Horizontal Imbalance and Fiscal Equalization:

The fiscal equity argument is significant in inter-governmental transfers as an instrument used to resolve horizontal imbalances. State governments differ in their economic conditions and stages of development. The revenue raising capacity and expenditure responsibilities of states vary significantly. The inter-jurisdictional differences in revenue capacity and expenditures needs are present even with the efficient assignment of functions and sources of finances. The provision of public services, therefore, is lower in poorer states having weak fiscal base and higher unit cost of providing such services. Thus inter-governmental transfers are required to offset the fiscal disabilities of the states with lower revenue capacity and expenditure needs. To fulfill the concept of horizontal equity, it is necessary to give transfers so that each state is enabled to provide same level of public services at a given tax rate.  This type of transfer is known as equalizing transfers and is designed to offset differences in revenue capacities and variations in the unit cost of providing public services due to reasons beyond states' control.