Fiscal and spending behavior of local governments

This paper treats local governments as utility maximizing agents when they allocate resources among different service sectors. We present estimates for eight service sectors, based on a modified version of the extended linear expenditure system (ELES) and using observations at the municipal level for Norway. Our econometric model recognizes user fees and budget deficits as endogenous variables. Moreover, the model accounts for heterogeneity in local tastes and production costs. Price information for local public services is not available in the data. However, by allowing for heterogeneity in the marginal budget share parameters, we achieve identification of the complete ELES. The empirical results show that local public services are in general price-inelastic. Welfare services like education, social services and care for the elderly and disabled are income-inelastic, while infrastructure is rather income-elastic. A strong flypaper effect is revealed by the response of user fees to income changes. Finally, results from out-of-sample predictions show that the ELES model is able to simulate local government behavior quite well.