In the next paper, Professor Bev Dahlby of the University of Alberta, extends the theoretical work of Smart (1998) that shows that equalization grants give recipient governments the incentive to set tax rates too high because a portion of the resulting loss of revenue is made up through equalization. Using a richer model, Dahlby shows that the theory predicts that recipient governments will set higher tax rates and spend more on consumption-related programs. Conversely, recipient governments are predicted to spend less on income-producing initiatives. Professor Dahlby recognizes that other factors may play an important role in the determination of the tax rates and the size and mix of government expenditures. His contribution provides us with a framework to test whether behaviour predicted by his theory is discernable in the data and is economically significant.

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