This paper addresses the role of the Australian local government grants system in promoting efficiency, and examines whether or not the intergovernmental grants process, along with institutional, structural and environmental characteristics, exerts an influence on the efficient provision of local public services. Data envelopment analysis (DEA) is used to obtain measures of technical and scale efficiency across three local government functions; namely, library services, waste management services, and planning and regulatory services. When grant relativities are regressed against these efficiency indices using simultaneous equation tobit models, the results generally indicate that the desired objective of effort (or policy) neutrality is maintained. However, failure to address issues of optimal scale size, amongst others, may force local councils to provide an inappropriately funded scale of operations. The findings also suggest that deviations from the distribution of financial assistance solely on the basis of horizontal equalisation may be a further influence on inefficient outcomes in the local public sector.