Grants and marginal cost of public funding: Empirical evidence for local governments in Brazil

Resumo

This paper documents empirical evidence on price-effect caused by unconditional transfers for local governments in Brazil. Dahlby (2011) demonstrates theoretically that lump-sum transfers can reduce the cost of public goods provision (price-effect), in addition to the traditional income effect. Our contributions are threefold. First, we estimate the effects off tax rate changes on tax base. More important, we calculate the marginal cost of public funding (MCF) regarding the local tax imposed on the supply of services (ISS). Third, we control for potential simultaneity between unconditional transfers and local tax revenue in a two-stage least square approach using instrumental variables. Our price-effect estimation for tertiary sector tax suggests that a 10% increase in the amount of unconditional transfers resources reduces the local price effect (MCF) around 0.01%.