Intergovernmental fiscal transfer in Germany, Nigeria and Ethiopia

Term Paper, 2018

49 Pages




1. General overview of intergovernmental fiscal Transfer
1.1 Definition of intergovernmental fiscal transfer
1.2 Rationales and purpose for intergovernmental Fiscal Transfers
1.3 Objectives of intergovernmental fiscal transfers

2. Concept of Fiscal imbalance
2.1 Vertical fiscal imbalance
2.2 Horizontal fiscal imbalance

3. Intergovernmental fiscal transfer Types and Institutions
3.1 Types of Intergovernmental fiscal transfer
3.2 The Design of Intergovernmental Transfers: Types and Mechanisms
3.3 Procedures for Establishing and Modifying Intergovernmental Transfers
3.4 Institutions for Intergovernmental Fiscal Transfers

4.1 Legal framework and practice of intergovernmental fiscal transfers
4.2 Dispute Resolution and Adjudication
4.2 Challenges of fiscal transfer

Conclusion and lesson learned



Federalism is alleged to serve various purposes that could not be effectively handled by other forms of state formation structures. It is a gain saying that the federal arrangement is chosen for driving a benefit from a strong union without compromising regional autonomy. In federal arrangements that are primarily concerned in devolving powers mainly from the central to the sub national governments. This may also involve assigning expenditure and revenue responsibilities between the federal and regional governments and the need to rectify the fiscal gaps arising there from. This is the subject matter of fiscal federalism. Fiscal federalism is in general dividing the fiscal aspects of the functions of government (expenditure and revenue assignments) and the subsequent need for intergovernmental fiscal transfer between the tiers of government. It is principally concerned in allocating expenditure responsibilities, the revenue raising power, and rectifying the fiscal imbalances between the central and sub national governments through intergovernmental fiscal transfers. In that the whole paper deals with intergovernmental fiscal transfer in comparative analysis of Germany, Nigeria and Ethiopia federation.

The paper has four chapters. The first chapter concerns about the concept of intergovernmental fiscal transfer and the rational as well as the objective of having intergovernmental fiscal transfer.

In chapter two the types of fiscal imbalances discussed from the view of three federal countries arrangements. Types of intergovernmental fiscal transfer and Institutions are discussed in chapter three. In addition to that procedure for establishing and modifying intergovernmental transfers as well as the design of intergovernmental transfers are included in this chapter.

Chapter four is particularly concerned in reviewing the legal frame work and experience of three federal countries (Germany, Ethiopia, and Nigeria) on intergovernmental fiscal transfers. The chapter discusses in brief intergovernmental fiscal transfers legal frame work and practice as well as challenges of each of the three federal countries and dispute resolution mechanism.

Lastly the paper ends with conclusion and in indicating the comparative lessons that Ethiopia could draw from the foreign experiences.


1. General overview of intergovernmental fiscal Transfer

1.1 Definition of intergovernmental fiscal transfer

Intergovernmental fiscal transfer is meant to bridge the horizontal and vertical fiscal imbalances that are inevitable to exist between the federal and regional governments and among the regional governments. Once we have ascertained that the possibility of horizontal and vertical fiscal imbalance is inevitable, there has to be a mechanism devised to bridge the fiscal gaps that occur between the federal and state governments or among the latter. Such gaps can be mitigated through a transfer of a predetermined share of, in most cases, the revenues collected by the federal government. It is at this juncture that the issue of intergovernmental fiscal transfer is raised. Different scholars of fiscal federalism propagated that these fiscal imbalances have to be rectified by devising different means. Boadway and Shah contended that there are two broad ways through which fiscal gaps are rectified. The first is revenue sharing while the second falls under the general rubric of federal- state transfers. Revenue sharing and grants (transfers) are therefore the two main means through which fiscal imbalances are handled.1 Intergovernmental fiscal transfer is, therefore, an allocation by the federal government as a means of bridging the fiscal imbalances (vertical or horizontal). Intergovernmental fiscal transfers involve two main decisions: the federal government needs to decide on the aggregate pool of federal grants and the pool has to be distributed among the respective lower sub-national governments. The federal government may use different parameters both to decide on the aggregate pool and the amount that is going to be distributed to sub-national governments. In Germany Intergovernmental Fiscal Transfers are used as a means of bridging the vertical and horizontal fiscal imbalances and the German fiscal equalization system provides for four steps.2 But, in Nigeria intergovernmental fiscal transfers are used to ensure that revenues roughly match the expenditure needs of various levels of sub-national governments. The structure of these transfers creates incentives for national, regional, and local governments that affect fiscal management, macroeconomic stability, distributional equity, allocation efficiency, and public service delivery.3

