Fiscal imbalance is a mismatch in the revenue powers and expenditure responsibilities of a government.
A fiscal imbalance emerges when sub-national governments have different abilities to raise funds from their tax bases and to provide services.
This creates differences in ‘net fiscal benefits’, which are a combination of levels of taxation and public services.
It is these NFBs which are the main cause of horizontal fiscal disparities that in turn generate the need for equalization grants.
[1] Thus, the transfer system can promote efficiency in the public sector and can level the field for intergovernmental competition.