Fiscal imbalance is a mismatch in the revenue powers and expenditure responsibilities of a government.
In the literature on fiscal federalism, two types of fiscal imbalances are measured: Vertical Fiscal Imbalance and Horizontal Fiscal Imbalance. When the fiscal imbalance is measured between the two levels of government (Center and States or Provinces) it is called Vertical Fiscal Imbalance. When the fiscal imbalance is measured between the governments at the same level it is called Horizontal Fiscal imbalance. This imbalance is also known as regional disparity.
While Horizontal Fiscal Imbalance requires equalization transfers, Vertical Fiscal Imbalance is a structural issue and thus needs to be corrected by reassignment of revenue and expenditure responsibilities between the two senior order of the governments.
Horizontal Fiscal Imbalances as Differences in Net Fiscal Benefits
A horizontal fiscal imbalance (HFI) emerges when sub-national governments have different abilities to raise funds from their tax bases and to provide services. This creates differences in ‘net fiscal benefits’, which are a combination of levels of taxation and public services. It is these NFBs which are the main cause of horizontal fiscal disparities that in turn generate the need for equalization grants. Prominent among the objectives commonly attributed to intergovernmental fiscal transfers is ‘equalization’ of fiscal capacities or resolution of Horizontal Fiscal Imbalances.
Thus, the transfer system can promote efficiency in the public sector and can level the field for intergovernmental competition. The discussion of horizontal fiscal imbalance and equalisation was of particular importance in the drafting of the new
Iraqi constitution. It was a sticking point for the drafting process—with the oil rich regions seeking to minimise the reallocation of revenue while other regions sought to maximise equalisation payments.
Vertical Fiscal Imbalance as a Particular Type of Fiscal Asymmetry
Though there are multiple usages of the term in the fiscal federalism literature, yet, Sharma (2012) holds that strictly speaking, it shall only be used to denote a particular type of revenue-expenditure asymmetry.
[ This can be understood as follows:
Any existing revenue-expenditure asymmetry between the two levels of a government should simply be called, what it is, that is, a Vertical Fiscal Asymmetry (VFA). The precise nature of this asymmetry, in a particular country, is a matter of research.][
]
Types
Chanchal Kumar Sharma (2012) steers clear of the confusion in the existing literature and redefines the concepts with great clarity. In his contribution he argues that there can be three types of VFAs:[
*1. Fiscal asymmetry with fiscal imbalance: Vertical Fiscal Imbalance (VFI). This means inappropriate allocation of revenue powers and spending responsibilities. This state can be remedied by reassignment of revenue raising powers.
*2. Fiscal asymmetry without fiscal imbalance but with a ]fiscal gap
The fiscal gap is a measure of a government's total indebtedness proposed by economists Laurence Kotlikoff and Alan Auerbach, who define it as the difference between the present value of all of government's projected financial obligations, includin ...
: Vertical Fiscal Gap (VFG). This means a desirable revenue-expenditure asymmetry but with a fiscal gap to be closed. This state can be remedied by re-calibration of federal transfers.
*3. Fiscal asymmetry without fiscal imbalance and without fiscal gap: Vertical Fiscal Difference (VFD). This means a desirable revenue-expenditure asymmetry without a fiscal gap ( i.e. gap is closed). This is a state of fiscal asymmetry where there is "no imbalance and no gap" and thus needs no remedial measure.
Further extending the conceptual analytic framework presented by Chanchal Kumar Sharma (2012) which according to Bev Dahlby and Jonathan Rodden provides the most extensive review on the vertical fiscal gap and vertical fiscal imbalance concepts, the authors develop a “political economy model of the VFI and VFG in a federation (see Dahbly and Rodden 2013).Dahlby and Rodden 2013. A political economy model of the vertical fiscal gap and vertical fiscal imbalances in a federation
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See also
* Fiscal federalism
* Equalization payments Equalization payments are cash payments made in some federal systems of government from the federal government to subnational governments with the objective of offsetting differences in available revenue or in the cost of providing services. Many fe ...
* Cyclical asymmetry
Nations:
* Fiscal imbalance in Australia
The fiscal imbalance in Australia is the disparity between the revenue generation ability of the three levels of governments in Australia relative to their spending obligations; but in Australia the term is commonly used to refer more specificall ...
* Fiscal imbalance in Canada
Fiscal imbalance (French, ''déséquilibre fiscal'') is the term used in Canada to describe a monetary imbalance between the Canadian federal government
The government of Canada (french: gouvernement du Canada) is the body responsible for the f ...
* Fiscal imbalance in Nigeria
Further reading
* Bird, R. M. (2012)
Subnational taxation in large emerging countries: BRIC plus one
International Center for Public Policy Working Paper Series, at AYSPS, GSU paper1201, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
References
{{DEFAULTSORT:Fiscal Imbalance
Fiscal federalism
Fiscal policy
Federalism