The Economics of Intergovernmental Grants

Abstract

Chapters 7 and 8 demonstrated the allocative efficiency case for user-charges and local taxes. However, revenues from those two sources may be insufficient to finance an allocatively efficient level of local government expenditures. In particular, there will tend to be inadequate provision of local government outputs that spill over jurisdictional boundaries to benefit nonresidents (see Chapter 1). This provides an efficiency rationale for national government to pay grants to local governments in respect of such services. If it did not pay grants to local authorities, there would either be suboptimally low levels of provision of those services, or local tax levels would be suboptimally high.

Local authorities’ financial resources shall be commensurate with the responsibilities provided for by the constitution and the law. The protection of financially weaker local authorities calls for the institution of financial equalisation procedures or equivalent measures which are designed to correct the effects of unequal distribution of potential sources of finance and of the financial burden they must support. Such procedures or measures shall not diminish the discretion local authorities may exercise within their own sphere of responsibility. As far as possible grants shall not be earmarked for the financing of specific projects. The provision of grants shall not remove the basic freedom of local authorities to exercise policy discretion within their own jurisdiction.

(European Charter of Local Self-Government: Article 9)