Designing Intergovernmental Equalization Transfers with Imperfect Data: Concepts, Practices, and Lessons

The design of intergovernmental equalization transfer mechanisms, whether as the result of the introduction of a new transfer scheme or as part of the revision of an existing one, is a key element of local government finance reform around the world. While the basic elements and principles of designing intergovernmental fiscal transfer schemes apply universally across both developed and developing economies, less developed and transition countries (LDTCs) often face the additional challenge of designing their transfer mechanisms in the absence of substantial data on relevant local fiscal, demographic, and socio-economic variables. The absence of the necessary data to adequately quantify local expenditure needs and fiscal capacity in order to allocate formula-based equalization grants in an efficient, equitable and transparent manner forms an additional hurdle in the implementation of a sound system of intergovernmental fiscal relations in many developing and transition economies.