Fiscal federalism
Encyclopedia
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" (Oates, 1999). In other words, it is the study of how competencies (expenditure side) and fiscal instruments (revenue side) are allocated across different (vertical) layers of the administration. An important part of its subject matter is the system of transfer payment
s or grants
by which a central government shares its revenue
s with lower levels of government.
Federal governments use this power to enforce national rules and standards. There are two primary types of transfers, conditional and unconditional. A conditional transfer from a federal body to a province, or other territory, involves a certain set of conditions. If the lower level of government is to receive this type of transfer, it must agree to the spending instructions of the federal government. An example of this would be the Canada Health Transfer
.
An unconditional grant is usually a cash or tax point transfer, with no spending instructions. An example of this would be a federal equalization transfer
.
This may be noted that the concept of fiscal federalism is relevant for all kinds of government: unitary, federal and confederal. The concept of fiscal federalism is not to be associated with fiscal decentralization in officially declared federations only; it is applicable even to non-federal states (having no formal federal constitutional arrangement) in the sense that they encompass different levels of government which have defacto decision making authority.
This, however, does not mean that all forms of governments are 'fiscally' federal, only that 'fiscal federalism' is a set of principles that can be applied to all countries attempting 'fiscal decentralization'. In fact, fiscal federalism is a general normative framework for assignment of functions to the different levels of government and appropriate fiscal instruments for carrying out these functions
These questions arise: (a) how are federal and non-federal countries different with respect to 'fiscal federalism' or 'fiscal decentralization', and (b) how are fiscal federalism and fiscal decentralization related (similar or different)?
Chanchal Kumar Sharma clarifies that while fiscal federalism constitutes a set of guiding principles, a guiding concept that helps in designing financial relations between the national and subnational levels of the government, fiscal decentralization on the other hand is a process of applying such principles.
Federal and non-federal countries differ in the manner in which such principles are applied. Application differs because unitary and federal governments differ in their political and legislative context and thus provide different opportunities for fiscal decentralization.
A recent article published in Public Administration, Blackwell, Oxford, authored by Chanchal Kumar Sharma, clarifies the notion of vertical fiscal imbalance. The paper also demonstrates how the notion of Vertical Fiscal Imbalance (VFI) is conceptually distinct from the notion of Vertical Fiscal Gap (VFG). These terms are used as synonyms which they are not. Recent attempts at differentiating the notions, particularly in the Canadian literature on fiscal federalism, had rather added to the confusion (see Sharma 2011, Tables 1,2,3; section VI). The incisive analysis of the aforementioned paper at once clarifies the entire conceptual confusion.
The article states that 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, can be determined by using certian criterions that the author has evolved. The kind of policy solution to be applied will depend on the nature of asymmetry (VFA). Thus, there can be three types of VFAs:
The relationship between central and subcentral government bodies has a profound effect on efficiency and equity within the government and on macroeconomic stability of the country. The role of the OECD Network on Fiscal Relations Across Levels of Government is to provide data and analysis on these relationships between organizations at different levels of government.
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...
s or grants
Grant (money)
Grants are funds disbursed by one party , often a Government Department, Corporation, Foundation or Trust, to a recipient, often a nonprofit entity, educational institution, business or an individual. In order to receive a grant, some form of "Grant Writing" often referred to as either a proposal...
by which a central government shares its revenue
Revenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....
s with lower levels of government.
Federal governments use this power to enforce national rules and standards. There are two primary types of transfers, conditional and unconditional. A conditional transfer from a federal body to a province, or other territory, involves a certain set of conditions. If the lower level of government is to receive this type of transfer, it must agree to the spending instructions of the federal government. An example of this would be the Canada Health Transfer
Canada Health Transfer
The Canada Health Transfer is the Canadian government's transfer payment program in support of the health systems of the provinces and territories of Canada...
.
An unconditional grant is usually a cash or tax point transfer, with no spending instructions. An example of this would be a federal equalization transfer
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....
.
This may be noted that the concept of fiscal federalism is relevant for all kinds of government: unitary, federal and confederal. The concept of fiscal federalism is not to be associated with fiscal decentralization in officially declared federations only; it is applicable even to non-federal states (having no formal federal constitutional arrangement) in the sense that they encompass different levels of government which have defacto decision making authority.
This, however, does not mean that all forms of governments are 'fiscally' federal, only that 'fiscal federalism' is a set of principles that can be applied to all countries attempting 'fiscal decentralization'. In fact, fiscal federalism is a general normative framework for assignment of functions to the different levels of government and appropriate fiscal instruments for carrying out these functions
These questions arise: (a) how are federal and non-federal countries different with respect to 'fiscal federalism' or 'fiscal decentralization', and (b) how are fiscal federalism and fiscal decentralization related (similar or different)?
Chanchal Kumar Sharma clarifies that while fiscal federalism constitutes a set of guiding principles, a guiding concept that helps in designing financial relations between the national and subnational levels of the government, fiscal decentralization on the other hand is a process of applying such principles.
Federal and non-federal countries differ in the manner in which such principles are applied. Application differs because unitary and federal governments differ in their political and legislative context and thus provide different opportunities for fiscal decentralization.
Main Concepts
The concepts of fiscal federalism are related to vertical and horizontal fiscal relations. The notions related to horizontal fiscal relations are related to regional imbalances and horizontal competition. Similarly the notions related to fiscal relations are related to vertical fiscal imbalance between the two senior levels of government, that is the centre and the states/provinces. While the concept of horizontal fiscal imbalance is relatively non controversial (as explained above), the concept of vertical fiscal imbalance is quite controversial (see Bird 2003 and Sharma 2011 )A recent article published in Public Administration, Blackwell, Oxford, authored by Chanchal Kumar Sharma, clarifies the notion of vertical fiscal imbalance. The paper also demonstrates how the notion of Vertical Fiscal Imbalance (VFI) is conceptually distinct from the notion of Vertical Fiscal Gap (VFG). These terms are used as synonyms which they are not. Recent attempts at differentiating the notions, particularly in the Canadian literature on fiscal federalism, had rather added to the confusion (see Sharma 2011, Tables 1,2,3; section VI). The incisive analysis of the aforementioned paper at once clarifies the entire conceptual confusion.
The article states that 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, can be determined by using certian criterions that the author has evolved. The kind of policy solution to be applied will depend on the nature of asymmetry (VFA). Thus, there can be three types of VFAs:
- 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.
- 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.
- Fiscal asymmetry without fiscal imbalance and without fiscal gap: VERTICAL FISCAL DIFFFERENCE (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.
Fiscal Federalism Network
OECD Network on Fiscal Relations Across Levels of GovernmentThe relationship between central and subcentral government bodies has a profound effect on efficiency and equity within the government and on macroeconomic stability of the country. The role of the OECD Network on Fiscal Relations Across Levels of Government is to provide data and analysis on these relationships between organizations at different levels of government.