This paper analyzes municipal expenditures in the light of horizontal fiscal interactions. I investigate total expenditures and a set of non-earmarked expenditure subcategories in the largest German federal state, North Rhine-Westphalia (NRW). The empirical analysis is based on a Spatial Durbin Model in a panel for the years 2009-2015. Using a two-regime spatial matrix, I also examine the impact of agglomeration on the intensity of public expenditure interactions, thus testing the hypothesis that an agglomerated region can decrease the amount of public goods without losing mobile factors to the periphery. The findings indicate that significant municipal expenditure interaction effects do exist. The reaction functions also vary for different expenditure subcategories. Unlike spillover effects and fiscal competition, yardstick competition is an insignificant source of potential interactions. Expenditure interaction is fiercer if there is less agglomeration in a municipality. Urbanized and populous municipalities appear to benefit from agglomeration economies, a fact that enables them to spend less. Robustness checks confirm the findings.

We investigate how lump-sum equalization transfers affect expenditures and taxes in the municipalities of the largest German state North Rhine-Westphalia. In general, those general-purpose transfers cannot be treated as exogenous variables. Thus, for the identification of causal effects, two exogenous adjustments in the transfer allocation formula are used as instrumental variables. Findings suggest the existence of the “flypaper effect” – municipalities use transfers to increase expenditures but do not reduce tax rates. Extra money from transfers is mainly used to finance social expenditures and public facilities. A set of robustness checks, including a spatial dependence model, confirm the results.

We investigate the effect of general-purpose transfers on different expenditure categories and tax rates in the municipalities of Saxony (eastern Germany) and North Rhine-Westphalia (western Germany). Findings from the panel data analysis suggest the existence of the “flypaper effect” – municipalities use transfers to increase expenditures but do not reduce taxes. For most expenditure subcategories the estimated coefficients are alike, suggesting similarity of spending priorities in the two federal states despite the differences in the transfer dependency. Targeted support of eastern municipalities could potentially explain few identified differences in the spending behavior.

We investigate the effect of general-purpose transfers on different expenditure categories and tax rates in the municipalities of Saxony (eastern Germany) and North Rhine-Westphalia (western Germany). Findings from the panel data analysis suggest the existence of the “flypaper effect” – municipalities use transfers to increase expenditures but do not reduce taxes. For most expenditure subcategories the estimated coefficients are alike, suggesting similarity of spending priorities in the two federal states despite the differences in the transfer dependency. Targeted support of eastern municipalities could potentially explain few identified differences in the spending behavior.

We investigate how lump-sum equalization transfers affect expenditures and taxes in the municipalities of the largest German state North Rhine-Westphalia. In general, those general-purpose transfers cannot be treated as exogenous variables. Thus, for the identification of causal effects, two exogenous adjustments in the transfer allocation formula are used as instrumental variables. Findings suggest the existence of the “flypaper effect” – municipalities use transfers to increase expenditures but do not reduce tax rates. Extra money from transfers is mainly used to finance social expenditures and public facilities. A set of robustness checks, including a spatial dependence model, confirm the results.

This paper analyzes municipal expenditures in the light of horizontal fiscal interactions. I investigate total expenditures and a set of non-earmarked expenditure subcategories in the largest German federal state, North Rhine-Westphalia (NRW). The empirical analysis is based on a Spatial Durbin Model in a panel for the years 2009-2015. Using a two-regime spatial matrix, I also examine the impact of agglomeration on the intensity of public expenditure interactions, thus testing the hypothesis that an agglomerated region can decrease the amount of public goods without losing mobile factors to the periphery. The findings indicate that significant municipal expenditure interaction effects do exist. The reaction functions also vary for different expenditure subcategories. Unlike spillover effects and fiscal competition, yardstick competition is an insignificant source of potential interactions. Expenditure interaction is fiercer if there is less agglomeration in a municipality. Urbanized and populous municipalities appear to benefit from agglomeration economies, a fact that enables them to spend less. Robustness checks confirm the findings.