Effect of Vertical Fiscal Imbalance in India

Effect of Vertical Fiscal Imbalance in India

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In general, a fiscal imbalance can be defined as the mismatch between the expenditure and revenue powers of a government. In fiscal federalism, there are two types of fiscal imbalances – horizontal and vertical. While we will deal with horizontal imbalance at a later stage, the vertical fiscal imbalance highlights a type of condition in which revenues and expenditures do not match for various levels of a government. Thus, it is purely a structural issue that can only be corrected if expenditure and revenue responsibilities are reassigned and that needs proper mechanisms to address the faults.

The effect of vertical fiscal imbalance guidelines on government debt is high in those countries that offer expenditure decentralization at high levels and especially those countries that have a high score in the regional authority index. Therefore, it can be more pronounced in countries that follow a federal structure as the autonomy of the subnational governments is quite high. Also, when there is a long tenure for the current government, the fiscal imbalance can display a moderately stronger effect on the generation of government debt.

The vertical fiscal imbalance in India is partly due to the economic structure and the push-pull powers between the states and the center. The empirical and theoretical literature on the subject clearly shows and suggests that it is a hindrance to enhanced fiscal performance as well as sub-national accountability. It is also because most nations are decentralised economies and there is a marked distinction between the revenue-generating and spending responsibilities of the states and the centre.

A glaring example of vertical fiscal imbalance within the country can be that of a condition in which a state requires its cities and towns to impart quality educational services while at the same time, it leaves the responsibility of funding the process through local property or sundry taxes. Thus, it can create a condition of vertical imbalance because the revenue and spending may not match correctly. Therefore, the state must contribute towards the funding so that the financial obligations can be met to provide the towns and cities with the best educational services. However, it is also important to state here that some earlier research into vertical fiscal imbalance and fiscal performance has come up with evidence to suggest that higher imbalances can increase government deficits significantly.