The paper is based on a study of the 1993 Finnish grant reform, changing from a ... meant a shift from specific matching grants to general type non-matching.
Public Choice 91: 397–416, 1997. c 1997 Kluwer Academic Publishers. Printed in the Netherlands.
397
Real and perceived effects of changing the grant system from specific to general grants LASSE OULASVIRTA Department of Local Government Studies, University of Tampere, P.O. Box 607, Tampere, Finland Accepted 10 July 1996 Abstract. The paper is based on a study of the 1993 Finnish grant reform, changing from a system with earmarked matching grants to a system with general, non-matching grants. The analysis of cross-sectional data confirms the “fly-paper effect” and also that matching grants have a stronger stimulating effect than non-matching grants on local expenditure. The fly-paper effect is then modified to take account of the distribution of power inside local government. The change to general grants without central government supervision might mean more power to the central management in the local government and a diminished power for sector officers and groups dependent on the sector services. Perceptions of principal actors in the local government budget process were that the reform changed the distribution of power, in some municipalities to the disadvantage of locally small weak groups that could benefit under the old system of earmarked matching grants.
1. Introduction In this article we will contrentrate on the economic and political effects of central government grants to local governments. The analysis is done in the context of the Finnish grant reform that was implemented in 1993 and which meant a shift from specific matching grants to general type non-matching grants. By specific matching grants we mean grants that are dependent on the receiving local government’s own effort in the grant-eligible specific activity. By general type non-matching grants we mean grants that are not directly tied to production of a specific service or to the receiving local government’s own effort. This kind of a shift must have important ramifications for the economic and political processes in local governments and also for the relations between central state and local governments. The analysis of grant effects is linked to the distribution of power within the local governments. With this linkage we are trying to develop a public choice approach to grant reforms. The author gratefully acknowledges comments made by Dr. Stephen J. Bailey, Glasgow
Caledonian University, professor Heikki A. Loikkanen, University of Tampere, and an anonymous referee.
398 We begin in Section 2 with some general remarks about developments in Finnish local government and the main features in the grant reform. In Section 3 we analyse the economic implications of the grant reform and in Section 4 the political implications of the grant reform. In Sections 3 and 4 we use municipal-level empirical data, gathered from munipalities in 1991. This survey was targeted to 260 Finnish municipalities, which totally numbered 460 in 1991. The respondents were central administration leading executives (CAOs), chairmen of municipal boards (CHB) and leading executives of social administration (SAOs). In the questionnaire the respondents were asked about their opinions of the grants system that were in force in 1991 (“the old system”) and of the coming new system (“the new system”), that came into force in 1993. The response rates were quite high, 84% for CAOs, 78% for SAOs and 70% CHBs respectively. This survey was completed in 1994 by interviews with 33 CAOs and 54 SAOs in different municipalities. We also gathered quantitative crosssectional data from all Finnish municipalities – this data is used for estimation of expenditure effects of grants in municipalities, and the estimation results are reported in Section 3. Finally, in Section 5, we finish with conclusions of economic and political effects of grants and a discussion how to further develope public choice analysis.
2. The reform of the grant system From the 1960s up to the 1980s, during a period of building a Nordic welfare state, municipalities continuously received new tasks through special legislation of the parliament. The grant system had an fundamental role in the Welfare State project. It was necessary to equalize the capabilities of municipalities to launch new statutory services and keep the local taxation within acceptable levels. The categorial grants were linked with central state supervision and specific norms for how to manage the grant-eligible tasks. At the same time, this meant that the latitude of municipalities was restricted, in spite of the strong formal local self governance and fiscal autonomy in the income side. The Finnish municipalities have the right to tax personal incomes without any restrictions for setting the taxing rates. The personal income tax is the most important income source beside grants for local governments. 2.1. The system prior to 1993 Over 90 percent of the grants were specific matching grants before 1993. These specific grants have heavily favoured the fields of education, social services and health care. The rates of matching grants have been graded
399 since 1969 with a so called capacity-classification system which differentiates between municipalities according to their need for state support. The most important criterion for classification was tax base per resident (weight of criterion 50%). Other criteria were net tax burden from mandatory tasks, poor financial standing of municipality, some unfavorable structural factors (for instance, dispersed population) and structural changes (high unemployment, etc). On the basis of these criteria a special committee prepared the classifications each year and the classifications were approved by the Minister of the Interior. Municipalities in the first class received the highest percentage of cost-related subvention and municipalities in the tenth class received the smallest percentage of cost-related subvention. State grant legislation included strict provisions about expenditures that qualified for grants; not all expenditures related to a task that drew state support were automatically covered. This classification has not been undertaken since the establishment of the new system, and the classification system were completely abolished from the beginning of 1996. Because Finnish municipalities are usually quite small, they have formed voluntary or statutory joint organizations to take care of functions such as the operation of hospitals, health care centres and vocational schools. Before 1993 these joint authorities received grants (cost-related, as for municipalities) for managing their functions. 2.2. The new system since 1993 A system based on general grants and non-matching sector grants was introduced in the beginning of 1993. The new system reduced the sector-specific supervision of municipalities and gave them more independence in providing services. Meanwhile, the macroeconomic policy objectives of controlling local government economy have remained an important issue. The general grants consist of population-based grants, tax-income supplementing payments and discretionary payments. The two sector grants to social welfare and health care and to education and culture are non-matching and also actually general even though they are officially named “sector specific grants”. The shift to non-matching grants means that marginal costs fall more efficiently than before on local tax payers. Some fiscal illusions of local residents might disappear. Municipalities that are competing of mobile tax payers must more than before take the full costs of service provision into consideration – competition with service supply cannot any more be based on service specific matching grants and this might have an impact on migration (compare with Tiebout, 1956).1
