Spend and Tax or Tax and Spend? Panel Data Evidence from Finnish Municipalities during 1985 - 1999

This paper studies the dynamic interrelationship between total expenditures, own source revenues, grants received from state and loans in Finnish municipalities. Two separate panel data sets that cover the years 1985-1992 for matching grants period and 1993-1999 for formula based grant period are used for all municipalities. The analysis is done using the VAR method for panel data. I find, first, that there are important dynamic interrelationships between the variables in question. Second, I find that during the matching grants period, expenditures Granger-cause revenues uni-directionally, whereas during the formula based grants system the revenues and expenditures Granger-cause each other. The grants Granger-cause expenditures during both periods. In the end of the 1990s municipalities have been able to pay off their loans primarily by cutting expenditures and not by increasing own source revenues.