Microeconomic Policy Evaluation: Grants - Literature review Example

Microeconomic Policy Evaluation: Grants Name Institution Course Title Instructor Date Microeconomic Policy Evaluation: Grants Over the years, Australian local governments have played a vital aspect in the livelihood of the citizens. Brackertz (2013, p.4) argued that the local governments were created to offer amenities and services to the local citizens such as clean water, allocation of lands and properties, management of parking, parks and sewerage systems, and construction of roads, hospitals and schools. However, local funds from taxes are sometimes not enough to provide better service compelling the local government to look for funds elsewhere (Boadway & Shah, 2007, p.6). Nevertheless, allowing Commonwealth and States and territories to provide grants to local government has been a huge boost to service provisions to different areas. In most cases, the grants provided have not been effective leading to a contentious debate of which type of grant providers should use to fund local government programs. Therefore, using relevant theoretical considerations and diagrams, the essay will argue that Commonwealth government and different Australian state and territory Local Grants Commissions should use both matching and non-matching grants to fund local government programs. According to Grossman (1994, p.296), grant is described as the intergovernmental transfers of the purchasing power. Research has shown that there are several types of the intergovernmental grants which exist today. Some of the grants include conditional grants, unconditional grants, matching grants, matching close-ended grants and non-matching or specific purpose grants (Pal, Dahlberg & Mork, 2004, p.317). However, in this essay the paper will majorly focus on matching grants and non-matching grants to establish the best grant type Australian state and territory Local Grants Commissions should use matching grants to fund local government programs. Matching grant is one that is formulated to balance sub-national contributions. Baker, Payne and Smart (1999, p.270) claimed that in the grant program, the beneficiary has also to contribute in percentage or absolute terms. Policy makers argue that matching grant is reliant on actual or normative or spending for the purpose for which such funds are allocated or on the revenue collection associated with these services. On the other hand, the non-matching grant is described as a fixed amount of funds to be used for specific purposes (Boadway & Shah, 2007, p.4). In Australia, this fund has always been provided by the state government or Commonwealth government to the local governments with a restriction that it should be used to fund local services or goods. In most cases, grants are provided when there are constraints on countries’ budget. Australia has often experienced vertical fiscal imbalance. Boadway and Shah (2007, p.17) contended that this form of imbalance means the central government collects higher revenue than how it uses and state governments use more funds compared to what they raise. It is this fact that the three levels of government normally do not match up in their expenditures. Studies have shown that local govern can handle the vertical fiscal imbalance by using intergovernmental grants obtained from Commonwealth and state governments (Oates, 1999, p. 1120) Commonwealth government and the various Australian state and territory Local Grants Commissions can use both matching and non-matching grants based on its advantages. As stated earlier, in matching both recipient and the grant provider contributes funds for service delivery (Baker, Payne and Smart, 1999, p.270). One benefit of this fund is contribution from both parties complements each other, making it easy for local government to promote development in their area. One advantage of this is that local government does not entirely rely on grants to conduct development. This can be illustrated using the graph below. A Other products B C O Quantity of goods covered by the grant Figure 1: Matching Grant The original budget line of the local government is line AB. If the matching grant is offered by the Commonwealth or state government, the new line denoting the budget will be AC owing to the fact that the goods covered by the grant will be cheaper to local government. Economists argue that the fact that local government also contributes towards financing a project keeps them on toes to try and source their own funds from collecting taxes and land rates among others (Zou, 1996, p. 304). Well-formulated matching grants could enable the Commonwealth and state government help local government to attract investors and private investments into underserved but growing markets by reducing particular market entry barriers for particular target groups, service providers and technologies. Christian, Huber and Lichtblau (2002, p.634) asserted that they can also influence market growth and improve public policies making markets to work for underprivileged people. Since the research shows that demand for service in local setting is often price inelastic, the matching grants can be applied for the tax relief (Christian, Huber & Lichtblau, 2002, p.632). The evidence shows that with matching grant tax prices often drops from 1 dollar to $.68 signifying a reduction by 33%. Meaning that is the demand’s price elasticity for product is inelastic (less than one), the expense with rise by not more than 33% thus reducing taxes. The Commonwealth and State government can provide grants to local government to provide tax relief (Christian, Huber & Lichtblau, 2002, p.632). It has been argued that matching grant instigates rise in spending on aided category, though the rise cannot be larger than the grant. Therefore, it also enables tax