400 The reform had a significant impact also on the operations of joint authorities of municipalities since the finances of the joint authorities are more than ever dependent on whether they can sell their services to member municipalities and other buyers. Joint authorities of municipalities are no longer recipients of direct grants: municipalities receive all grants based on health care needs and other relevant criteria. Municipalities use the money to finance their own service production and services bought from their joint authorities. Thus the reform increases cost consciousness of both municipalities and their joint authorities. The welfare state project came to a halt in 1990s. In the new situation the central government wanted to stop the local sector growth and grants expenditure growth. These aims were promoted by the change from matching to non-matching grants and by the fact that general grants are not as vulnerable to rent-seeking activities than specific grants that have special interest groups defending and lobbying for them. The local government incentive for the reform was the wishes of municipal leaders to gain more independence and latitude in decision-making. Some sector specific interests in both local governments and sectoral ministries were against the reform (Oulasvirta, 1992).
3. Economic implications of the grant reform 3.1. Theoretical background Some expectations can be drawn from the grant theory developed by neoclassical economists and public choice economists and from international empirical results from grant expenditure-effect studies. The expectation is that matching grants, that have both income and substitution effects, stimulate more local service output and spending than general grants, that have only an income effect. In other words pure specific matching grants are price subsidies that will lower the price of the grant-eligible commodity and so they alter the price relations of locally-produced commodities. Pure general grants do not alter price relativities and so they have only an income effect, which means that the local government spending on different services should reflect each service’s income elasticity of demand. The neoclassical approach to grants assumed that the effect of non-matching general grants is no different from the effect of private community income. An increase say of 1 million FIM in incomes of the local community ought to have the same income effect on local government spenditure as an increase of 1 million FIM of general grant money. This is because the representative local government ought to mirror the wishes of the voters (in the median voter model the preferences of the median voter are decisive in the local government
401 decision-making). However, empirical research in the 1970’s revealed that general grants stimulated more local expenditure than community income (Mieszkowski and Oakland, 1979). This phenomenon, “fly-paper effect”, caused a revision of the grant theory (Courant et al., 1979). The fly-paper effect could be explained with a Niskanen-type public choice approach (Niskanen, 1971 and 1975), in which local bureaucracy were maximising their budgets or gathering organizational slack because of self interest (Romer and Rosenthal, 1980; Filimon, Romer and Rosenthal, 1982; Wyckoff, 1990). The heads of different bureaux can manipulate the budget by preparing and setting the agenda. Median voters have fiscal illusions and they don’t know well enough how the budget is constructed. This gives the bureaucrats (and also local politicians) possibilities to make self-interested decisions and use the grant money against median voter preferences (Oates, 1979; Hewitt, 1986; Logan, 1986; Logan and O’Brien, 1989). In this article we have a particular interest in reforms of grant systems. A shift from earmarked matching grants to general and non-matching grants that don’t change price relationships between different local commodities will make the receiving local government and local consumers better off. Money used freely according to local preferences brings more benefits from a local point of view than the same amount of money that must be used according to orders originating from outside that local community. On the other hand the interests of the donor, the central government, can be better fullfilled with specific grants that are promoting positive externalities and merit goods that the central government considers important and that are not taken sufficiently into consideration by the local decision-makers. These are the standard statements of the public finance and fiscal federalism handbooks (Williams, 1963; Musgrave and Musgrave, 1980; Boadway and Wildasin, 1984; Rosen, 1988; Cullis and Jones, 1992). In this section and in Section 4 we are trying to analyse the fly-paper effect in the Finnish local government context. If the fly-paper effect is strong and the local democracy is not functioning well, we must reconsider the standard statement of specific matching grants and general grants and the welfare of the local community. In the following survey we will analyse how the different groups can benefit from grants and sector supervision related to specific grants and how the reform of the grant system can disturb the power constellations developed during the old system (before 1993) of specific matching grants. 3.2. The survey results In the 1991 survey the respondents of local government central administration (CAOs and CHBs) were convinced that the grant reform would enhance the
402 Table 1. Implications of the old system according to respondents The proportion of respondents agreeing with the statements
CAO
CHB
SAO
Due to the grant reform, in your municipality: 1. Specific matching grants have had a negative impact on costconsciousness in sectoral grant-eligible tasks 2. The allocation of resource inputs would be different if all municipal tasks had received the same percentage of matching grants 3. The impact of matching grants on service supply has not been in accordance with the need of local residents 4. Your municipality’s share of grants can be better calculated with such criteria as the size of different age groups, population density and area of municipality than with grant eligible real costs 5. The system of earmarked matching grants have caused much administrative work 6. Cost-related matching grants give more security than calculated nonmatching grants for the level of grant money in your municipality N
% 68
% 65
% 28
70
69
60
45
51
20
66
70
42
91
81
64
53
53
57
217
181
203
CAO = central administration leading officer, CHB = chairman of the municipal board, SAO = social sector administration leading officer.
