COST VERSUS PERFORMANCE SUBSIDIES AS TOOLS OF INTERGOVERNMENT FINANCE

Abstract

This paper addresses the question of whether, in the context of decentralization among levels of government, an output or performance subsidy is demonstrably superior to a cost subsidy as a tool for influencing the behavior of a local unit. Grants-in-aid for example are cost subsidies; are they therefore inherently inferior incentive devices? The answer suggested to this question is that a performance subsidy may be superior to, equal to, or inferior to a cost subsidy depending upon three factors: (1) the technology of local production, (2) the optimizing behavior of local officials, (3) the equity objectives of federal government.