Equity and Efficiency Issues:

While the fiscal operations are carried out by a single level of government in some countries, they are carried out by different tiers of government in several other countries. The number or the levels of governments that deal with the fiscal operations also differ across nations with federal structure. For instance, USA, India, Australia, Canada and West Germany have a three tier  governments in the federal structure while Holland and Switzerland have two-tier federal structures. Whether it is a two- tier or three-tier federal structure or whether a federation is formed by aggregation or desegregation what is very essential rather inevitable is separation or segregation of powers and functions. In fact this division is the most crucial and delicate issue which needs coordination and intervention by the central government to avoid problems in the federation. One of such problems is the fiscal problem that arises due to the division of powers and functions which needs federal or central intervention to ensure  efficient solutions in case of less-than-optimum solutions and to bring in horizontal equity.

Horizontal equity gets added significance in several federal countries, especially in the developing economies due to the existence of regional disparities.  One method widely accepted across the federal economies around the globe to reduce regional disparities is federal fiscal transfers to finance regional development.  In other words, federal fiscal transfers has a very important role in bringing down regional disparities through financing regional development.  Of course, there is no unanimity among economists with regard to the transference of fiscal resources from the federal government to the backward regions or states.  While one approach does favour the equity aspect, the other opposes it commending the efficiency approach. Economists like J.M.Buchanan advocated fiscal transfers from the federal government to the needy poorer regions or states to promote economic development. According to him, the grants-in-aid or subsidies provided by the federal government encourages an in-migration of highly skilled labour along with capital and at the same time checks out-migration of skilled labour and capital from the poorer state, thus helping in accelerating the development process in the backward States.