Incentives, Optimality, and Publicly Provided Goods: the Case of Mental Health Services

Abstract

In this article, the authors investigate the incentives present in intergovernment transfers for public mental health care. This represents an important issue because of the large portion of mental health care that is provided by local governments, the central role of states in financing care via intergovernment transfers, and recent innovations adopted by some states altering the traditional terms of these transfers. Using a relatively simple model, the authors show that when a state government provides both financing and a free input into local government production, there will be excessive use of that input. If local government and society differ in their preferences, setting the price of the input at marginal cost will not induce optimal behavior. The optimal prices are proportional to the sum of the elasticities of the provider's expected supply of services with respect to the subsidy (tax). These results are analogous to those for optimal commodity taxation. Examination of the transfer contracts for Wisconsin, Ohio, and for Texas reveals that these contracts may not be optimal. These departures from optimal decisions may be partially due to the practical issues related to implementation of optimal transfer arrangements, such as setting subsidy or tax levels or imposing budget reductions.