Fiscal illusion and the Australian local government grants process: How sticky is the flypaper effect?

It has been argued that evidence supporting the widely documented flypaper effect is a statistical artefact; more specifically that previous studies a re compromised by the use of inappropriate functional forms and the endogen eity of intergovernmental grant programs. Whilst the first issue may be res olved with careful econometric testing, the second requires the incorporati on of institutional constraints into governmental expenditure equations. Co mbining Australian local government expenditure equations and intergovernme ntal grant parameters, the flypaper controversy is analysed. Empirical resu lts confirm the sensitivity of the flypaper effect to specification, and te sts of fit unambiguously favour one functional form. That specification yie lds no evidence of a flypaper effect in the Australian institutional milieu .