FISCAL ILLUSION, INTERGOVERNMENTAL GRANTS AND LOCAL SPENDING

This paper provides some evidence of fiscal illusion of a reduced tax- price of public service, engendered by provincial grants to local gove rnments. A model of fiscal response to grants, based on expected vote maximization approach, is tested on time series data as well as pooled time series and cross-section data for 39 upper-tier municipalities i n Ontario over the period 1977-91. A generalized two-stage least squar e procedure is used to estimate the model, adjusting for autocorrelati on, heteroscedasticity in errors and simultaneity between grants and e xpenditures. The results show that the fiscally-induced price effects of grants varies quite widely from one municipality to another and the se variations can be attributed to differences in municipal characteri stics and their institutional relations with the province. Additionall y, the results show evidence of considerable tax exporting (and import ing) to (and from) non-residents.