What is Vertical Fiscal Imbalance (VFI)?

About Vertical Fiscal Imbalance (VFI):

• It is defined as the share of sub-national governments’ own spending not financed through their own revenues.
• A VFI describes a situation in which revenues do not match expenditures for different levels of government. 
• In other words, VFI is the fiscal gap in the sub-national governments due to improper decentralization of public revenue and expenditure.
• This asymmetry in revenue and expenditure decentralization is called Vertical Fiscal Asymmetry (VFA).
• It is a structural issue that can be resolved if revenue and expenditure responsibilities can be reassigned.
• It can be corrected through the financial transfers from the Union to the state governments.
• What's the Difference Between Horizontal and Vertical Fiscal Imbalance?
  • The simple difference between horizontal and vertical fiscal imbalances lies in who they affect.
  • With a horizontal fiscal imbalance, revenues and spending are mismatched for different regions of the country.
  • In a VFI, revenue and spending are not balanced for different government levels.

Q1: What is fiscal federalism?

Fiscal Federalism refers to the financial relationships and arrangements between different levels of government in a federal system, such as the central (or federal) government, state (or regional) governments, and local governments. The primary focus is on how powers, responsibilities, and resources are divided among these different levels of government, particularly in terms of taxation and expenditure.

Source: What is vertical fiscal imbalance?