If it's a government position, the government won't take notes of how you handled things. However, the individual people in the process will likely hold a grudge if they feel slighted. Be polite and up front with both employers but don't feel like you owe either any loyalty yet. Do try to give the position you are turning down as much notice as possible and don't lead them on. They are trying to fill a position and each stage likely cuts off possibilities for them for candidates. Also you might be screwing over someone who would've moved to to the next stage of you'd decided earlier.
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