Horizontal Fiscal Imbalance Concept

Horizontal Fiscal Imbalance Concept

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In any federal system, fiscal imbalances are a common concern. These imbalances can arise both vertically and horizontally. While vertical fiscal imbalance refers to the distribution of financial resources between the central and subnational governments, horizontal fiscal imbalance focuses on the disparities among subnational governments within a country. Horizontal fiscal imbalance refers to the unequal distribution of fiscal resources among subnational governments within a country. It arises when there are variations in revenue-generating capacities and expenditure needs across different regions or states. As a result, some regions may have more financial resources at their disposal, leading to disparities in service delivery and economic development.

Horizontal imbalance growth can be attributed to several factors. Firstly, regional disparities in economic development and natural resource endowments can contribute to differences in revenue generation capacity. Regions with a strong industrial base or access to valuable natural resources tend to have higher revenue potential. Secondly, historical factors such as uneven infrastructure development, imbalanced investment patterns, and regional economic policies can perpetuate horizontal imbalances. Economic activities and investment tend to concentrate in certain regions, creating an uneven distribution of wealth and resources. Thirdly, rapid population growth or decline in certain regions can strain local resources, leading to imbalances in service delivery and infrastructure development.

To address horizontal fiscal imbalances, governments often employ various mechanisms. One such approach is the use of fiscal equalization transfers, where funds are redistributed from wealthier regions to those with fewer resources. This aims to bridge the gap in revenue capacities and ensure comparable levels of public services across regions. The weightage given to horizontal imbalance depends on the policy priorities and objectives of the government. Horizontal imbalance weightage aims to strike a balance between promoting regional equity and incentivizing regional self-sufficiency.

It is also pertinent here to highlight the difference between horizontal imbalance vs vertical imbalance. While horizontal fiscal imbalance focuses on inter-regional disparities, vertical fiscal imbalance deals with the distribution of financial resources between the central government and federal governments. Vertical imbalance arises when the central government holds a significant share of fiscal powers and resources, leaving federal governments dependent on intergovernmental transfers. The key distinction between the two imbalances lies in their scope. Horizontal imbalance looks at the disparities among federal governments, whereas vertical imbalance examines the relationship between the central and federal levels of government.