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Vertical fiscal imbalances (VFIs) have often been identified as an obstacle to sub-national accountability and good fiscal performance. VFIs occur when spending decentralisation outpaces revenue decentralisation. In these cases, sub-national governments must rely on central government transfers and borrowing to finance expenditures.
VFIs come into greater scrutiny during difficult times. Attention to VFIs increases when deficits become chronic, necessitating frequent bailouts. Sub-national bailouts can put intergovernmental fiscal relations under severe strain, providing ground for re-centralisation as a means to eliminate the VFI. Changes in relative fiscal positions—for example, when central government revenues thrive while those at the local level languish—also tend to put VFIs into the limelight. This is especially critical in Europe, where the ongoing financial crisis has exacerbated fiscal pressures at all levels of government. Understanding how changes in VFIs affect performance is thus of critical importance for the design of fiscal adjustment strategies, especially those that contemplate changes in intergovernmental relations as part of their fiscal reforms.
The countries Belgium, Italy, Norway, and Spain were selected because they have experienced a significant decline in VFI over the past two decades.
This paper finds that the decline in VFI was achieved through progressive devolution of revenues to sub-national governments in Belgium, Italy, and Spain, while re-centralisation of health sector expenditures was the cause of the decline in the VFI in Norway.