In 2003, the Dutch government introduced a VAT-compensation fund in order to create a level playing field for local governments with respect to Value Added Tax (VAT). This fund eliminates the effect of the tax difference between local governments that supply services themselves and local governments that contract out services to the private sector. However, as this article shows, according to most municipalities, differences in their treatment in terms of VAT did not hinder the contracting out of public services. Therefore, the VAT compensation fund lacks legitimacy. It appears to have had little effect so far, as the number of contracted-out public services has hardly increased since its introduction. In general, municipalities have a negative opinion of the fund. They state that non-budgetary effects and institutional considerations, such as the quality of services, the vulnerability of municipal activities and concern for employment in the municipality itself, are more relevant to decision making on outsourcing. © 2010 Taylor & Francis.