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

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  • Richard Frank
  • Martin Gaynor

Abstract

In this paper we investigate the incentives present in intergovernmental transfers for public mental health care. This represents an important issue due to the large portion of mental health care that is provided by local governments, the central role of states in financing care via intergovernmental transfers, and recent innovations adopted by some states altering the traditional terms of these transfers. Using a relatively simple model we 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 the preferences of society and those of the local provider of service are identical. this problem can be remedied by simply charging the provider a price equal to marginal cost for use of the input. If. however, the provider and society differ in their preferences, setting the price of the input at marginal cost will not induce optimal behavior, nor will the imposition of capacity constraints. Setting the correct Pigovian subsidies and taxes may induce social optimality. However it is unlikely that optimality will be achieved if the budget for the public good is fixed. The optimal prices are proportional to the sum of the elasticities of the provider's supply of services with respect to the subsidy (tax). These results are directly 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, e.g., setting subsidy or tax levels or imposing budget reductions.

Suggested Citation

  • Richard Frank & Martin Gaynor, 1991. "Incentives, Optimality, and Publicly Provided Goods: The Case of Mental Health Services," NBER Working Papers 3700, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3700
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    1. Robert P. Inman, 1987. "Federal Assistance and Local Services in the United States: The Evolution of a New Federalist Fiscal Order," NBER Working Papers 2283, National Bureau of Economic Research, Inc.
    2. Holmstrom, Bengt R. & Tirole, Jean, 1989. "The theory of the firm," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 2, pages 61-133, Elsevier.
    3. Thomas McGuire & Michael Riordan, 1993. "Contracting for Community-Based Public Mental Health Services," Papers 0043, Boston University - Industry Studies Programme.
    4. A. J. Auerbach & M. Feldstein (ed.), 1985. "Handbook of Public Economics," Handbook of Public Economics, Elsevier, edition 1, volume 1, number 1.
    5. Shapiro, C. & Willing, D.R., 1990. "Economic Rationales For The Scope Of Privatization," Papers 41, Princeton, Woodrow Wilson School - Discussion Paper.
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    1. Richard G. Frank & Martin Gaynor, 1991. "Organizational Failure and Government Transfers: Evidence From an Experiment in the Financing of Mental Health Care," NBER Working Papers 3923, National Bureau of Economic Research, Inc.
    2. Machnes, Yaffa, 1996. "Incentives and production of mental health services," European Journal of Political Economy, Elsevier, vol. 12(3), pages 459-466, November.

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