List of Abbreviations
List of Tables
List of Figures
Chapter One: Introduction
1.1Background of the Study
1.2Statement of the Problem
1.3Broad Purpose of the Study and Research Questions
1.5Significance of the Study
1.6Scope and Limitation of the Study
1.7Organization of the Paper
Chapter Two: Review of Related Literature
2.1.The Concept and Essence of Decentralization
2.4.Causes of Vertical and Horizontal Fiscal Imbalances
2.5.Intergovernmental Fiscal Transfers
Chapter Three Fiscal Decentralization in Ethiopia
3.1.Legal Framework for Fiscal Decentralization in Ethiopia
3.2.Expenditure and Revenue Assignments under the FDRE Constitution
3.3.Legal Framework for Intergovernmental Fiscal Transfer in Ethiopia
3.4. Federal Block Grant in Ethiopia
Chapter Four: Research Methods
4.1.Description and Rationales for Selecting the Study Area…
4.2.Data Type and Source
4.3.Research Strategies and Design
4.4.Target Population & Selection of Respondents…
4.5.Data Collection Methods
4.6.Methods of Data Analysis
Chapter Five: Results and Discussions
5.1.Causes of Fiscal Imbalance in Tigray
5.2.The Causes of Fiscal Imbalance in the Study Weredas
5.3.Inter-Governmental Fiscal Transfer and Consequence of Fiscal Imbalance in Tigray
5.3.1.Intergovernmental Fiscal Transfer in study area
5.3.2.Major Consequences of Fiscal Imbalance in study area
Chapter Six: Conclusion and Recommendation
List of Appendixes
List of Tables
Table 1.1:The Trend of Fiscal Imbalance in Tigray
Table 1.2:The Trend of Fiscal Imbalance in Wukro and Maichew Weredas
Table 3.1:Table 3.1 Grant Percentage Shares of Regions to 2009/10-2011/12
Table 4.1:Planned and actual revenue collection in Tigray
Table 4.2:The contribution of total grant to the expenditure of Tigray
List of Figures
Figure 2.1:Conceptual Framework of the Paper
CHAPTER ONE: INTRODUCTION
1.1. Background of the Study
In recent decades, there has been a growing curiosity among development specialists, multifaceted development agencies, economists, and governments on decentralization as a primary tool for promoting economic growth (Oates, 1994). Hence the term decentralization holds a variety of concepts which must be carefully analyzed in any particular country before determining if projects or programs should support restructuring of financial, administrative, or service delivery systems. In line with this, decentralization refers to the restructuring or reorganization of authority so that there is a system of co-responsibility between institutions of governance at the central, regional and local levels according to the principle of subsidiaries, thus increasing the overall quality and effectiveness of the system of governance, while increasing the authority and capacities of sub-national levels (UNDP, 1997). The ministry of finance and economic development (MOFED, 2008), also states that, decentralization is a process of devolving the authority and responsibilities of raising and allocating resources from the central government and its agencies to subordinate units or lower levels of government.
Fiscal decentralization is one component of decentralization that gives authority to local governments to collect revenue through taxes and non-tax mechanisms and responsibility over spending decisions. It takes many forms such as expansion of local revenues through property or sales taxes, responsibility of spending decisions and others. In addition to this, Giugale and Webb (2000), argue that, access to own revenues is key to fiscal decentralization because it gives sub national governments control over the size of public spending within their jurisdictions. Even though fiscal decentralization has given revenue raising and spending decision powers to lower levels of government, the implementation process has often been a daunting task for many local authorities in the developing world (Edson & Tendayi, 2010).
In the case of Ethiopia, it has been one of the most centralized economies and centralized state in Africa until early 1990s. But 1995 federal constitution is the basic document that laid out the legal and institutional outline for decentralization in Ethiopia (Berhanu, 2009). According to FDRE 1995 constitution, the Federal Democratic Republic of Ethiopia comprises of states. Accordingly there are nine regional states namely, Tigray, Afar, Amhara, Oromia, Somalia, Southern Nations, the state of the southern nations, nationalities and peoples, Benshangul-Gumuz, Gambela and Harari national Regional States and two autonomous administrative cities, namely, Addis Ababa and Dire Dawa. According to Berhanu (2009), the principles and the need for fiscal decentralization in Ethiopia emanates from federal and regional states’ Constitutions. The objectives of the respective constitution include the need to devolve fiscal decision-making power to lower tiers of government; to enable regional states and Wereda governments/administrations provide standard services; and to narrow the vertical fiscal gap Berhanu 2009).
