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Unformatted text preview: to perform their assigned functions. Figures 11 through 15 present the importance of intergovernmental
transfers in the composition of subnational governments' revenue structure across regions.
There are different forms of transfer mechanism: sharing revenues and tax bases, establishing conditional or
unconditional grant systems. Central government and subnational governments can share revenues based on a formula
or share a tax base by one of them applying a surcharge on other’s tax. In the case of establishing grant system,
conditional grants require matching elements by recipient government but unconditional grants are given to recipient
government with full discretion to spend. The choice of transfer mechanism depends on the objectives of the
intergovernmental policies. If the only concern of the intergovernmental system is to address vertical fiscal gap, this
could be achieved either by revenue sharing or by “gap-filling” unconditional grants. The horizontal imbalances can be
alleviated with equalization transfers from the central government to subnational government. However, in practice,
measuring the horizontal imbalance and relative fiscal capacities of subnational governments is very difficult task and
only very few countries review them. The countries that undertake a comprehensive review of horizontal balances are
Australia, Canada, and Germany (Ahmad and Craig, 1997). 166 Commission on Fiscal Imbalance FIGURE 10
VERTICAL IMBALANCE BY REGION 70% 60% 50% 40% 30% 20% 10% 0%
Africa (2) East Asia and
the Pacific (6) Latin America
Caribbean (9) Europe and
(15) High Income,
OECD (20) South Asia (1) Note: Measured as transfers to sub-national governments as a share of sub-national
expenditures. Simple average of most recent observations in available countries.
Numbers in parenthesis indicate number of countries represented.
Source: International Monetary Fund. Government Finance Statistics Year Book 1998,
Country Tables. The intergovernmental transfer system of a country usually has diverse objectives to meet and in most cases, these
objectives may need to be met through a combination of policy tools. According to Ahmad and Craig (1997), there are
three different policy responses to establishing the link between vertical and horizontal balances:
1. Correct each imbalance by separate policy measures: The vertical imbalance at each level is resolved by taxsharing or grant arrangements. Horizontal imbalances are then resolved by payments from regions with higher
fiscal capacity to poorer regions. This is the approach used in Germany. 2. Implement an integrated system of equalization grants: The vertical and horizontal imbalances are dealt with
simultaneously through a system of grants, including equalization payments and special purpose grants. This is the
Australian and Canadian approach. 3. Correct only the vertical imbalance and ignore horizontal balance: As under the first option, vertical balances are
resolved by tax sharing and grants, but no action is taken to correct horizontal imbalances. Capital and labor
migration then responds, not only to earned income differentials, but also to the regional net fiscal benefits (net
benefit received from government expenditure and of taxes paid). There may be, however, special purpose grants
servicing central government objectives, which may also reduce horizontal imbalances at least in some functional
areas. This is broadly the approach in the Un...
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