1 of 10

PROBLEMS OF FEDERAL FINANCE

Dr. Yogita Beri

Assistant Professor,

Department of Economics,

Vasanta College for Women,

Rajghat Fort (B.H.U),

Varanasi- 221001.

​

2 of 10

Introduction

  • Federalism whereby two or more sovereign units of government Co­exist within the same political environment, provides the primary basis for the intergovernmental fiscal problems. It is very difficult to decide which level of government will perform the specific functions as per community preference.
  • In addition the revenue sources nec­essary to finance these expenditure functions must be allocated among the various levels of government in a specified manner. A considerable divergence exist between the sources of revenue and functional expenditure obligations among the government of a federation.

​

3 of 10

Problems

  • Financial Resources according to work
  • Factor adjustment with the changing conditions
  • Problem of Factor resources

-Vertical Fiscal Imbalance

- Horizontal Fiscal Imbalance

  • Fiscal Dependency

4 of 10

Financial Adjustment

  • Sharing of tax revenue
  • Surcharges on taxes
  • Grant-in-Aid

5 of 10

Fiscal imbalance

  • Fiscal imbalance is a mismatch in the revenue powers and expenditure responsibilities of a government.
  • In the literature on fiscal federalism, two types of fiscal imbalances are measured: Vertical Fiscal Imbalance and Horizontal Fiscal Imbalance. When the fiscal imbalance is measured between the two levels of government (Center and States or Provinces) it is called Vertical Fiscal Imbalance.

​

6 of 10

Vertical Fiscal Imbalance

  • When the fiscal imbalance is measured between the two levels of government (Center and States or Provinces) it is called Vertical Fiscal Imbalance.
  • The situation of imbalance of revenue and expenditures vertically between levels of government is referred to as the problem of non-correspondence or vertical fiscal imbalance.
  • Fiscal federalism tries to bridge this gap and attain a balance through vertical co-ordinations between the centre, state and local level public expenditure and resources needed to finance them.

​

7 of 10

  • The important methods adopted to achieve vertical fiscal equality be­tween the centre and regional governments in a federation are:
  • 1. Tax sharing :Under tax sharing arrangement a tax is levied and collected by single administration. But the proceeds are shared either wholly or partly with two or more units.
  • 2. Tax credit: Under the tax credit, a superior government unit allows a credit against its tax to anyone who pays the same kind of tax to subordinate units. This method eliminates tax competition problem and thereby increases the capacity of the subordinate units

​

8 of 10

  • 3. Tax deductibility: Tax deductibility is another method to correct vertical imbalance. Under the method permission is granted by one government to deduct tax paid from the tax payers upon which another government levies taxes.
  • 4. Grants-in-ad: Another method of correcting vertical imbalance in fiscal resources transfer is grants-in-aid. There are two types of grants : General (Block or unconditional) grant, or selective grant (restrictive or conditional grant.

9 of 10

Horizontal Fiscal Imbalance

  • When the fiscal imbalance is measured between the governments at the same level it is called Horizontal Fiscal imbalance. This imbalance is also known as regional disparity.
  • When fiscal imbalance occurs between different units of gov­ernment at the same level of government in a federation, it is known as problem of equalization or horizontal fiscal imbalance.

10 of 10

  • Horizontal fiscal imbalance is corrected and the principle of fiscal equity is achieved through inter state fiscal transfers.