relief of the local government. The studies point out that so long as demand for service is considered price inelastic, the matching raises expenses by less total sum of the grant hence free local finance to be used in other projects. Relief in taxes means locals have more to save or to use in other projects (Heijdra & Ligthart, 2009, p.84). With more funds, local government can not only speed up the project milestones, but also carry out more projects hence development in their area of jurisdiction. The Commonwealth government and the various Australian state and territory Local Grants Commissions should use matching grants when funding local government because of its income and substitution effect. Zou (1994, p.102) pointed out that certainly the most basic result of the microeconomics has been that, a reduction in price hold a strong effect on the rate of consumption compared to the growth in income. When the price of product or service such as pizzas or education decreases, customers are impacted by two different factors (Nora, 2004, p.1775). It means the product or service that its price has dropped is affordable in comparison to other product and the purchasing power of the consumer has grown even when the income remains constant. This is called price or substitution effects due to the fact that it provides incentive to the buyers to substitute relatively less expensive goods. Matching grant also has income effect. Baicker (2005, p.372) argued that when local consumers get increases in their income, their purchasing power also increases even if the cost or prices of various goods have not changed. Thus, if the income effect which emanates from the price reduction is the same level as one that comes from a growth in income, then the decrease in price ought to affect consumption. Baicker (2005, p.373) opined that the price remains similar though the decrease bears an extra substitution effect. In reality, the changes in price are anticipated to stimulate stronger change in the consumption compared to the same change in the income. Zou (1996, 307) posited that The effect of such microeconomic standard is that matching grant can raise government spending on the project by higher amount compared to the same amount of non-matching grant. Income and substitution effect can be illustrated on graphical representation as follows. Removing fuel subsidies will be used to illustrate how income and substitution effects work in matching grants. Figure 2: Income and substitution effect of represented on a graph When fuel subsidies in removed, the price goes up. The line of budget moves from black line to red one. Consumption also moves A to B. The movement signifies the effect of price increases. This leads to drop in fuel consumption and that of other goods. Pal, Dahlberg and Mork (2004, p.317) postulated that to reduce the effect of high prices, the Commonwealth government can give the public income. The income can be provided in the form of grant to employee more people. Economists argue that if such income had compensated the people perfectly, the fresh constraint in the budget represents the tangent to the initial indifference curve (Bucovetsky, 1997, p.365). The indifference is signified by blue within the graph. In the graph, Consumption stops at C. However, the substitution effect moves from point A to point C. Since blue line recompenses public for the decreased purchasing power, the change in the consumption because of changes in the costs. The increase in prices pushes the public to save fuel. Points C and B which are on the parallel lines denotes the income effect. The effect is as a result of change in the consumption which is caused by purchasing power. The income they currently have is not adequate to enable them to purchase goods at point A. It would need more funds which, if the family gets make them better off. The perception that comes out is that even if the family was to get more money to buy at A, they might not select the goods at that point. However, because the price has increased, they would spend additional income to but other commodities as a substitute. The commonwealth or state government can also use non-matching grant to fund the local governments in Australia. As mentioned earlier, non-matching grants are a fixed amount of money, which is directed to a purpose (Boadway & Shah, 2007, p.4). Some scholars argue that a non-matching grant from commonwealth or state government channeled to the local government serve as the increase in of the income. This type of grant has several benefits to local government. The fact the Commonwealth and State governments grant a fixed sum of money to be used for specific projects enable the local government to use their collected taxes to other projects (Bucovetsky, 1997, p.467). Furthermore, local government projects are known to stall at some point due to lack of funds. This problem is attributed to the fact the local government collect small amount of taxes compared to the federal government, hence the fund may not be enough to complete the projects. Therefore, providing a fixed sum of grant for a specific project may lead to quick completion. Baicker (2005, p.374) contended that common and state government can identify more development projects and fund them to conclusion hence removing more burden of development of local governments. Non-matching grants has been found to have different effects on tax and consumption. Studies demonstrate that non-matching grants are likely to raise the rate of public commodities produced and also enable the local government to reduce taxes in order for more private products to be consumed (Boadway & Shah, 2007, p. 6). In other words, non-matching grant offer tax relief to the local public. When more grants are provided by the commonwealth or state government to