Matching grants and Ricardian equivalence

This paper investigates the effectiveness of matching grants to correct for interjurisdictional spillovers in the light of Bernheim general neutrality result. Indeed this result suggests that the usual argument that matching grants are needed to internalize the externality arising from the existence of interjurisdictional spillovers is an artifact of the assumption that jurisdictions neglect the impact that their decisions have on the federal budget. Relaxing this assumption and using a classical model where the arbitrage resulting from labor mobility implies that redistribution has the properties of a public good, we find that matching grants can restore the first-best but need to be larger. We also find that optimal matching rates are independent of the number of jurisdictions and their strategic variables contrarily to the case where jurisdictions ignore the impact of their decisions oil the federal budget. (C) 2002 Elsevier Science (USA). All rights reserved.