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Huber, Bernd; Runkel, Marco (2006): Optimal design of intergovernmental grants under asymmetric information. In: International Tax and Public Finance, Vol. 13, No. 1: pp. 25-41

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This paper develops a theoretical explanation why it may be optimal for higher-level governments to pay categorical block grants or closed-ended matching grants to local governments. We consider a federation with two types of local governments which differ in the cost of providing public goods. The federal government redistributes between jurisdictions, but cannot observe the type of a jurisdiction. In this asymmetric information setting, it is shown that the second-best optimum can be implemented with the help of categorical block grants and closed-ended matching grants, but not with unconditional block grants or open-ended matching grants.

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