efficiency of the local service production. The interviews made after the reform gave an impression that economy and efficiency really had improved in municipalities although many CAOs and SAOs said that the fiscal squeeze due to the depression was actually the most important factor stimulating economy and productivity. From the point of view of central government, the abolition of earmarked matching grants will reduce the instruments that are open for the central government to promote locally-produced merit goods and positive externalities, spill-overs that are desired from the point of view of the society larger than the municipality. Standard examples are, for instance, elementary education, health care and environmental protection that also benefit society and inhabitants outside the municipality producing and paying for these services. Table 1 shows that most of the central administration respondents believed that the specific matching grants had a negative impact on cost-consciousness and economy in grant eligible tasks. The social sector chief administrators were not so negative as central administration respondents about the grant impact on cost-consciousness and economy. Nearly half of the CAOs and half of the CHBs also seemed to think that the specific matching grants had perverse incentives regarding the responsiveness of the local service supply to local needs. On the other hand, the majority of social sector chief administrators did not consider that matching grants in their municipalities had a perverse impact on service supply.
403 This difference between SAOs and other respondents can be partly due to their differing service perspectives. SAOs are nearer to customers and they probably thought only of their social- and health sectors. CAOs and CHBs are representing the central management, which oversees the whole service field and tries to balance the overall economy. The SAOs’ view of the old grant system was all the time more positive compared to central management views. One reason for this might be that earmarked grants and the supervision connected to them helped SAOs in their budget struggle inside the municipality. SAOs are also a profession that has been intimately connected to the sectorwise Welfare State project supervised by central government agencies. Unlike SAOs, the Finnish CAOs see themselves as corporate managers who want to release almost totally their municipalities from central government supervision. Earmarked grants always bring some central supervision with them whereas general grants give municipal managers more latitude in their decision-making. 3.3. The results of the cross-sectional study 3.3.1. Model and data The cross-sectional municipal data consisted of grant income and expenditure variables for 1991. The data also consisted of geographic, demographic, political and economic variables that a priori were thought to have causal links with the level and targeting of municipal expenditure. The variables were gathered from the large data file ALTIKA that is kept by the Central Statistical Office of Finland in Helsinki. For this cross-sectional expenditure-determinant study we constructed a model in which the dependent variable was municipal expenditure exclusive of certain non-comparable expenditure items and inclusive of the expenditure that could be calculated for each municipality from the joint authorities’ expenditures. This was necessary because small Finnish municipalities have often arranged certain services like health care services via their joint authorities while bigger municipalities have enough own-resources to themselves take care of these same services. This variation in the organisation of activities causes differences in expenditure registration which had to be corrected. The chosen expenditure variable was then explained with the grants and the other variables: service need variables such as the size of different age groups; political variables such as the share of socialist seats in the council; and the cost conditions in the municipality (variables such as distance and population dispersion). The main purpose was to build an expenditure model by which the independent effects of two types of grants could be differentiated: the effect of general grants and the effect of current earmarked matching grants.