local government, the authorities may lower taxes for the public, hence making them to have more income (Grossman, 1994, p.298). In this way, local companies and individuals are likely to produce more private goods. In a bigger picture, the grant benefits the whole jurisdiction of the local government but also promotes individual growth. This argument can be represented in a graph as follows; Figure 3: Non-matching grant on taxes The local government administrators move from the points A to B, thus distributing part of funds to the expenditures and some part to reduce taxes so as to raise private expenditures as depicted in figure 3. The unconditional non-matching grant moves the public budget line externally from lines PQ to TV. The line PT is equal to QV. Commonwealth or state government needs to use non-matching grants to fund the local government because they increase income. Boadway and Shah (2007, p.7) posited that selective non-matching grants provide a certain amount of money without local restriction, provided it is used for a particular project. Such restriction often ensures that the spending of the local government on the particular category will be equal to amount provided. If the local government is already using its funds equal to ones provided by the grantors, the grant can be channeled to other projects. Theoretically, owing to fungibility of the grants, rise in expenses on the particular project category could at the limit equal to the grants. Oates (1999, p.1131) argued that practically, it means the lumpiness of the investment in such areas could increase spending. This is good for growth of the local government. If the local government spending makes the more people to get jobs within the projects, then they it will increase opportunities of getting more income which they can spend resulting to rise in the aggregate demand (Harnerger, 2008, p.78). It implies construction workers hired by the local government will increase their spending in products and services making more sectors to benefit. When matching grants and non-matching grants are both used at the same time to fund local government programs the process is even efficient. Boadway and Shah (2007, p.5) claimed that non-matching grants creates stronger economic welfare for the local public with more goods consumed. The situation is attributed the fact that non-matching grants stimulate income effect which is good for person and societal growth. On the other hand, matching grants stimulates both income effect and substitution effect (Baicker, 2005, p.377). Use of both matching grants and non-matching grants can be depicted in a graphical presentation as shown in figure 4. A D G Other products F O B E C Quantity of goods covered by the grant Figure 4: Matching Grant Matching rants yield the equilibrium at point F within line AC. On the other hand, non-matching grant generates equilibrium at point G just above F on indifference curve as shown in figure 4. In conclusion, the essay has provided a comprehensive analysis of why Commonwealth government and other arms of governments should use both matching grants and non-matching grants in funding local government programs. The researchers have found out that in matching grant the receiver also contributes some percentage of the funds thus making the local government not to entirely rely on grant for development. On the other hand, in non-matching grants, the provider contributes a fixed sum of money directed towards a specific project. The analysis established that while non-matching grants creates an income effect, matching grants produce substitution and income effects. As such, it recommends the use of both two grants for greater economic welfare of the society. References Baicker, K. (2005). Extensive or Intensive Generosity? The Price and Income Effects of Federal Grants. Review of Economics and Statistics, 87 (2), 371–84. Baker, M.A., Payne, A., & Smart, M. (1999). An Empirical Study of Matching Grants: The ‘Cap on CAP. Journal of Public Economics 72 (2), 269–88. Bergvall, D., Charbit, C., Kraan, D., & Merk, O. (2006). Intergovernmental Transfers and Decentralized Public Spending. OECD Journal on Budgeting, 5(4), 112-158. Brackertz, N. (2013). Political Actor or Policy Instrument? Governance Challenges in Australian Local Government. Commonwealth Journal of Local Governance, 12, 3-19. Boadway, R., & Shah, A. (2007) Intergovernmental Fiscal Transfers: Principles and Practice. Washington, D.C: The World Bank, 1-532. Bucovetsky, S. (1997). Insurance and Incentive Effects of Transfers among Regions: Equity and Efficiency. International Tax and Public Finance, 4, 463–82. Christian, B., Huber, B., & Lichtblau, K. (2002). A Tax on Tax Revenue: The Incentive Effects of Equalizing Transfers: Evidence From Germany. International Tax and Public Finance, 9 (6), 631–49. Grossman, P. (1994). A Political Theory of Intergovernmental Grants. Public Choice, 78, 295- 303. Heijdra, B.J., & Ligthart, J. E. (2009). Labour tax reform, unemployment, and search. International Tax and Public Finance, 16, 82‐104. Harnerger, A. C. (2008). Microeconomics: In David R. Henderson (ed.). Concise Encyclopedia of Economics (2nd ed.). Indianapolis: Library of Economics and Liberty Nora, G (2004). Do Federal Grants Boost School Spending? Evidence from Title I. Journal of Public Economics 88 (9–10), 1771–92. Oates, W.E. (1999). An Essay on Fiscal Federalism. Journal of Economic Literature, 37(3), 1120-1149. Pal, B., Dahlberg, M., & Mork, E. (2004). The Effects of Grants and Wages on Municipal Labour. Labour Economics 11 (3), 315–34. Zou, H. (1996). Taxes, Federal Grants, Local Public Spending, and Growth. Journal of Urban Economics, 39, 303-317. Zou, H. (1994). Dynamic Effects of Federal Grants on Local Spending. Journal of Urban Economics, 36, 98-115. Read More