Fiscal Illusion at the Local Sphere: An Empirical Test of the Flypaper Effect using South African Municipal Data

Despite South Africa’s relatively decentralized governance and administrative structure, an important feature of the country’s intergovernmental fiscal relations system is the gap that exists between the expenditure responsibilities of sub-national authorities and their assigned revenue bases. The resulting vertical fiscal imbalance is mainly addressed via significant intergovernmental transfers to provinces and local governments. This factor presents strong a priori grounds in assuming that in the South African context, the heavy dependence of many local governments on intergovernmental transfers may generate fiscal illusion. Despite this, no significant effort has been geared towards an empirical investigation of the issue of fiscal illusion. This paper extends existing literature on the empirical analysis of fiscal illusion by using the fiscal year 2005/06 financial and expenditure data from 237 local government authorities in South Africa to evaluate the flypaper variant of the fiscal illusion hypothesis. Empirical results indicate that the marginal effects of municipal own-source revenues on local expenditure exceed those of intergovernmental transfers. This outcome yields no statistical evidence in support of the flypaper hypothesis within the context of municipal expenditures in South Africa.