Fiscal imbalance

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.[1]

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.[2] 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.[3]

Thus, the transfer system can promote efficiency in the public sector and can level the field for intergovernmental competition.[4] 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

Within the realm of fiscal federalism literature, there are diverse interpretations of the term Vertical Fiscal Imbalance (VFI). Sharma's research in 2012, however, presented a clarifying perspective by suggesting that VFI should refer to a specific kind of revenue-expenditure asymmetry: an "inappropriate" assignment of revenue-raising powers and spending responsibilities.[2]

To bring clarity to this perspective, Sharma introduces the term 'Vertical Fiscal Asymmetry (VFA)' which is defined as a hallmark of  multi-level fiscal systems in which the central government has access to more revenues as compared to the subnational governments (SNGs), while the SNGs are assigned more expenditure responsibilities as compared to the central government. Whether to label VFA as an Imbalance (VFI), a Gap (VFG), or merely a difference in revenues and expenditures between the two levels (VFD) depends on the politics of fiscal federalism specific to a country at a particular point in time. Navigating the literature, he posits that there can be three types of VFAs:

Types of Vertical Fiscal Asymmetry

Chanchal Kumar Sharma (2012) argues that there can be three types of VFAs:[1]

  • 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: 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.

Overall, when expenditure responsibilities are taken as a given, VFA can be addressed in one of two ways: if perceived as VFI, through a reallocation of revenue powers (excluding borrowing powers); if perceived as VFG, through a system of intergovernmental transfers (excluding loans). Further extending this 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).[5]

Many public policy experts now follow Sharma's conceptualization of "vertical fiscal asymmetry" due to its relative neutrality,[6][7] and VFA's implicit support for decentralization.[8] Others prefer Sharma's notion of "vertical fiscal asymmetry" over its alternative "vertical fiscal imbalance" because the latter subtly negates fiscal decentralization and intergovernmental transfers.[6] Economists prefer this because Sharma's concept of “vertical fiscal asymmetry” can possibly explain the extent to which a given VFA manifests as VFI or VFG.[9] Others assert that the concept of VFA, as articulated by Sharma (2012) is a more nuanced concept than the conventional understanding of vertical fiscal imbalance because it highlights the unfeasibility of a balance or symmetry purporting to eliminate any kind of vertical fiscal asymmetry.[10] Legal scholars argue that Chanchal Kumar Sharma's (2012) conceptualisation "leverages both James Buchanan’s emphasis on vertical tax separation and Richard Musgrave’s emphasis on centralized transfers to provide an integrated intergovernmental financing model for devolved states. Under this approach, the mere existence of a vertical fiscal asymmetry (VFA) in an intergovernmental fiscal system’s design is not in any way indicative of the nature or scope of subnational revenue autonomy."[11]

See also

Nations:

Further reading

References
  1. Sharma, Chanchal Kumar (2011). "Beyond Gaps and Imbalances: Re-structuring the Debate on Intergovernmental Fiscal Relations". Public Administration. 89: 99–128. doi:10.1111/j.1467-9299.2011.01947.x.
  2. Sharma, Chanchal Kumar (March 2012). "BEYOND GAPS AND IMBALANCES: RE-STRUCTURING THE DEBATE ON INTERGOVERNMENTAL FISCAL RELATIONS". Public Administration. 90 (1): 99–128. doi:10.1111/j.1467-9299.2011.01947.x.
  3. Boadway, R. (2000). "Recent Developments in the Economics of Federalism". In Lazar, Harvey (ed.). Canada: The State of the Federation 1999–2000: Toward a New Mission Statement for Canadian Fiscal Federalism. Kingston: Institute of Intergovernmental Relations. pp. 41–78. ISBN 978-0-88911-843-0.
  4. Breton, A. (1998). Competitive Governments: An Economic Theory of Politics and Public Finance. New York: Cambridge University Press. ISBN 9780521646284.
  5. Dahlby and Rodden 2013. A political economy model of the vertical fiscal gap and vertical fiscal imbalances in a federation
  6. Zhao, Heng; Liu, Jianmin; Wu, Jinguang (2023-05-01). "The impact of vertical fiscal asymmetry on carbon emissions in China". Environmental Science and Pollution Research. 30 (24): 65963–65975. doi:10.1007/s11356-023-27054-6. ISSN 1614-7499. PMC 10124686. PMID 37093387.
  7. Martínez, Gemma (2018). International Perspectives on Fiscal Federalism: The Basque Tax System. United States of America: Center for Basque Studies, University of Nevada, Reno. ISBN 978-1-949805-01-7.
  8. Alonso, Jose M; Andrews, Rhys (March 2019). "Fiscal decentralisation and local government efficiency: Does relative deprivation matter?". Environment and Planning C: Politics and Space. 37 (2): 360–381. doi:10.1177/2399654418784947. ISSN 2399-6544.
  9. Srinivasan, R. (2022). Fiscal Federalism in India: A Case for Reassigning of Tax Powers (PDF). MADRAS SCHOOL OF ECONOMICS.
  10. Barrios-Suvelza, Franz Xavier (2019-04-04). "Refining the Concepts of Territorial Revenue Assignment, Substate Fiscal Self-rule and Territorial Fiscal Balance". International Journal of Public Administration. 42 (5): 432–454. doi:10.1080/01900692.2018.1466899. ISSN 0190-0692.
  11. Gichana, Henry Paul; Omboto, Henry Paul Gichana (2022). "Intergovernmental fiscal systems and self-rule: A Kenyan case study": 387–88 – via Dullah Omar Institute, University of the Western Cape. {{cite journal}}: Cite journal requires |journal= (help)
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