<P> Fiscal imbalance is a mismatch in the revenue powers and expenditure responsibilities of a government . </P> <P> In the literature on fiscal federalism, two types of fiscal imbalances are measured: Vertical Fiscal Imbalance and Horizontal Fiscal Imbalance . When the fiscal imbalance is measured between the two levels of government (Center and States or Provinces) it is called Vertical Fiscal Imbalance . When the fiscal imbalance is measured between the governments at the same level it is called Horizontal Fiscal imbalance . This imbalance is also known as regional disparity . </P> <P> While Horizontal Fiscal Imbalance requires equalization transfers, Vertical Fiscal Imbalance is a structural issue and thus needs to be corrected by reassignment of revenue and expenditure responsibilities between the two senior order of the governments . </P> <P> A horizontal fiscal imbalance (HFI) emerges when sub-national governments have different abilities to raise funds from their tax bases and to provide services . This creates differences in' net fiscal benefits', which are a combination of levels of taxation and public services . It is these NFBs which are the main cause of horizontal fiscal disparities that in turn generate the need for equalization grants . Prominent among the objectives commonly attributed to intergovernmental fiscal transfers is' equalization' of fiscal capacities or resolution of Horizontal Fiscal Imbalances . </P>

An example of horizontal imbalance in terms of own source funding at lower levels of government is