The Crowding-in Effect of Simple Unconditional Central Grants on Local Own-Source Revenue: The Case of Benin

Abstract : The design of grants from central government to local government is an important issue in developing countries. In hese countries the decentralisation process involves a vertical gap, i.e. an imbalance between the cost of local public competences and local governments' revenue-raising powers. Our analysis considers the crowding-in (or crowding-out) effect of simple unconditional central grantsonlocal own-source revenue.Wedemonstrate atheor- etical ambiguity concerning the nature of this effect by taking into account the collection costs of local governments'ownrevenue.Ourempirical analysis focuses on Benin.We study the impact of a very simple grant that is collected at the border by Customs and is allocated to local governments through a fixed rule (based on population). Our empirical analysis covers panel data for the seventy-seven Benin communes (local governments) from 2003 to 2008, and addresses the potential endogeneity issues of transfer from the centre. We conclude unambiguously that there is a positive impact of this grant on local own-source revenue. This effect is contingent on a minimum level of wealth of the commune and is stronger for local governments that do not share the same political affiliation as the president in office. Our result emphasises a neglected property of those unconditional transfers whose allocation rule is solely population based: their complementarity with local own-source revenue. Such transfers are not only simpler than other formula-based equalisation transfers, but they may also have an incentive effect on local own-source revenue.