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182. Matching grants should as a rule be inversely correlated to the income level of the recipient govenmment. The purpose of such transfers is essentially to ens that all local govermmnts, regardless of their fiscal capacity, provide a similar level of certain specified public services to their residents. The idea is simply to set the pQce of the service (1-m) to each local goverment in such a way as to neutrlize difference in capacity by varying the matching rate (m). Th higher the income elasticity, the higher the matching rate needed for low-income recipients (to offset the higher local expenditues on the aided sevice in higher-inokom areas), and the higher the price elasticity, the lower the matching rato needed to achieve a given level of total expenditures. In practice, there is thus a case for varying matching rates inversely with income levels even when only the incenutive offcts (and not the distributionad effects) of matching grants are considered.

183. Unfortunaely, neither thoory nor available empitical studies provide clear guidelines to determine the precise matching rate appropriato for particular expenditure progrms, lot alone how those rates should be varied in accordance with the charcteristics of different local governments. Nonetheles, a possible approach might be to consider the matching rate for each progrnm as having two components. The basic matching rate for eah service would then reflect the degree of centrl goverment interest in the provision of that service whether that interest is motivated by concem over spillovero, the *merit good natre of the activity, or simply the desire to implement some plan). This basic rate could then be increasod inversely to a uniformly determined measur of capacity. Th matching rate faced by any particular locality for any particular prgram would then be higher the greater the degree of central interest and the lower the (expected) degree of local enthusiasm (price-elasticity) and ability (incomeelasticity) to support that progrmL Though data limitations mtn that such refinmets are most unlikely to be relevant in any transitional economy for many years, these principles should nonetheless be kept in mind in developing an intergovernmental trasfer system - or any system of subsidized municipal credit, where exactly the same considerations are relevant.

# Other Obiectives of Transfers.

184. In addition to the economic ar _ments for transfers discussed above, there are of course also important political arguments for transfers in all countries:

* It may be necessay, for example, to transfer some resources to jurisdictions that do not, strictly speaidng, need them in order to make it politically feaible to transfer needed amounts to other jurisdictions.

* It may also be essential to transfer resources simply in order to keep some economically non-viable - loc,t govenmments (eg., small riral governments) alive for political reasons to salvage regional pride, to provide jobs for local supportes, or for some other mason.

In both these cases, the main design problem is to minimie any collateral damage to the presumed economic objectives, both by achieving the political ends in as cost-effective a way as possible and by trying to ensure that the design of such transfers offsets the good features of other trasfers as little as possible.

185. In summary, the main substantive aim of a well-designed transfer program is to 'get the prices right' in the sense of facing local decision-makers with the full consequences of their actions. The first step in getting the right incentives from intergovemmental transfers is, as argued ealier in this paper, to establish the local public finance system itself as much on a benefit basis as possible. Ideally, local own-source revenues should come entirely from local taxpayers. Local governments should not have acces to taxes that they can export to non-residents (except to the limited extent such taxes may offset the provision of local public goods that lower production costs).