404 We also wanted to compare expenditure effects of grants with the effects of the variation of taxable incomes in municipalities. This was motivated by the theoretical interest to see if there is also a fly-paper effect in Finnish local governments. The fly-paper effect is also to be analysed from the point of view of power distribution in local governments. The expenditures of municipalities are dependent of both supply- and demand-side factors. Relevant factors are, for instance, income resources (of which grants and tax incomes are most important), the size and socioeconomic features of the different age groups, the area of the municipality, cost conditions (like distances and location and density of population), and party politics. In our model we chose variables that municipalities cannot directly manipulate – that is why we, for instance, chose taxable incomes per capita and not the actual tax revenues that are dependent on the tax rate of each municipality (the income tax rate variation was from 14.5% to 19.5%). The constructed model can be expressed mathematically as follows: Yj
= a + bi Gij + ciRij + diDij + eiSij + fi Pij
;
where Yj is the per capita expenditure of municipality j, the lower case letters are coefficients that are estimated and capital letters variables (Gi grant variables, Ri income resource variables other than grants, Di demographic variables, Si structural and geographic variables and Pi political variables). All variable values are calculated per capita. 3.3.2. Methods The method for parameter estimation is ordinary least squares (OLS). Because of probable heteroscedasticity in cross-sectional analysis, we made an inspection with the White’s method how the t-values change when heteroscedasticity is taken into consideration (Gujarati, 1995: 379–383). The White’s heteroscedasticity-corrected variances and standard errors didn’t move central grant variables outside the statistical significanse level (Oulasvirta, 1996). In addition to OLS we used two-stage least squares (TSLS) because the OLS method is best suited for the estimation of a causal linkage that is only in one direction. The Finnish matching grants stimulated spending but local government spending also influenced grants. In the old system the more the local government was able to get grants the more it could spend and this spending, as far it was grant eligible, drew more matching grants and so on. The social welfare, health care and education were financed, depending on the task and capacity class of the municipality, from about 20% up to 80% by matching grants. Because of this two-directional causal linkage we also used TSLS. The endogenic grant variable is first regressed with other exogenic variables in the
405 equation and in the second phase this exogenic part of the endogenic variable is used to regress local government expenditure. The matching grants were mostly closed or in other words restricted in the sense that not all spending was grant eligible.2 3.3.3. Estimation results The first three models were estimated for the grant effects on aggregated expenditures of municipalities (municipal expenditures we included with relevant joint authority expenditures belonging to the member municipalities in question). The estimated parameters are in Table 2. When we are discussing the results we will pay most attention in this article to the estimated coefficients of different grant variables and also to the community income (taxable income) per capita and not to other variables. In OLS model 1, ceteris paribus, when grant money per capita is raised with one FIM the local government expenditures grow by 1.38 FIM. As anticipated the specific grants stimulate more local spending than general grants. If the local government can no longer add its grant eligible service output, the raising of the subvention percentage has a price effect that expresses itself mostly as an income effect (and perhaps as a modest substitution effect in a sense that the restrictions are not absolute and are moving inside some flexible area – active local governments can try get some additional expenses approved by the grant agency, see Section 4). We can also assume that the general price elasticity of demand of municipal services is not zero – if the price elasticity would be zero, the matching grants would have only an income effect for this reason. Even if we take into consideration the reciprocal linkage between matching grants and spending, the specific grant coefficient (TSLS model 1) still exceeds one. We can also draw the conclusion that there is a fly-paper effect because general grants stimulate more spending than taxable income resources. The effect of general grants is below one (0.89–0.93 in OLS and TSLS models 1) and that of taxable incomes only 0.17–0.18. These coefficients are of the same size as the mean personal income tax rate of Finnish municipalities. The fly-paper effect means that Finnish general grants not only had an income effect but also a price effect, in the sense that general grants had an impact on the price relation between all publicly provided commodities taken together and privately produced commodities. We also experimented with “grant share of expenditure” variables (TSLS model 2). In this model a rise in the grant share of expenditure of one percentage point means, ceteris paribus, more local government expenditure with 437 FIM. The expenditure effect of general grants and capital investment grants is smaller.
406 Table 2. Regression analysis of the variation of municipal expenditure Variables
Constant Specific grants per capita Specific grant share of expenditure General grants per capita General grant share of expenditure Capital investment grants per capita Investment grant share of expenditure Taxable incomes per capita Urban population Population density Area Distance to nearest city centre Share of children (0–6) Share of young people (7–15) Share of old people (75+) Share of people too disabled to work Unemployment rate Mortality rate Share of socialist seats in council Share of centre party seats in council Change of population figure Population total R2 R2 adjusted F N = 439
OLS model 1
t values
TSLS model 1
t values
TSLS model 2
t values
–5611.5
–0.9
6657.7 1.38
2.4 20.7
8000.4 1.14
2.8 9.4
0.89
4.8
0.93
4.9
1.12
10.3
1.18
10.4
0.18 9.1 –1.93 –0.1 4.38 6.9 –0.15 –2.0 2.41 0.9 –20.29 –0.2 –222.67 –2.8 –138.59 –1.6 –156.55 –1.8 9.37 0.3 –2236.63 –2.5 12.26 1.4 –7.85 –1.3 –5.20 –0.2 –0.01 –3.8 0.786 0.776 85.46
0.17 7.7 –0.55 –0.1 4.36 6.8 –0.10 –1.2 4.71 1.5 70.04 0.6 –212.70 –2.6 –130.80 –1.5 –53.86 –0.6 22.82 0.7 –2396.29 –2.7 8.70 1.0 –7.81 –1.3 –35.89 –1.3 –0.01 –3.5 0.735 0.723 64.65
436.82
5.4
373.12
5.3
97.78 0.37 11.10 6.16 –0.17 13.59 84.13 –451.89 –401.24 –19.42 97.19 –5568.30 21.85 –15.90 –130.26 –0.02 0.433 0.409 17.811
7.1 6.2 0.9 4.9 –1.1 2.6 0.4 –2.7 –2.3 –0.1 1.6 –3.2 1.2 –1.3 –3.1 –2.6
OLS = Ordinary Lest Squares method, TSLS = Two Stage Least Squares method. The instrument variable in TSLS models is the capacity classification class of the municipality.
