There are many studies, including those of J. Pucher et al. and S. C. Anderson, that
found higher costs to be associated with transit operating subsidies. However, none
of them investigated the effect of state and local federal subsidy formulas on cost
efficiency of transit operations. In this article, the subsidy-cost relationship is
derived by using the federal operating subsidy formula directly within the transit
firm's optimizing framework, and the resulting system of equations is estimated. Our
results demonstrate that there exists a positive cost-subsidy relationship that conforms with the previous studies and that the formula results in very little capital bias.
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