Public Funding
What is Formula Funding and its role in public sector of resource allocation?
Formula funding is used to distribute public money fairly and consistently by applying predefined rules instead of discretionary decisions. Its role is to allocate resources based on costs, activity, or needs, while creating predictability and financial discipline. Formula funding also helps distinguish between legitimate cost differences and illegitimate inefficiency or strategic behavior.
What is meant by the principal-agent relationship, and why is it important in public funding?
In a principal–agent relationship, a funder (the principal) gives money to someone else (the agent) to do a job. The problem is that their goals may not fully match, and the agent’s actions are not always visible. This creates risks like self-interested behavior, inefficiency, and extra control costs.
What two types of efficiency do we have in public funding?
Allocative efficiency is about spending money on the right things. Resources are efficient if they are allocated according to what society or the funder actually wants and values.
Technical (managerial) efficiency is about doing things in the cheapest effective way. It means delivering a given level of service or outcome using as few resources as possible. Closely related to the value fraction.
Please describe the difference between Legitimate & Illegitimate costs.
Legitimate cost drivers (exogenous)
These are costs that arise because of who you serve or where you operate, and that you cannot control yourself.
Illegitimate cost drivers (endogenous)
These are costs that arise because of how you choose to operate, and that you can influence.
What types of risks do we have in case-based payments and capitation-based payments. And how are they distributed under the two payment types?
Case-Based Payments
Quantity risk (Amount of Cases) lies with the funder (more cases = higher total spending).
Intensity risk (Cost related to each case) lies with the provider (must treat each case within fixed payment).
Incentive created: efficiency through scale and volume control.
Capitation Payments
Both quantity and intensity risk lie with the provider.
Incentive created: efficiency through cost control and prioritization.
How does Formula Funding models balance efficiency, equity, and policy priorities?
Formula funding balances efficiency by encouraging providers to deliver services at lower cost or with better outcomes, guided by the value fraction.
It addresses equity through horizontal equity (equal inputs) and vertical equity (unequal funding based on different needs).
At the same time, political and policy priorities are embedded in the choice of allocation type (general vs. specific, block vs. matching, case payments vs. capitation), which directly influences behavior and spending patterns.
What different types of allocations are used in public funding?
The first dimension is General vs. Specific, which describes how earmarked the funding is. General funding can be used freely by the organization, while specific funding must be used for a particular purpose, such as a museum receiving funding based on the number of visitors.
The second dimension is Block vs. Matching, which describes how closely funding is linked to actual costs or activity. Block funding is a fixed amount that is not directly tied to real costs, whereas matching funding increases with activity or spending — the more you do or spend, the more funding you receive.
Memory rule: General = freedom, Specific = earmarked, Block = fixed, Matching = activity-based
What do we see happening to the PPF, when spending or costs rises over time?
The key idea is that more spending usually leads to better outcomes, but at a decreasing rate, and that different people or services have different PPFs. This can be due to differences in needs, circumstances, or efficiency. As a result, achieving the same outcome may require different levels of spending for different individuals
What Two sets of issues is being faced when designing public funding?
1. First, what incentives the formula creates: funding must encourage desired behavior (prevention, efficiency, quality) and avoid perverse incentives that reward quantity, inefficiency, or gaming.
Can risk be elimated? What happens to risk in public funding? And what is the consequence of risk?
In Summary
Budgetary risk is not a flaw — it is a design choice. Public funding systems deliberately distribute risk to steer behavior, but the effect depends on cost structures, service type, and formula quality.
Bottom line: Funding models don’t just allocate money — they allocate risk, and risk shapes incentives.
How are costs generated in Public Funding and what is the PPF?
Costs in public services arise at different levels, including general costs, batch-based costs, and case-based costs, depending on how services are organized. Costs also vary because individuals differ in needs, circumstances, and efficiency, which is captured by different Personal Production Functions (PPFs).
What is required for a funding model to work?
To work well, formula funding requires that financial responsibility is delegated, good data is available, clear performance requirements exist, and there are real incentives to follow the rules.
Describe Case-Based payments in depth please.
Describe Capitation-Based Funding please
Case-based payments are a public funding mechanism where organizations receive funding based on the number of cases or services delivered, with a fixed payment per case. In the ideal form, funding is directly proportional to activity: more cases generate more funding.
This approach is widely used in public sectors such as healthcare, education, and culture because outputs (e.g. visits, students, treatments) can be clearly defined and counted.
Capitation-based funding is a public funding
mechanism where organizations receive funding based on the expected level of cost or expenditure, rather than actual activity. Funding is allocated according to the characteristics of the population served, not the number of cases delivered.
Capitation = funding follows people and expected cost, not actual activity
Case-based payments = funding follows activity, not costs.
What are the symptoms of not meeting the needs? So the symptoms of unmet needs.
Unmet needs are mainly a cost estimation problem: the funding formula underestimates what it actually costs to provide an adequate level of service.
Demand-side unmet needs arise when the formula fails to capture true need in the population → either everyone gets too little (general unmet needs) or specific groups are underfunded (specific unmet needs).
