The effects of grants-in-aid on state and local expenditures: The case of AFDC

This paper develops econometric methods to estimate the effect of the piecewise-linear budget constraints created by grant formulas in which the subsidy rate is not constant over expenditures (e.g. closed-end grants). The methods are applied to the AFDC program. The results show that, because of the kinked nature of the grant formula, (1) the present federal formula actually increases cross-state inequality in AFDC benefits, (2) several subsidy rates in the formula actually reduce benefits, and (3) the so-called ‘flypaper’ effect disappears.