Intergovernmental grants and fiscal competition

Abstract

This theoretical paper shows how a central government can induce a policy concerning a municipal matter through a package of a policy requirement and a grant. We find that, due to fiscal competition and the possibility for citizens to move between municipalities, the central government can make all municipalities adopt the policy requirement despite the grant not being sufficiently high to make them gain from the reform. We apply this model to a recent Swedish child-care fee reform and can explain why all Swedish municipalities implemented the maximum child-care fee although it had a negative impact on many municipalities’ finances.