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

Richard Frank, Martin Gaynor

NBER Working Paper No. 3700 (Also Reprint No. r2011)
Issued in May 1991
NBER Program(s):Health Economics

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.

download in pdf format
   (996 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w3700

Published: Richard G. Frank & Martin Gaynor, 1995. "Incentives, Optimality, and Publicly Provided Goods: the Case of Mental Health Services," Public Finance Review, , vol. 23(2), pages 167-192, April. citation courtesy of

Users who downloaded this paper also downloaded* these:
Frank and Gaynor w3923 Organizational Failure and Government Transfers: Evidence From an Experiment in the Financing of Mental Health Care
Sabatini Dwyer, Mitchell, cole, and Reed w5297 Evaluating Mental Health Capitation Treatment: Lessons from Panel Data
Gaynor and Gertler w3373 Moral Hazard in Partnerships
Klick and Markowitz w9994 Are Mental Health Insurance Mandates Effective? Evidence from Suicides
Frank and McGuire w6838 Parity for Mental Health and Substance Abuse Care Under Managed Care
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us