Evaluating fiscal equalisation : Finding the right balance

Fiscal equalisation refers to the transfer of financial resources to and between subnational governments with the aim of mitigating regional differences in fiscal capacity and expenditure needs. However, the determination of fiscal capacity and expenditure needs is not a straightforward task. OECD countries use widely varying mechanism design approaches in their equalisation systems. This paper compares national approaches, covering the three modes of fiscal equalisation: pure revenue equalisation, revenue/cost equalisation and gap-filling equalisation, describing the distinct impacts of each approach on subnational revenue disparities. A clear inverse relationship emerges between the size of the cost-equalising component within a system and the percentage change in subnational per capita revenue disparities after equalising transfers are applied, although no significant relationship emerges between equalisation and regional convergence.