Grants:

In most federal countries inter-governmental transfers have been employed as an effective instrument to resolve fiscal imbalances, both vertical and horizontal, and to offset inter-jurisdictional spillovers. Inter-governmental transfers are also often used by the central government to influence the spending pattern of sub-central governments or to implement its expenditure plans through sub-central governments using them as agencies. Inter-governmental transfers have been emphasized in federations as political tools to pursue national goals, enabling the sub-central governments to follow their objectives, while influencing their priorities through conditionalities and coordination.

The inter-governmental transfers are designed to fulfill certain objectives. The economic objectives are important parameters for designing and evaluating the transfer scheme. The analysis of inter-governmental transfers should focus on allocative efficiency, distributional equity and macroeconomic stability. The efficient transfer system depends to a great extent on the institutional mechanism that determines the overall scheme. Economic rationale of inter-governmental transfers is significant, though in actual practice, the quantum and distribution of transfers are influenced by non-economic factors like political considerations.

Intergovernmental transfers target four principal objectives;

1) Correcting vertical fiscal imbalance: transfers are used to fill the gap between revenue-raising capacity and needs

2) Reducing horizontal fiscal imbalance and harmonizing tax burdens: transfers may bring in additional resources to government units with lower fiscal capacity

3) Compensating for jurisdictional spillovers: local government units providing services to people living in other jurisdictions must receive adequate compensation.  The rationale for transfers is both equity and allocative efficiency.

4) Implementing federal public policy through local governments: transfers make it possible to achieve minimum standard of provision of certain services imposed by regulation, while leaving local governments more freedom in the choice of instruments.