Correcting Vertical Imbalance:

Vertical imbalance results when revenue sources assigned to sub-central governments do not match the expenditure requirements. Sub-central governments, it is felt, are also not able to raise tax rates due to political considerations. It is also a fact that sub-central governments in their quest to attract trade and industry, try to provide attractive packages by reducing tax rates. As a result central government succeeds in raising more taxes and the sub-central governments are left with more spending responsibility. Due to weak revenue base the public services provided by sub- central governments suffer. This vertical imbalance can be corrected by making inter-governmental transfers from central to sub-central governments to finance the required level of public services.