Welfare Financing: Grant Allocation and Efficiency

Abstract

Welfare is often administered locally, but financed through grants from the central government. This raises the question how the central government can prevent local governments from spending more than necessary. Block grants are more efficient than matching grants, because the latter reduce the local governments' incentive to limit welfare spending. However, conventional block grant financing is less equitable, indeed, it may put a heavy burden on local governments in economically weak regions. This paper considers block grants which depend on exogenous spending need determinants, and are estimated from previous period welfare spending. This allocation method gives rise to perverse incentives by reducing the marginal costs of welfare spending. We derive the conditions for such a grant to be more efficient than a matching grant, and apply our results to the Netherlands, where such a grant exists since 2004. We conclude that the Dutch style grant is likely to be more efficient than a matching grant. As it is also more equitable, other countries might want to consider introducing a similar grant.

Capitalization of equalizing grants and the flypaper effect

“…Even though many governmental tasks have been assigned to municipalities, national regulation and guidelines ensure that basic public services are to a large extent uniform across the country. 10 For instance, municipalities administer welfare, yet the norms for assignment and benefit levels are set nationally (Toolsema and Allers, 2014). About a third of the budget of municipalities is spent on welfare and social services.…”

Do Incentives for Municipalities Reduce the Welfare Caseload? Evaluation of a Welfare Reform in the Netherlands

“…In principle, it rewards municipalities for each recipient finding work with the present value of the benefits saved. The block grant based on historical expenses on the other hand gives a reward which will be close to zero, because municipalities will anticipate that the gain of their efforts will be lost three periods later (see also Toolsema and Allers 2014).…”

“…Although financial incentives are optimal from this theoretical perspective, Toolsema and Allers (2014) argue that, if municipalities operate at different levels of efficiency, actual welfare expenditures are a biased indicator of spending needs. Based on a theoretical model, they expect this bias to be small.…”