October 1, 2001
This paper questions the effectiveness of matching grants to correct for interjurisdictional spillovers in the light of Bernheim general neutrality result. Indeed this result suggests that the usual argument that matching grants are needed to internalize the externality arising from the existence of interjuridictional spillovers is an artifact of the assumption that jurisdictions neglect the impact that their decisions have on the federal budget. Relaxing this assumption and using a classical model where the arbitrage resulting from labor mobility implies that redistribution has the properties of a public good, we find that matching grants are relevant although much less effective. We also find that optimal matching rates are independent of the jurisdictions' choice of policy variable contrarily to the case where jurisdictions ignore the impact of their decisions on the federal budget.
J.E.L classification codes: H23, H70
Keywords:Fiscal federalism, Ricardian equivalence, Matching grants