Abstract
This paper studies the optimal combination of government grants that provide direct public funding to nonprofits and tax incentives that reduce the cost of charitable giving. When nonprofits face high fundraising costs to attract donors, tax incentives cannot fully replace grants, which remain part of the optimal funding policy. When fundraising costs are sufficiently low, a government that can tailor tax incentives across causes can finance some causes entirely through donations. However, when cause-specific tax differentiation is unavailable, grants remain necessary to accommodate differences in funding needs across causes. In a calibrated example, imposing a uniform tax treatment of donations across charitable causes raises the optimal share of nonprofit funding covered by grants from 0 to 60%.