The Incentive Effects of the Belgian Equalization Scheme: Proposals for Reform

Abstract

Equalization transfers from central to sub-central governments are a pervasive feature of nearly all systems of multi-level government. Not surprisingly, in many federal countries such as Canada and Germany, major programs transfer resources from more wealthy jurisdictions to those with relatively small tax bases or tax revenues. The literature mentions both equity and efficiency reasons for these equalization transfers (see Boadway (2004)). They may be an instrument for achieving horizontal equity among residents of different regions, that is, for ensuring that people can obtain comparable public services at comparable tax rates in all regions. Equalization might also serve as a stabilization device, insuring regions against adverse idiosyncratic shocks with which they may not be able to cope by themselves. Finally, equalization transfers may provide a more “level playing field” for interjurisdictional competition (Oates, 2006). Equalization schemes may have unintended consequences due to different moral hazard problems (see Boadway (2004)).