The use of aggregated expenditure and grant figures as a solution is a not a very precise way to estimate grant impacts because the specific grants in the old system could have different effects on different tasks depending on the local government price and income elasticities of demand, central government restrictions and bureaucratic and political influences in different municipal activities. In the next three tables (3 to 5) we will disaggregate the expenditure figures to the three biggest spending items in local government budgets (social care, health care and education including cultural and recreation services) and see if the grant effects remain in line with those of Table 2. We are not now comparing the effects of general and specific grants; instead we concentrate only on the expenditure effect of specific grants.
407 Table 3. The variation of municipal health care expenditure Variables
OLS model 2
Constant –915.44 Specific grants 1.30 Price variable (1-g) Taxable incomes per capita 0.04 Urban population 2.40 Population density 0.58 Area 0.1 Mortality rate –69.05 Share of old people (75+) 54.81 Share of people too disabled to work –8.67 Unemployment rate 0.75 Share of socialist seats in council 2.27 0.904 R2 R2 adjusted 0.902 F 403.30 N = 439
t values
TSLS model 3
t values
OLS model 3
t values
–3.5 45.1
498.56 0.68
1.2 7.0
3134.50
5.2
12.6 2.0 6.1 1.1 –0.4 5.7 –0.6 0.1 1.4
0.02 4.09 0.64 0.06 –299.89 89.54 141.49 25.83 –2.78 0.703 0.696 101.07
4.1 2.3 4.7 3.1 –1.2 6.1 4.6 2.7 –1.1
–43.57 0.03 5.4 0.85 0.10 –639.09 134.87 248.87 45.13 –5.35 0.490 0.478 41.16
–6.0 3.6 2.0 3.9 3.3 –1.7 6.1 7.5 3.2 –1.4
The health care grants have a coefficient of 1.30, which means that the expenditure effect is of the same level as in OLS-model 1 for all current grants. If we take into consideration that the grant variable is endogenic, the effect diminishes to 0.68 (TSLS model 3). Using a “price” variable in OLS model 3, when the “price” of current activity is raised by one percentage point the spending is cut by 44 FIM. The “price” variable is calculated by subtracting the grant share of current expenditures. The result is the share of the total expenditures that must be paid by local tax payers. Again we see from Table 4 that the specific grants have, when estimated with OLS, an expenditure effect higher than one – the coefficient for social service grants is 1.23 (OLS model 4). The estimation with TSLS method also shows again a considerable cut in estimated expenditure effect – the coefficient in TSLS model 4 is only 0.56. In Table 5 the effects of grants estimated with OLS and TSLS gives results similar to those in Tables 3 and 4. The price effect seems to be stronger both in health care and education (including recreational and cultural services) services than in social care services. We also calculated partial price elasticities of demand. The results were that the price elasticity of demand for health care was –0.384, for social care –0.118 and for education (culture and recreation included) –0.237. The price
408 Table 4. The variation of munipal social service expenditure Variables
OLS t model 4 values
Constant 99.52 0.2 Specific grants 1.23 32.9 Price variable (1-g) Taxable incomes per capita 0.04 10.3 Urban population –2.4 –1.7 Population density 0.86 7.7 Area –0.01 –0.7 Share of children (0–6) 11.08 0.6 Share of old people (75-) 10.19 0.7 Share of people too disabled to work –12.22 –0.7 Unemployment rate –13.57 –1.9 Share of socialist seats in council 7.55 4.0 0.846 R2 R2 adjusted 0.843 F 235.39 N = 439
TSLS model 4
t values
OLS model 5
t values
2209.53 0.56
3.2 4.2 2.6
4416.17
5.4
0.02 –10.37 –4.3 1.20 7.5 –0.01 –0.2 78.62 3.0 34.67 1.7 126.21 3.7 –13.42 –1.4 3.33 1.3 0.635 0.626 74.55
–13.55 0.01 –16.27 1.53 –0.00 126.79 50.18 224.13 –15.98 1.56 0.462 0.450 36.78
–1.8 0.7 –6.3 7.4 –0.2 3.9 1.7 7.2 –1.2 0.4
Table 5. The variation of municipal education expenditure Variables
OLS model 6
t values
Constant –930.31 –2.4 Specific grants 1.29 36.5 Price variable (1-g) Taxable incomes per capita 0.03 5.1 Urban population 6.7 3.1 Population density 0.48 2.8 Area –0.02 –0.9 Share of young people (7–15) –44.45 –2.3 Distance to nearest city centre 1.68 1.7 Share of Swedish speaking people 4.83 2.5 Share of people with university degree 23.79 2.9 Share of center party seats in council –2.73 –1.0 R2 0.846 R2 adjusted 0.840 F 231.02 N = 439 including cultural and recreational services.
