Vertical Imbalance in the Fiscal Systems of Federal States

Abstract

A theory of vertical fiscal imbalance in federal states (VFI) is developed which distinguishes between long-run and short-run imbalances and between normative and positive interpretations of the concept. The analysis is carried out in the context of a simple three-sector model where the allocation of national output among sectors results from interaction of a public choice process with an overall resource constraint. The paper proposes welfare-theoretic definitions of long-run and short-run VFI. In addition, it uses the concept as part of a positive analysis in order to reassess broad trends in Canadian fiscal history.