On the other hand intergovernmental transfers are the dominant source of revenues for sub national governments in most developing and transition economies. These transfers come in a variety of forms unconditional or conditional. Unconditional transfers come simply as a budget support with no strings attached. Conditional transfers typically specify the type of Expenditures that can be financed.

Intergovernmental financial transfers as the system through which most countries achieve vertical fiscal balance, that is, ensure that the revenues and expenditures of each level of government are approximately equal.4 Fiscal transfers to local governments are direct financial allocations from the federal government or state government to the local government. In Nigeria, it is called grants or statutory allocations. The transfer of funds from the central government to the local administrations is premised on certain considerations. Most important of the considerations concerns the relative reluctance of the federal government to vacate some certain revenue fields for the local governments.5

Intergovernmental fiscal transfer in Ethiopia is to address these imbalance that exist between territorial define level of government which assume expenditure and revenue raising responsibilities, although this process adjusting imbalances, the reason for some state entitled some federal revenue generate from businesses or individual in other region. Intergovernmental transfer aims to equalize financial capacity between the sub national important to measure financial governments. But capacity before transfer is made Measuring of fiscal capacity of region for fiscal relation at federal between federation and state. Fiscal relation exists at state level between the state and local government at local level.6

1.2 Rationales and purpose for intergovernmental Fiscal Transfers

In federal arrangements that are primarily concerned in devolving powers mainly from the central to the sub national governments. This may also involve assigning expenditure and revenue responsibilities between the federal and regional governments and the need to rectify the fiscal gaps arising there from. The international community is well aware of federalism these days probably than any other time in human history. Federalism is alleged to serve various purposes that could not be effectively handled by other forms of state formation structures. It is a gain saying that the federal arrangement is chosen for driving a benefit from a strong union without compromising regional autonomy. In order to do so, to understand which functions and instruments are best centralized and which are best placed in the sphere of decentralized levels of government. This is the subject matter of fiscal federalism.7

One aspect of fiscal federalism is assigning responsibilities between the national and sub national governments following both economic and political parameters. The common understanding in this regard is that among the allocation, redistribution and stabilization roles of the government, it is wise to give the sub national governments the allocation role (save for those allocations such as defense that provides services for the entire population of the country) reserving the other two to the central government. The role of government in maximizing social welfare through public goods provision came to be assigned to the lower tiers of government. The other two roles of income distribution and stabilization are regarded as suitable for the central government. Each assignment has its own justifications. It also distributes the fiscal decision making powers between the federal government and the nine regional States. The theory of fiscal decentralization, inter alia, involves the assignment of responsibilities and functions between the federal governments and the sub-national governments and the assignment of taxation powers. While the former imposes a duty of expenditure, the latter entitles the bearer for revenue capacity to exercise its expenditure duties.8

However, it is usually contended that the expenditure responsibilities imposed up on sub-national governments far more exceed their revenue power which puts them in disadvantageous position by letting them substantially dependent on the central government at the expense of prejudicing their autonomy. In other words, the distribution of the tax base (revenue power) of sub-national governments and the demand for public goods (their expenditure duties) does not follow equal pattern and this gives rise to the emergence of fiscal imbalances, vertical or horizontal.

