Demand for local public expenditures: evidence of the effects of fiscal illusion in Brazil

Abstract

In addition to the complexity and opacity of taxation, the strong reliance of Brazilian municipalities on federal and state transfers increases the chance of fiscal illusion.
Under fiscal illusion, taxpayers tend to underestimate the costs of the goods and
services provided by the government and, thus, to demand them in excess of what
would be demanded in the absence of fiscal illusion. The purpose of this study is
to estimate the effects of fiscal illusion on the demand for local public spending in
Brazil. Based on a median voter model and using data from 2010 for 5249 municipalities, a demand function for local public goods that includes variables to capture fiscal illusion is estimated. The results indicate that fiscal illusion associated to the tax structure and to the fiscal transfers can help to understand the expansion of public spending in Brazil.