This article offers an empirical test of the fiscal illusion hypothesis. It is argued that,
if fiscal illusion increases with the degree of separation in taxing and spending
powers, then federal unconditional grants ought to have a greater stimulatory
impact on local government spending than state unconditional grants. Data for the
136 counties and cities of Virginia were examined and evidence in support of this
hypothesis is provided. Federal grants were found to be the primary source of the
stimulatory impact of grants. At the minimum, federal unconditional grants have
twice the stimulatory effect as state unconditional grants.
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