Supply-side unmet needs arise when funding ignores organizational or local constraints → either all users are affected (agency-wide) or some groups more than others (specific supply factors).
General demand-side unmet needs (everyone gets too little):
A national funding formula for elderly care is based only on the number of residents aged 65+, but ignores increasing levels of dementia and chronic illness. As a result, all municipalities receive too little funding per elderly citizen, and overall service levels decline.
Specific demand-side unmet needs (some groups are underfunded):
A school funding formula is based on the number of students but does not sufficiently account for students with special educational needs or language barriers. Schools with many vulnerable students receive the same funding as others, leading to unmet needs for specific groups.
As risk cannot be eliminated, what measures can be taken to reduce og minimize risk?
To prevent this, public funding systems aim to manage rather than eliminate risk through risk adjustment, better variable choice, and mechanisms such as stop-loss, damping, and carve-outs.
Describe the Value Fraction pleeeeease
The Value Fraction
Value Fraction = Outcomes / Cost
Outcomes are the real results or benefits created — focusing on what actually improves for citizens or society.
Cost includes all resources used to achieve those outcomes, not only money but also time, labor, infrastructure, and opportunity costs, and it depends on who pays and over what time period.
The value fraction is used to show how well resources are converted into meaningful results, with the goal of maximizing outcomes for each unit of cost
What types of payments do we use in formula funding?
Case payments:
Organizations are paid per activity (for example per patient or per student). If they do more, they receive more money. This encourages activity, but can also lead to doing too much (overproduction).
Capitation funding:
Organizations are funded based on the expected needs of a population, not on how much activity actually happens. Areas with older, sicker, or poorer populations get more money. This encourages prevention and efficiency, but may create incentives to limit services to stay within the budget
What can you tell about the institutional dynamics in public funding. What does this imply?
The essence of the lecture is that formula-based funding and costing models do not just allocate resources — they reorganize public institutions. They introduce new institutional logics, reshape roles and responsibilities, shift risk downward, and translate political and professional questions into financial ones. The Herning case shows how this works in practice: policy goals are embedded in funding formulas, and organizations adapt their behavior in response—sometimes fully, sometimes symbolically, and sometimes in tension with existing professional values.
What is the goal of public funding. Here I mean. Do we aim for perfection?
Public funding is not about finding the “true” cost — it is about agreeing on a cost that is good enough to fund services without rewarding inefficiency.
What is the idealogical idea behind formula fundings? By this I mean in the perfect world, what happens due to public funding? And how is this view challenged by the involvement of politics?
Up to this point, formula funding has been presented as a technical and rational system: allocating resources based on legitimate cost drivers, measured need, and transparent rules. This creates the impression of an “enlightened funder” that neutrally distributes money according to objective criteria.
This lecture challenges that view by showing that formula funding is also a political tool. Every formula produces distributional effects—some actors gain, others lose—and these outcomes have real consequences for services, access, and quality. Because formulas allow considerable flexibility in variable choice, weights, and adjustments, political priorities inevitably shape their design.
What is transfer pricing?
Transfer pricing is about setting prices for goods or services exchanged inside the same organization so different units are treated fairly and work toward the same goals. These prices are usually set to look like market prices to avoid distortion.
Example: A municipality has a central IT department that provides support services to schools and administrative units. Instead of providing IT services for free, the IT department charges a transfer price per support hour based on standard costs. This makes each unit aware of the cost of IT usage, discourages unnecessary requests, and helps the municipality allocate resources more efficiently. The purpose is not profit, but to ensure that public services are delivered at the lowest possible cost without reducing quality.
Describe the two types of equity in public funding.
Horizontal equity (inputs) means that people should be treated with the same input disregarding their situation. The focus is on fairness in what people put into the system, not on what they get out.
Vertical equity (outcomes) means that people in different situations should be treated differently. The goal is to create fair outcomes, even if treatment is unequal.
What do see in practice in relation to case-based funding and capitation-based funding? And why do we see this?
Mixed funding systems dominate because the ideal types create one-sided incentives.
Case-based payments increase activity and efficiency, but also lead to overproduction, gaming, and quality distortion.
Capitation funding strengthens cost control and prevention, but risks low effort, under-provision, and technical inefficiency.
How does risk come into play in public funding? Does it exist? And what is the risk?
Risk in public services = the probability that actual expenditures differ from expected expenditures.
This risk is unavoidable — the key issue is who bears it and how it affects incentives.
How is decision-making related to public funding? Where do we see it?
Funding formulas are the result of active choices by the funder, not neutral technical rules. The funder decides how costs are estimated (actual vs. ideal), what counts as legitimate need, and how many variables to include—balancing precision against simplicity and transparency. These choices affect risk sharing and which needs are actually funded.
The funder also decides how fast funding changes are implemented. Because many providers have high fixed costs, sudden redistribution can be disruptive, so mechanisms like damping are used to soften or delay formula outcomes.
Key point: Funders shape outcomes by deciding what matters, who bears risk, and how quickly change happens.