The fiscal imbalance in Australia is the disparity between the revenue generation ability of the three levels of governments in Australia relative to their spending obligations; but in Australia the term is commonly used to refer more specifically to the vertical fiscal imbalance, the discrepancy between the federal government's extensive capacity to raise revenue and the responsibility of the States to provide most public services, such as physical infrastructure, health care, education etc., despite having only limited capacity to raise their own revenue.
In Australia, vertical fiscal imbalance is addressed by the transfer of funds as grants from the federal government to the states and territories.
Vertical fiscal imbalance in Australia is largely the product of the Commonwealth's takeover of income taxes in 1942, during World War II, and rulings of the High Court of Australia that made various state taxes unconstitutional under the Australian Constitution, in particular section 90 and section 109.
Vertical fiscal imbalance means that the revenue-raising abilities of the governments do not coincide with their spending responsibilities.
Before 1942, consistent with the concurrent power in section 51(ii), both the states and the Commonwealth levied income taxes.
There was a second constitutional challenge in which the scheme was upheld on the basis of Section 96, in Victoria v Commonwealth (1957) 99 CLR 575 (the Second Uniform Tax case).
[1] This imbalance is addressed by a horizontal fiscal equalisation (HFE) policy overseen by the Commonwealth Grants Commission.
Australia has a formal horizontal fiscal equalisation (HFE) scheme, introduced in 1933, which distribute more funds to States and territories which have a lower capacity to raise revenue or have a greater cost burden, to enable each State and territory to have the capacity to provide services and the associated infrastructure at the same standard, if each made the same effort to raise revenue from its own sources and operated at the same level of efficiency.