The practice of fiscal equalization: a political economy clarification

The objective of this chapter is to present the main issues associated with equalization in such a way that one can more easily compare the fundamental architecture of equalization between countries. This chapter first highlights milestone contributions to the political economy of interregional solidarity then distinguishes between interregional disparities (equalizable) and differences (not equalizable). It then introduces the notion of first- and second-generation equalization models: they differ in their treatment of expenditure needs. First generation equalization either ignored expenditure needs or mixed revenue and expenditure needs in one formula. Second generation equalization addresses revenue and expenditure needs equalization explicitly yet in complementary fashion. The chapter then presents a comprehensive and coherent listing of the key issues in equalization policy followed by a synoptical table linking possible determinants of disparities to revenue, needs and cost differences. It shows that high unit costs for public services is often linked to high revenue potential.