Challenges in the Design of Fiscal Equalization and Intergovernmental Transfers

Abstract

Responding to a variety of forces over the past decade, many developing and transitional countries have embarked upon serious fiscal decentralization reform initiatives. In recent years, many developed economies have also deepened their decentralized government structures. Very often the allocation of expenditure and revenue assignments in a fiscally decentralized nation leads to horizontal fiscal imbalances because of the different fiscal capacities and expenditure needs of sub-national governments. Decentralization design also often leads to vertical imbalances in favor of the central government because tax revenue sources are seldom as decentralized as expenditure responsibilities.