Vertical fiscal imbalance
Also called: VFI · Topic: Fiscal Federalism: Finance Commission, Devolution and Centre-State Finances · NCERT: Beyond NCERT
Meaning
Vertical fiscal imbalance (VFI) is the mismatch between levels of government. The Centre has greater revenue powers, while the states carry larger spending duties. Buoyant, mobile taxes such as income tax, corporation tax and customs sit with the Centre. Buoyant taxes grow fast with GDP, and mobile taxes are easy to shift across state lines. Services people use daily, such as health, school education and police, sit with the states. This gap is closed through tax devolution (sharing central taxes with states) and grants.
Example
States account for about 60% of general government expenditure but raise a much smaller share of total revenue. To close this gap, the 16th Finance Commission (2026-31) gives states 41% of the divisible pool, which is the part of central taxes that is shared with states.
Don't confuse with
- Horizontal fiscal imbalance: VFI is the gap between the Centre and all states together. Horizontal imbalance is the gap among individual states.