Fiscal imbalance is a mismatch in the revenue powers and expenditure responsibilities of a government. When the revenue powers are divided between two or more tiers of government in a federation (i.e. center, state, local). In general, the Central government is entrusted with more financial resources. This is because due to its functional responsibilities like defence, space research, pension etc.

There is always a greater demand for its expenditure requirement than its revenue resources. That can lead to Fiscal crisis where the government expenditure is much higher than government revenue.

Types of Fiscal Imbalance

There are two types of fiscal imbalances:- Vertical Fiscal Imbalance and Horizontal Fiscal Imbalance.

Vertical Fiscal Imbalance:- It is the fiscal imbalance measured between the two levels of government (Center and States or Provinces).

Horizontal Fiscal imbalance:- It is the fiscal imbalance measured between the governments at the same level. For e.g. local and state governments of two states.

Vertical and Horizontal Fiscal Imbalances in Indian Economy

The division of expenditure functions and revenue-raising powers between the Union and the State Governments is given in the Indian constitutions.
division of revenue india constitution
As per the Union List and the State List, the major and elastic sources of tax revenue belongs to the Center, while relatively inelastic sources of revenue come under the purview of State Governments.
Also, the center enjoys almost unlimited powers to borrow from the domestic market as well as from abroad whereas borrowing powers of the states are subjected to various restrictions.
Horizontal fiscal inequality is part of the Indian fiscal federalism. The institutional framework of Indian fiscal federalism openly acknowledges this fact. A good example is giving the state of Jammu & Kashmir and Northeastern states the status of “Special Category” where the aim is to give higher grants shows the existence of horizontal fiscal inequality. 
To mitigate this kind of inequality, the Constitution of India has created a statutory authority called the “Finance Commission”.

Leave a Reply

Your email address will not be published. Required fields are marked *