Economic theory suggests that intergovernmental grants are equivalent to private income. A large empirical literature, however, contradicts this prediction. A school finance reform in New Hampshire, where local public goods decisions are made by a form of direct democracy, provides an unusually compelling test of the theory. The results, which suggest that approximately ninety cents per grant dollar are spent on tax reduction, provide support for equivalence. The paper's findings have important policy implications for the financing of local public goods in general and for school finance reform in particular.
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