State governments fund more than one-half of public mental health service system costs through mental health departments, other state agencies, and the Medicaid program. They use some of these resources to finance community-based mental health services through purchase-of-service contracts. I explored the reasons why states privatize mental health services and focused on political, economic, and organizational theories as possible frameworks for contracting. I gathered data during site visits to Massachusetts, Michigan, New York, Oregon, Tennessee, and Texas, where I interviewed more than one hundred individual stakeholders about mental health purchase-of-service contracting. I also examined relevant documents about contracting practices for mental health services in each state. My results suggest that state policy makers can use mental health contracting to effect multiple goals. Contracting helps states achieve political, economic, and organizational objectives, such as avoiding the influence of interest groups and leveraging state resources, while avoiding conflict. With contracting, state policy makers can also continue the ongoing mental health policy paradigm shift begun during deinstitutionalization, in which persons with serious and persistent mental illnesses receive services from community-based providers rather than in state hospitals. Finally, my results suggest that contracting will continue to be an important state policy tool in further development of state-supported mental health systems.

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