TSLS t model 5 values
OLS model 7
t values
146.02 0.72
0.3 6.7
2039.86
2.6
0.01 14.31 0.48 0.11 –36.61 6.33 7.59 36.04 3.44 0.606 0.597 66.00
1.3 4.8 2.2 2.7 –1.5 4.2 3.1 3.4 1.0
–29.49 0.01 22.86 0.54 0.24 –30.75 11.93 11.18 53.99 9.0 0.377 0.363 25.90
–3.6 0.3 5.5 1.6 4.8 –0.8 6.2 3.0 3.3 1.7
409 elasticity of health care is of the same size that H¨akkinen and Luoma find out in another study of grant impact on health care expenditure in Finland (1994).
4. Political implications of grant reform for municipalities 4.1. Rent-seeking and power in municipalities Economics of rent-seeking is interested in the rational behaviour of special interest groups and politicians (Buchanan et al., 1980; Tullock, 1983 and 1989; Olson, 1965). Municipalities and CAOs who are lobbying for their municipalities grants from central government grant agencies can be seen as rent-seekers. Additional grant money benefits more or less also local voters as customers and tax payers, municipal bureaucrats as budget maximizers and politicians as vote maximizers – the outcome depends of the possibilities of the mentioned parties to influence the budget process according to their wishes. From the view of national politics, ministers and MPs want to maximize their votes and support can be derived by allocating grant money for their election districts. Voters in the district have invested support in their politicians at the national level and are expecting transfers benefitting their area and municipality. The interviews of this study (see also Oulasvirta, 1995) showed that especially CAOs are often very active grant lobbyists. SAOs were more active than CHBs. Especially CAOs had also a self interest in grant lobbying because their success as managers have been partly assessed according to their capability to derive grants to the municipality. CAOs considered especially ministers elected from their district, region or municipality as important lobbying objectives in grant matters. How is rent-seeking and lobbying changing as grant system changes? When specific earmarked grants are changed to general grants, special interest groups face a new situation. A specific matching grant benefitted the special group using the service and the municipal personnel running the grant eligible service. In the survey SAOs had a more positive attitude towards the old system and a less positive attitude towards the new system than CAOs and CHBs. Earmarked grants even benefitted the central government service agencies paying grants and controlling municipalities (for instance, jobs for planners, controllers and inspectors). For tax payers of national income taxes and central governments struggling to balance their budgets general and nonmatching grant systems have been a better choice. A general grant system might also be a better choice for local median voters and strong groups who do not need the support of specific grant regimes and who may strenghten their
410 Table 6. The anticipated political effects of the grant reform The proportion of respondents agreeing with the statements
CAO
CHB
SAO
Due to the grant reform, in your municipality: The corporate management of your municipality becomes easier The power of the central management gains strength The municipal sector administration can no longer take advantage of central governmental sector supervision There will be considerable changes in budgetary allocation for different tasks The municipal sector administration becomes more cost-consciousness The reform promotes efficiency in municipal sector administration The local municipal supply of services becomes more responsive to local demand Small groups become weaker in the budgetary allocation process N
% 88 72 96
% 80 81 94
% 69 80 88
35
50
47
82 94 77
79 91 69
60 86 37
43 217
56 181
70 203
CAO = central administration leading officer; CHB = chairman of the municipal board; SAO = sector administration leading officer.
position in the local budget process when central government supervision is diminishing. In Table 6 the results are reported of the questions that handled the anticipated effects of the coming grant reform. In the following we concentrate on the questions that have something to do with the influence of different actors in the local budget decision process. What is the anticipated influence of the grant reform that changes earmarked sector supervised grants to general and freely usable grant money? From the table we can draw the conclusion that most respondents in all three groups considered that the coming new system of non-matching general type of grants will strenghten the power of the CAOs. At the same time many of the CAOs and CHBs and 70% of the social sector respondents (SAOs) anticipated that politically weak groups inside the localities will suffer as a result of the grant reform. Earmarked grants and service norms and control connected to these grants may be a safety guarantee for politically weak groups, which find it difficult to get their wishes transformed into local political decisions. A neoclassical grant theory explanation might be that the abolition of earmarked matching grants means a higher price for the local government and the median voter (who decides in the median voter model of local government) doesn’t have a strong demand for services benefiting other groups. A public choice explanation may be that politicians are vote maximizers who don’t benefit enough from very small voter groups (ethnic minorities, handicapped and disabled people, special patient groups etc).
