcoming)
We study the fiscal and tax response to intergovernmental grants, exploiting
quasi-experimental variation within Germany’s fiscal equalization scheme triggered
by Census revisions of population counts. Municipal budgets do not adjust instantly.
Instead, spending and investments adapt within five years to revenue gains, while
the adjustment to losses is more rapid. Yet, the long-run response is symmetric.
The tax response is particularly slow, stretching over more than a decade. Wellknown
empirical “anomalies” such as the so-called flypaper effect may thus reflect
a short-run phenomenon, while long-run fiscal behavior appears more consistent
with standard theories of fiscal federalism.