Measuring the Flypaper Effect: The Interaction between Lump-Sum Aid and the Substitution Effect of Matching Aid

Abstract

According to one theory, consumer-voters mistake lump-sum aid for matching aid such that lump-sum aid reduces their tax price of the aided service. Consumer-voters misunderstand that the substitution effect of matching aid comes from lump-sum aid, resulting in higher expenditures for the aided service. This flypaper effect is more likely when both lump-sum aid and matching aid (or equivalent tax-price reducing mechanisms) coexist and there is a high likelihood of interaction between the lump-sum aid and the substitution effect. However, surprisingly few studies have developed a clear formula to evaluate the flypaper effect while the literature generally assumes the interaction as one of potential causes for the flypaper effect. This paper fills in the huge gap in the literature by providing a formula to show whether and how lump-sum aid causes the flypaper effect.

Keywords

flypaper effect substitution effect matching aid lump-sum aid fiscal illusion

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