Rescuing the concept of vertical fiscal imbalance

This article restores the concept of vertical fiscal imbalance (VFI) to its original meaning. The literature shows that there is neither a universally accepted definition of VFI nor a commonly accepted approach to measuring it. Estimates of VFI are derived, much like accounting or deficit measurements, by comparing the revenues and expenditures of two levels of government. VFI is, however, too nuanced an issue to be described by this kind of national accounting procedure. We argue that ease of measurement should always take second place to the appropriateness of the economic concepts used; it makes no sense to adopt a definition that is convenient for measurement if it does not have a sound theoretical basis. The conventional definition of VFI however, falls into this trap, and the ad hoc definition was adopted for its expedience. This measure does not reflect whether taxes and expenditures across the various levels of government are too high, too low or about right. Unfortunately, the sacrifice of rigour for tractability has seriously harmed the quality of public policy debate on the issue.