How to fund nonprofits?

Governments support nonprofits through direct grants and tax incentives for private donations, but the optimal mix of these tools remains unclear. I develop a model in which households donate to multiple causes and the government can use both instruments to support nonprofit funding. A key determinant of the optimal policy mix is tax discrimination, defined as the ability to vary tax incentives by cause. When tax discrimination is feasible, warm-glow giving makes private funding more efficient, reducing the need for grants. However, when tax discrimination is constrained, grants become essential to compensate for the rigidity of the tax system. In a calibrated example, the optimal government share of nonprofit funding rises from 0% to 60% as tax discrimination becomes more limited. When donations are leaky, delivering less than a dollar of value per dollar given, the importance of tax discrimination declines. In the extreme case of uniform leakage, Pareto efficiency can be achieved with grants and a linear tax credit, uniform across causes, similar to the systems currently implemented in Belgium, France, or New Zealand.