Evaluating the need assessment in fiscal equalization schemes at the local government level

The assessment of expenditure needs is a contentious issue surrounding European fiscal equalization schemes. While the assessment via output standards is very complex, the measurement via regression techniques is limited by preference and efficiency variations that affect local government spending. The procedure to be presented allows evaluating current need assessments without depending on any kind of output measure. Assuming that the socioeconomic environment critically affects the cost of public services, we test the extent to which current need indicators account for socioeconomic disparities among localities. If some neglected differences can be detected, we argue that the resulting cost differences are also neglected. We illustrate this evaluation method using the example of the German state of Saxony.