One of the principal rational of the laws and policies on fiscal federalism is then to at least minimize, if not get rid of, these fiscal imbalances that occurred between the federal government and regional governments on one hand and among regional governments on the other. As such, the problem of fiscal imbalance requires measures that include the provision of subsidies as well as policies that promote balanced growth of regional economies and their taxation bases. The most common practice is providing federal fiscal transfers or subsidies to bridge the fiscal gaps in the regional governments.

The first purpose of transfer is bridging the fiscal gap. To deal with the vertical fiscal gap, however, we should not hasten to use transfers which should only be used as a last resort. It is wise to exhaust other alternatives as reassignment of responsibilities, tax decentralization, and tax base sharing (by allowing sub national governments to levy supplementary rates on a national tax base). Only as a last resort should revenue sharing or formula based transfers be considered in order to deal with this gap. This is because the latter have the tendency to weaken accountability to tax payers.9

The other purpose of fiscal transfer could be bridging the fiscal divide through fiscal equalization transfers. This purpose is to deal with the horizontal fiscal imbalances persisted among the sub national entities. The main purpose here is bringing the equal treatment of citizens nationwide irrespective of their place of residence. Such transfers are made with the purpose of redistributing revenues from better offs to less-well-off states.10 This is a case even when the scheme is a gross one financed by the federal government because the financing itself comes from federal general revenues that are drawn predominantly from relatively well- off states.11 Here, grants from the federal government to states/local governments can eliminate differences in net fiscal benefits if the transfers depend on the tax capacity of each state relative to others and on the relative need for and cost of providing public services. However, it is argued that it is better if fiscal equalization programs take in to account the fiscal capacity of the states leaving the fiscal need consideration to be filled by conditional grants. In this connection, Boadway and Shah argue that:12

…in the interest of simplicity, transparency, and accountability, it would be better for such programs to focus only on fiscal capacity equalization to an explicit standard… Fiscal need compensation is best dealt with through specific purpose transfers for merit goods, as is done in most industrial countries”.

In general equalization transfers are, to use the words of Robin Boadway, the life blood of federations that facilitate the decentralization of fiscal responsibilities by addressing the inequities and inefficiencies that would result from decentralization of spending and revenue raising responsibilities.13

It is usually contended that poorly assigned grant systems can create perverse incentives for sub national governments on diligently pursuing their revenue and expenditure responsibilities and on their efficiency. To go away with this problem of perverse incentive, it is argued for the fiscal transfer endeavors for the enhancement of tax effort and expenditure efficiency.14

1.3 Objectives of intergovernmental fiscal transfers

Intergovernmental transfer systems have various objectives; equalization and redistribution are the key ones. Intergovernmental transfers are used to improve both vertical and horizontal differences in the abilities of governments to mobilize resources and their needs to provide public services. Although the two dimensions are generally considered separately, they are obviously related since any attempt to improve vertical equity through grants can affect horizontal equity.15

According to conventional economic theory, the primary aim should be to promote efficiency in the allocation of resources while the central government would be responsible for stabilization and income distribution. Theory argues that if the benefits of particular services are largely confined to local jurisdictions, welfare gains can be achieved by permitting the level and mix of such services to vary according to local preferences. Local consumers confronted with the costs of alternative levels of service can express their preferences by voting for rival political candidates (voting with their hands) or moving to other jurisdictions (voting with their feet). In this respect, local politics can approximate the efficiencies of a market in the allocation of local public services by pricing municipal services and relying on the local political process and household mobility to clear the market. On this basis, a successful system of intergovernmental relations would be one in which each level of government (1) performs only functions whose benefits are confined to its boundaries and (2) derives its revenues from sources (such as local taxes and fees) that confront its residents with the costs of these functions.16

A/ Vertical Equalization objective

The issue of vertical inequities in a multi tier system of governments stems primarily from the outcomes of public service responsibility and revenue assignment decisions. Economic justifications for public sector involvement in the economy. These include economic stabilization, redistribution of incomes and wealth, and allocation of goods and services to correct market failures. It is generally argued that the national or central government has an advantage in the first two of these, whereas sub national governments can provide many public services more efficiently than can a central government.17 Local rather than higher levels of government can often provide local roads, water supply, waste management, police and fire protection, primary education, and primary health services more efficiently. On the other hand many important tax revenue sources, however, such as the value-added tax, business and personal income taxes, and international trade-based taxes, are more efficiently administered by national government. These realities imply that there is likely a significant imbalance between national revenues and spending requirements and local revenues and spending needs, thus necessitating intergovernmental transfers to correct the imbalance.