411 Despite the severe financial troubles during the recession years of 1991– 1993 only few CAOs and SAOs said in the follow-up interviews of 1994 that their basic municipal services like care of old people and childrens’ day care had come into danger. On the other hand some SAOs said in these interviews that certain special groups such as alcoholics did suffer more than other groups in local cutback policy. These results are in accordance with the earlier survey for 1991. Some research results of the Ministry of Social Welfare and Health Care shows that for instance mentally sick people, who have been transferred from hospitals to local non-institutional treatment in the name of economy and service structure reform can lose in the local budgetary process (Marjam¨aki, 1993; Kalland, 1993; Lehto, 1995). On the other hand we must note that SAOs probably don’t readily admit to outsiders that, due to cutback management, weak groups are suffering more than others. The professional ethics of SAOs say that their job is to take care of the needs of the weakest in the society. So it seems that the fly-paper effect is dependent on the power distribution in the local government. The shift from earmarked grants to general grants have an impact on power relations inside municipalities. 4.2. Power and central state grant agencies The restrictions in the old grant system were not fixed exogenic variables. Local governments could persuade and influence central government and provincial state agencies in making decisions concerning grant-eligible investments, grant-eligible new vacancies and grant eligible current costs in local governments. This question was studied in the 1991 survey. In the survey CAOs were asked, how much the municipality influenced the decisions of central and provincial grant agencies. The agency decisions of the capacity classification, the investment projects and quotas of grant-eligible vacancies for the municipality, in particular, were decisions that the municipality had influenced according to CAOs. Classes 1–2 in Table 7 are the municipalities that have been assessed as in greatest need of central government grants. In classes 7–10 are the wealthiest municipalities that have been assessed as least in need of grants. From the table we can see that municipalities in classes 1–2 feel themselves more successful than the bigger and economically stronger municipalities in classes 7–10. The rules of the game have not been against small and weak municipalities – in fact we can say that small and weak have been more successful if we rely on the CAOs’ answers. We also got some empirical evidence that CAOs, who declared their municipalities to have been successful, really did get more investment grants than CAOs, who announced their municipalities to have been uns´uccessful. It seems that in the old system there were some traits in
412 Table 7. CAOs’ assessment of municipal influence on grant decisions
CAOs contacts have influenced:
Capacity class of municipality 1–2 3–6 % %
7–10 %
The decisions of capacity classification committee
Much Little Nothing Can’t say
11.9 23.8 23.8 40.5
18.5 23.2 41.7 16.7
4.0 12.0 68.0 16.0
Capital investment grant
Much Little Nothing Can’t say
40.5 40.5 11.9 7.1
33.3 47.2 11.1 8.3
12.0 64.0 16.0 8.0
Discretionary general (ad hoc) grant
Much Little Nothing Can’t say
8.3 41.7 29.8 20.2
9.3 20.4 38.9 31.5
0.0 24.0 48.0 28.0
The number of grant eligible vacancies
Much Little Nothing Can’t say
16.7 39.3 25.0 19.0
16.7 46.3 16.7 20.4
8.0 60.0 20.0 12.0
Central government investments inside the local government area
Much Little Nothing Can’t say
22.6 48.8 20.2 8.3
28.7 48.1 13.0 10.2
12.0 60.0 20.0 8.0
84
108
25
N
the grant policy that favoured other than the strongest municipalities. The Centre Party has in Finland had a strong position in governments – the party derives its traditional support from countryside small municipalities. This situation might change when grant policy changes at national level. 5. Conclusion and discussion At the national macrolevel the change from specific matching grants to general non-matching grants makes the system easier for the government to coordinate economic policy.3 The new system makes cutting of grants easier for the central government than before. Central politicians, in order to avoid severe political costs (lost votes), are inclined to transfer the responsibility of unpopular task-specific cut decisions to local governments and local politicians.
