Okay, I thread hopped a bit/a lot.
My shower-time thoughts on censorship are like this:
Government doesn't need to waste money on censorship. I believe that self-regulation makes more sense. What I expect is that each media industry develops an informative code of what is contained within a particular piece of media (types of violence, sexual depictions, expletives etc) and then it is up to individuals to purchase or not purchase something based on that information.
For government grants, especially for the fine arts, I would sorta just spew that money in every direction. I don't think it worth the dollars wasted in managing money to only go to "moral" works. I know my government is attempting to do that and the first things it did was cut funding to a movie that had suggestive title, yet have no sexual depictions in the movie itself (they didn't even bother reviewing anything and cut funding to something that didn't hit their not-moral guidelines) and another one which simply disagreed with their political views (ie. it was a liberal movie... and liberalism is evil). So I would put no restrictions on art grants.
For making certain types of art illegal, my only criteria is this: if you have to do something illegal to produce it, then it is an illegal good. For instance, child pornography is illegal because then you have to sexually abuse children in order to produce it. Possession of illegal material is also illegal. Trading in illegal material is illegal.