B/ Horizontal Equalization

Although vertical equity is important, even more attention has been given to the horizontal dimension. There is little doubt that resources in most countries are not spatially distributed uniformly. All regions are not endowed with similar levels of natural resources or other economic advantages; likewise, the populations of all regions are unlikely to have identical demands for local public services.18

Two basic approaches are used in addressing equalization. One approach is to concentrate on the varying abilities of different regions to mobilize resources on their own and to provide relatively greater transfers to localities with lower fiscal capacities. A second approach is to include differential expenditure needs in the equalization exercise and provide relatively greater transfers to localities that have greater gaps between local spending requirements and local fiscal capacity.19

Specifically, intergovernmental transfer has the following objectives,

1/ Bridging /narrowing/Vertical Fiscal Gaps;

The vital or main objective of intergovernmental fiscal transfer program is to reducing the fiscal disparity among the regions and to enabling regions perform their tasks and promoting balanced development and to fill full or to eliminate the gap of fiscal imbalance among the intergovernmental or sub national state arising from a mismatch between revenue and expenditure needs, to deal with the vertical gap by different mechanisms or reassignment of responsibility like tax decentralization and tax base sharing.20

2/ Bridging the Fiscal Divide through Fiscal Equalization Transfers;

Intergovernmental fiscal transfers aim or target is to equalize the financial capacity among the sub national government.21 Fiscal equalization transfers play an important role in allowing poorer units to compete effectively with strong units and advocated to deal with regional fiscal equity concerns.22 Fiscal equalization is the means to correct sub national difference of revenue raising capacity or public service cost in the name of public service equality and factor mobility with in a common economic union and the purpose of fiscal transfer lies in the view that all citizens within the country should be entitled to get comparable service without having to be subject to excessively different tax rate.23 Other objective also to deal with the horizontal fiscal imbalance persisted among the sub-national entities the principal objective or target here is bringing the equality treatment of people of the nationwide irrespective of their place resident. This like transfer is made with the reason of redistribution revenues from the economic better to the weak region.24

3/ The fiscal transfer could also help to select national minimum standards

This is accomplished by conditional non-comparable output based conditional grants that reflect national efficiency and equity.

4/ Fiscal transfers could be used to compensate for benefit spill over

Compensating for benefit spill over is the traditional argument for providing matching conditional grants, for local and regional government will not face the true encourages to provides the correct level of service that yield spill over advantages to residents of other jurisdiction, the federal government provides comparable grants which is conditional block grants or specific purpose conditional grants in order to remove the vertical imbalance and to assist the poorer regions by the intergovernmental fiscal transfer in the form of tax share.25

5/ Intergovernmental fiscal transfer is to serve as to influence local priorities that means in federalism system there are at least two tiers government so inevitably have their own area of priorities. The federal government could only induce state and local government to follow priorities that established by the national or regional state government by using its spending power to provide comparable transfers.

6/ Fiscal transfer is to deal with infrastructure deficiencies and creating micro economic stability in depressed state.

These are the main objectives of intergovernmental fiscal transfers and it is done by capital grant. It can be used to gain political goals that means when the fiscal decentralization is made correctly or served politically decentralization but in practice or reality due to lack of resource sometimes local governments alive for political reasons.26


2. Concept of Fiscal imbalance

Any type of federal arrangement involves a division of functions between the Central Government and sub national governments (expenditure assignment) as well as assignments of different sources of revenue to different types of government (revenue assignment). Adopting the principles of expenditure and revenue assignments cannot by itself guarantee a balanced budget at all levels of government. Some degree of mismatch between expenditure needs and revenue means at various levels of government is likely to occur. It is alleged that it is inevitable to have fiscal imbalance for it is necessary to retain some taxing powers at the federal government. In such circumstances, Eshetu noted, only rarely does one encountered balance between the spending needs and revenue capacity of either the Central Government or the regions, and all too often, either the center or the region is unable to cover its expenditure from its own fiscal resources.27 The fiscal imbalance may either be vertical or horizontal.

