In this paper, it is shown that the institutional context within which lump-sum grants are given can be an important determinant of local (or state) government expenditure responses to such grants. By using the system of local government finance that operated in England until 1990 as a case study, it was shown that the two lump-sum components of the grant system can be predicted to stimulate substantially different expenditure effects. And this is so despite the fact that both of the grants are unconditional lump-sum grants. A model was developed and tested in which the differential expenditure effects are explicitly taken into account and this modelling exercise stands up well when tested against the empirical evidence.
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