Simpler is better : how do simple unconditional central grants boost local own-source revenue in Benin ?

Abstract

Intergovernmental grants design is an important issue in developing countries, where the decentralization process involves a huge vertical gap, i.e. an imbalance between the costs of local public competences and local governments’ revenue raising powers. Our analysis considers the (dis)incentive effect of simple unconditional central grants on local own-source revenue. We highlight a theoretical ambiguity over the nature of this effect in assuming less efficiency of local governments in collecting taxes than of the central one. Our empirical analysis focuses on Benin. We study the impact of a very simple grant that has the properties of being collected at the borders by customs and being allocated among local governments through a fixed rule (the population of jurisdictions). Our empirical analysis covers panel data of 74 local governments from 2003 to 2008, and addresses potential endogeneity issues of central transfer. We conclude unambiguously with a positive impact of this grant on local own-source revenue. This effect is contingent on a minimum level of wealth of the jurisdiction, and is stronger for local governments that do not share the same political affiliation as the president in office. Our result emphasizes a neglected quality of unconditional transfers whose allocation rule is only based on the population of jurisdictions: their complementarity with local ownsource revenue. Such transfers are not only simpler than other formula-based equalization transfers, but they may also have an incentive effect on local own-source revenue.