2.1 Vertical fiscal imbalance

Vertical fiscal imbalance is the disparity between revenue means and expenditure needs at various levels of government in a federation. It occurs when own revenue and expenditure capacity of varies levels of government within a federation are unequal. It is the result of an allocation of expenditure responsibilities with higher cost than the source of revenue assigned to sub-national governments.28 In that Ronald Watts pointed out that vertical fiscal imbalance occurs mainly for two reasons.29 Firstly, it has usually been found desirable to allocate the major taxing powers to the federal government because they are closely related to the development of the customs union and more broadly to an effective economic union. That means, when the federal government is assigned revenue power, it ends in its winning the lion’s share of the revenue. The second reason is that, no matter how carefully the original designers of the federation may attempt to match the revenue sources and the expenditure assignments of each order of government, over time the significance of different taxes change and the costs of expenditures vary in unforeseen ways.

From the outset it can be stated that the most lucrative taxing powers are granted to the federal government. For instance, the customs duties and other taxes on imports and exports constitute more than 30 per cent of the total revenue generated in Ethiopia is given for federal government.30 In Nigeria where natural resources are the overwhelming source of revenues, the federal government collects these and makes transfers to the states on a variety of criteria of which derivation is one. This has meant significant more per capita revenue for the producing states, but because they are underdeveloped and poor they have complained that this share is inadequate. They also want a special share of offshore revenues, though the offshore lies outside state boundaries. In addition, the producing states want a greater say in the actual management of the resources, which has often been done in an environmentally damaging fashion and with little regard for the local population.31

As far as the regional taxing powers are concerned, even at first sight it is clear that some of them taking into account the current state of Ethiopian society will generate little revenue. In this regard, we can mention the power of the regional states to levy taxes on the income of farmers. Obviously, agriculture is an important sector of Ethiopia’s economy, but one should not forget that the large majority of farmers are small scale peasants who are barely able to survive and who consequently have little taxable income. The taxes on income from transport services rendered on waters will neither generate substantial income. Ethiopia has many rivers and lakes, but there is little transport on these waters. Finally, the alarming scale of deforestation will negatively affect royalties for the exploitation of forests. For example: - The impression that the taxing powers of the regions will generate little income is confirmed by the following table.32

Abbildung in dieser Leseprobe nicht enthalten

The table shows that in the period 1993-2002 the regional states constantly generated less than 20% of the total Ethiopian tax revenue. More than 80% of the revenue was thus collected by the federal government. Whereas the contribution of the regions to the total fiscal revenue does not show an increasing trend, in the period 1993-1998 the regions had an increasing share of expenditure. The share of the regional states in the total expenditure augmented from about 35% in 1993/1994 to more than 45% in 1997/1998. We can observe a marked decrease of the regional share in total expenditure from 1998 to 2000, which can be explained by the higher federal expenditure for defense necessitated by the war with Eritrea.


1 Robin Boadway and Anwar Shah, Fiscal Federalism Principles and Practices of Multi Order Governance, Cambridge University Press, 2009, P.293)

2 (Lars P. Feld and Jurgen Von Hagen, “federal Republic of Germany”, in Anwar Shah (ed), a Global Dialogue on Federalism Vol IV, The Practice of Fiscal Federalism: Comparative Perspectives, Published for Forum of Federations, McGill- Queens University Press, Montreal and Kingston. London. Ithaca, 2007, P. 145)

3 ( Broadway, R & Shaw, A. (2007). Intergovernmental fiscal transfers: Principles and practice. Washington, D.C: The World Bank)

