Meaning and Types

Fiscal imbalance is the term used to denote 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 (Centre 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.

It may be noted that while Horizontal Fiscal Imbalance requires equalization transfers, Vertical Fiscal Imbalance is a structural issue and thus needs to be corrected by re-assignment 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 subnational 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

Constitution of Iraq

The Constitution of Iraq is Iraq's fundamental law.-History:Iraq's first constitution, which established a constitutional monarchy, entered into force under the auspices of a British military occupation in 1925 and remained in effect until the 1958 revolution established a republic...

. 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, 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. 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: 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.

See also

• Fiscal imbalance in Australia
  Fiscal imbalance in Australia
  The term fiscal imbalance is used in Australia in relation to the flow of funds between its federal, state and territorial governments. Currently in Australia, the Commonwealth government raises greater tax revenue than the state and territory governments...
  
  
• Fiscal imbalance in Canada
  Fiscal imbalance in Canada
  Fiscal imbalance is the term used in Canada to describe a monetary imbalance between the Canadian federal government and the provincial governments....
  
  
• Fiscal imbalance in Nigeria
• Fiscal federalism
  Fiscal federalism
  As a subfield of public economics, fiscal federalism is concerned with "understanding which functions and instruments are best centralized and which are best placed in the sphere of decentralized levels of government"...
  
  
• Equalization payments
  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....
  
  
• Transfer payment
  Transfer payment
  In economics, a transfer payment is a redistribution of income in the market system. These payments are considered to be exhaustive because they do not directly absorb resources or create output...