413 Local government autonomy in recession times means that local governments have the power themselves to decide how to target the expenditure cuts that central government is requiring from them. The importance of the local decision-making process, local democracy and rent-seeking becomes greater than ever. Grant lobbying were a common and a wide spread phenomenon especially during the old system. The municipalities usually used all the possible production factors that were grant-eligible and at the same time tried and also succeeded in influencing the quotas and limits for the grants targeted to the municipality. The rules of the game were not favouring economically strong municipalities. In fact the CAOs of the economically weak municipalities felt that they had been more successful than CAOs of the economically strong municipalities. The cross-sectional study with 1991 data showed that specific cost-related grants stimulated more municipal expenditures (including relevant joint authority spending) than general grants. This result is in line with the neoclassical grant theory (Oates, 1972; Musgrave and Musgrave, 1980) that anticipates the price effect to be stronger in matching grants than in non-matching grants. The shift from matching grants to non-matching grants means that the marginal costs of new activities and expanding existing activities fall fully on local tax payers. In the follow-up interviews in 1994 it became clear that in most municipalities it was the economic austerity and the necessity to balance the books that forced economy and cost-consciousness in the local sector administration. The interviews also supported the expectation that the shift from matching grants to non-matching grants had had some role in this new local attitude towards cost-consciousness and economy. The study also showed that general grants stimulate municipal spending more than local community income (taxable private income in the municipality). This result is contrary to the old neoclassical hypothesis that the rational local government mirrors perfectly the demand of the median voter and that the collective choice ought not to be different when there is a flow of additional money to voters or to local government representing those same voters. On the other hand, the result is more in line with the public choice model, which acknowledges the self interests of bureaucrats and politicians and the fiscal illusions of common people. A criticism of many public choice explanations so far is that they don’t take into sufficient consideration that the wishes of central government (expressed as statutes obliging local governments) might be such that local governments should use this general money for developing and even enlarging local services or, at least, not to reduce the tax rate. The public choice approach can be
414 developed by studying how the fly-paper effect actually allocates money to different service bureaux and services. A priori, it can be hypothesised that the outcome will be linked to the distribution of power in the local government. According to this study there seemed to be a fly paper effect in the Finnish context. The median voter preferences of how to use additional money will be distorted but not only because of self interested bureaucrats but of central government steering that have an impact on how municipalities allocate fungible resources. We must also notice that the distortion of median voter preferences seemes to have been an advantage to some weak groups. Documented grant impacts and fly paper effects are highly sensitive to the specification of the expenditure equation. Boyne and Becker have shown many misspecifications in earlier studies (Boyne, 1990; Becker, 1996). In this study we took into consideration the reciprocal linkage of grants and expenditures. We used also a survey material which has been quite an uncommon method in local government grant research. This survey data gave more light to the ways how grants and grant systems function in the politico-administrative context of local governments. Should we anticipate that rent-seeking of small weak groups is generally more succesfull at the central level than at the local level? At the national level we have some quite organized groups that take care of the interests of weak groups. These groups are not evenly represented locally, especially in small and dispersely populated municipalities. The national level policy has been connected to the Scandinavian type of welfare state project benefitting disadvantaged groups in all municipalities. Local governments and their associations have not always been eager to accept laws that give special groups legal rights to municipal services because of fear that they lack economic resources to fullfill new obligations. There might be even other factors that means more difficulties for small groups at the local level than at the central level. On the other hand small groups might try to compensate this by seeking national level publicity for their problems. The public choice analysis of local government behaviour can be developed by taking into consideration the politico-administrative context at the local level. We must further open the “black box” and analyse how the distribution of power and rent-seeking at the local level is connected to the fly paper effect and to the effects of grant system changes. The possibilities of politicians, bureaucrats, interest groups and voters to fullfill their self interests are dependent on the power distribution inside the public sector.
415 Notes 1. The Tiebout migration model has been developed in a local government world were municipalities are financed with property taxes. In Finland local taxes are largely personal proportional income taxes. One element in both the old and the new system were actually not enhancing municipalities to activate their economic policy – this was the system of tax-income supplementing payments. 2. When the central government sets a restriction to the matching grant the budget curve after receiving the grant becomes a kinked one. The restriction point shows the maximum of grant that the central government is ready to transfer to local government. In the Finnish old grant system without central government restrictions and control most municipalities would have been spending (under the open-ended matching grant regime) more than they actually were spending. This kind of a situation means that the closed-ended grant is not functioning like a “free” price subsidy. For an empirical cross-sectional study this could mean that the price effect is not as strong that it could be in a situation where the benefit optimizing point for the local government is on the left side of the restriction point on the budget line. We must also notice that local government can choose a point beyond the restriction point from its kinked budget line. If the municipality moves to the the right from the corner solution, the central government might have an incentive also to steer expenditures that are not grant eligible. 3. An earlier comparative study of grant policy in Nordic countries concluded that the structure of the grants system does explain to some extent the development differences of municipal expenditure (Oulasvirta, 1992).
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