4 In Raoul B. and Arnold K. (Eds). Federalism in a changing world – learning from each other.McGilli: Queen's University Press, Montreal and Kingston, Canada)

5 (Alo, E. N. (2012). Fiscal federalism and local government finance in Nigeria . World Journal of Education, 2 (5), 19-27)

6 Solomon neguse, fiscal federalism in the Ethiopian ethnic – based federal system , published 2006, p.47. )

7 Wallace E. Oates, an Essay on Fiscal Federalism, Journal of Economic Literature, Vol. 37, No. 3. , 1999, P. 1121

8 Getachewu Mengiste intergovernmental fiscal transfers in ethiopia: challenges and some options (a comparative study)

9 (Anwar Shah (ed), Global Dialogue on Federalism Volume IV, the Practice of Fiscal Federalism: Comparative Perspectives, Introduction, Principles of Fiscal Federalism, Published for Forum of Federations, Mc Gill- Queen‟s University Press, London, 2007, P. 28)

10 ( George Anderson, Fiscal Federalism: Comparison of Experiences of Federations (Amharic), Forum of federations, 2010, P.80

11 Robin Boadway and Anwar Shah, Fiscal Federalism Principles and Practices of Multi Order Governance, Cambridge University Press, 2009, P.341)

12 Ibid P. 375

13 Ibid p.376

14 (IEhtisham Ahmad and Bob Searle, „On the Implementation of transfers to Sub National Governments‟, in Ethisham Ahmad and Giorgio Brosio (Eds), Hand Book of Fiscal Federalism, Edward Elgar Cheltenham, UK. Northampton, MA, USA, 2008, P. 381

15 Paul Smoke and Yun-Hwan Intergovernmental Fiscal Transfers in Asia: Current Practice and Challenges for the Future: Kim pp33

16 William Dillinger, Intergovernmental Fiscal Relations in the New EU Member States Consolidating Reforms WORLD BANK WORKING PAPER NO. 111 , world bank 2007

17 Ibid 33

18 Ibid 37

19 Ibid 38

20 Fiscal federalism in the Ethiopian ethics-based federalism Dr.solomun niguse 2006 p.48

21 Ibid p.47

22 Journal of economic litreture Wallace e cate 1999 p 1127

23 Comparing federal system 3rd .edition Ronald L.WATTS 2008 P.45

24 Anwar shah p 28

25 Comparing federal system 3rd.edition Ronald L.Watts 2008 p.44

26 ibid P 115

27 melkamu bessie, fiscal decentralization in benishangul gumuz region: a review of problems of fiscal imbalance a thesis submitted to the school of graduate studies Addis Ababa university in partial fulfillment of the requirement for the degree of master of arts in regional and local development studies June 2004, p.22

28 Supra note 2, p.1

29 Ronald L. Watts, Comparing Federal Systems, third edition, Published for the School of Policy Studies, Queen’s University by McGill-Queen’s University Press Montreal & Kingston • London • Ithaca, 2008, p. 104

30 The Constitution of the Federal Democratic Republic of Ethiopia Proclamation NO.1/1995, 1st Year No.1, ADDIS ABABA, 21st August, 1995, art.96

31 Supra note 29, p. 97

32 DERESSE DEGEFA, Fiscal Decentralization in Africa: A Review of Ethiopia’s Experience, paper Economic Commission for Africa; (last visited, 4 april 2018). Solomon Negussie mentions that in the 2006/2007 fiscal year the regions still generated only 19% of their total expenditure; SOLOMON NEGUSSIE, “A Constitutional overview of Fiscal Federalism in Ethiopia”, Indi-an Journal of Federal Studies2010(1), (16) 30

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Intergovernmental fiscal transfer in Germany, Nigeria and Ethiopia
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intergovernmental, germany, nigeria, ethiopia
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Thokhat Nhial Lual (Author), 2018, Intergovernmental fiscal transfer in Germany, Nigeria and Ethiopia, Munich, GRIN Verlag,


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