The Dynamic Response of Municipal Budgets to Revenue Shocks

Research Seminars

The paper presented in this Mannheim Applied Seminar studies the dynamic response of municipal budgets to intergovernmental grants, based on quasi-experimental variation in transfers within Germany’s municipal fiscal equalization scheme. Because transfers depend on population counts, the 1987-Census led to sudden and permanent shifts in revenues across municipalities. Using an event-study design, the authors track the municipal fiscal and tax response to these revenue gains or losses. In contrast to prior work, they focus on the dynamic causal response over time. Fiscal budgets do not adjust instantly: municipal spending adapts over three to four years, predominantly driven by capital and infrastructure investments. Spending adjusts more rapidly to revenue losses, but the response is symmetric in the long run. Local tax rates adapt only slowly, with adjustments stretching over more than a decade. The authors contrast these findings with prior evidence on the “flypaper effect” and other anomalies in public finance. While they find such anomalies in the short run, the long-run decision-making of municipal governments is more in line with standard theories of fiscal federalism.

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Leitung und Dean of Graduate Studies, Prof. Dr. Sebastian Siegloch
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