Fiscal Federalism

Updated Dec 31, 2022

Definition of Fiscal Federalism

Fiscal federalism is the concept of how different levels of government (e.g., federal, state, and local) share the responsibility for providing public services and raising revenue. That means it describes the relationship between the different levels of government and how they interact with each other in terms of taxation, spending, and other fiscal matters.

Example

To illustrate this concept, let’s look at the United States as an example. The US federal government is responsible for providing services like national defense, regulating interstate commerce, and collecting taxes. In addition to that, the state governments are responsible for providing additional services like public education, maintaining roads, and collecting taxes. Last but not least, the local governments are responsible for providing police and fire protection, maintaining parks, and collecting taxes.

The way these different levels of government interact with each other is an example of fiscal federalism. For example, the federal government may provide funding to the state governments for certain projects, such as building a new highway. The state governments may then use this funding to build the highway and collect taxes from the local governments to help pay for it.

Splitting these responsibilities up between the different levels of government allows them to work more efficiently and make sure that federal, state, and local governments can focus on what they can do best.

Why Fiscal Federalism Matters

Fiscal federalism is an important concept because it helps to ensure that public services are provided in an efficient and equitable manner. Having different levels of government responsible for different services allows for a more efficient allocation of resources and a more equitable distribution of the tax burden. In addition, it allows for more localized decision-making, which can be beneficial in certain cases. For example, local governments may be better equipped to make decisions about local issues, such as zoning regulations or public transportation.