Fiscal Federalism:

Before analyzing the management of government finances in federal countries, it is useful to understand the concept of fiscal federalism.

Fiscal federalism relates to the division of government functions and finances in a logical way among multiple layers of government.  Traditional theory of fiscal federalism lays out general framework for the assignment of functions to different levels of government and appropriate financial powers for carrying out these functions. The public sector across the countries is not organised as a unitary or cenrtralised system. It is instead stratified into a number of levels of governments, each having its own particular set of functions and tax-raising powers. Over the years the fiscal federalism has gained world-wide recognition and decentralization of spending and revenue raising responsibilities to sub-central governments has increased. Political developments in post-communist countries in Central and Eastern Europe, and new trends in Latin America, Asia and Africa show that the tendency to adopt the principles of fiscal  federalism and decentralisation of governance has increased.

Fiscal federalism in addition to being economically efficient in providing and financing government services, can more effectively promote democratic and participatory forms of government. Fiscal federalism improves the responsiveness and accountability of policy makers and provision of services tends to respond to the preference of beneficiaries and taxpayers. It has the capacity to promote coincidence between the three circles of budgetary policy; those who decide, those who benefit and those who pay.