Municipal Secession and Transfer Incentives in Brazil

ABSTRACT The optimal number of subnational units within a country remains a debated issue, with no clear theoretical or empirical consensus. Institutional incentives often drive the expansion or reduction of jurisdictions for political, fiscal, or administrative purposes. This article investigates whether the design of Brazil's Municipal Participation Fund (FPM) encourages municipal secession through its transfer formula. We analyze rent‐seeking behavior, where actors engage in secession to access guaranteed transfers, and the flypaper effect, where transfers stimulate more spending than equivalent own revenues. Using multiple data sources, counterfactual simulations, and econometric analysis, we demonstrate that post‐1988 municipalities are typically smaller, more reliant on transfers, and allocate a larger share of spending to institutional operations rather than service delivery. Fragmentation can also be fiscally counterproductive at the state level, as extensive secessions reduce eligibility for the FPM‐Reserva, whereas the flypaper effect remains stronger in newer jurisdictions, sustaining pressures to expand transfer shares. Together, these findings strengthen the case for reforming FPM allocation rules.