However, revenue raising and expenditure management are not efficiently and effectively exercised, especially in lower level government units of Ethiopia. Insufficient revenue collection and reprehensible expenditure management leads to financial incapability such that public infrastructure and services could not be financed amply (Edson & Tendayi, 2010). Fiscal imbalance occurs when there is lack of coordination between public expenditures and public revenues. There are two kinds of fiscal imbalance, namely: vertical and horizontal fiscal imbalances (Richard & Andrey, 2002). According to Berhanu (2009), a vertical fiscal imbalance occurs when the own revenue and expenditure capacity of various levels of government within a federation are unequal. While horizontal imbalance occurs when the own fiscal abilities of various sub-national governments of the same level differ.
To sum up, this research composes six chapters. The first chapter presents background of the study, statement of the problem, broad purpose of the research, specific research questions, significance of the study, scope and limitation of the study and organization of the paper. The second chapter deals with reviewing of related literatures and empirical findings regarding to fiscal imbalance while chapter three assesses fiscal decentralization in Ethiopia. Chapter four also focuses on research methods while chapter five is all about results and discussions of the findings. Finally chapter six comes up with concluding remarks and possible recommendation to minimize the problem.
1.2. Statement of the Problem
Fiscal decentralization is intended to assist regional governments by improving their capacity for developing their localities through self-initiative. It is also meant to narrow the existing gaps in economic growth and development among regions (Kasshaun and Tegegne 2004). Despite this, fiscal imbalances between regions and heavy dependence of the regional governments on the federal government’s transfer and subsidies have persisted. Accordingly the dependence of the regional government on the federal grants is so significant that without federal grants most of the regions could not even cover their recurrent expenditure.
In other words, the revenue generating power of the central government by far exceeds that of the regional government. This clearly indicates the dominance of the federal government in revenue generating capacity and hence led the regional government to extensively rely on transfer from the central government. Furthermore, the federal structure of Ethiopia curved regional states that exhibit significance variation and heterogeneity. These diverse circumstances of the regional states gave rise to horizontal fiscal imbalance. The regional distribution of revenue sources is such that it leaves most of the regional states with revenue flows far short of their expenditure responsibilities (Deresse, 2003).
According to MOFED (2009), most regions do not cover their budgetary expenditures from their own revenue sources; it is through the Federal Block Grant transfers that regions get a major part of their budget. More than 80% of the budget sources in most regions and about 95% for the emerging regions, such as Afar, come from federal government subsidies. The remaining 5-20% of the budgets originates from the regions’ own revenue (MOFED, 2009).
In line with this, Tigray region is among the regions in Ethiopia which has been adversely affected by the problem of vertical as well as horizontal fiscal imbalance. The following table clearly reveals the 6 years trends of fiscal imbalance in the national regional state of Tigray.
Table No 1.1. The Trend of Fiscal Imbalance in Tigray
Abbildung in dieser Leseprobe nicht enthalten
Source: Revenue Authority; Five years strategic plan, 2011
Table 1.1 clearly reveals the existence of vertical fiscal imbalance in Tigray i.e. in the last 6 years, the total expenditure of the region was 6,662,057,604, while the internal revenue of the region was 1,911,104,391. Averagely speaking, the region only covers 29% of its expenditure from its internal revenue sources while 71% of its expenditure was covered by federal government.
In addition to the above point, the Weredas in Tigray shows a high vertical as well as horizontal fiscal imbalance. Wukro and Maichew Weredas are among 46 Weredas found in Tigray facing the problem of fiscal imbalance. The following table clearly shows the trend of fiscal imbalance in Wukro and Maichew Weredas:
Table No 1.2. The Trend of Fiscal Imbalance in Wukro and Maichew Weredas
Abbildung in dieser Leseprobe nicht enthalten
Source: Researcher’s compilation: Based on data from revenue authority and bureau of planning and finance of the region 2011
Table 1.2 clearly reveals the existence of vertical as well as horizontal fiscal imbalance in Wukro and Maichew Weredas i.e. Wukro Wereda only covers 14.5% of its total expenditure while Maichew Wereda covers 11.3% of its expenditure in the last five years. The implication is that, the expenditure assignment of the two respective Weredas exceeds the revenue generating power. On the other hand, there is horizontal fiscal imbalance between the study Weredas. Table 1.2 clearly shows revenue generating inequality between Wukro and Maichew Weredas i.e. the internal revenue generating power of Wukro Wereda is better than Maichew Wereda.
Thus, due to vertical as well as horizontal fiscal imbalance, the question arises on the fiscal autonomy of Wukro and Maichew Weredas. The increasing influence of federal government on regional government as well as the regional government on Weredas through intergovernmental fiscal transfer creates more dependencies of regional government on federal government and Wukro and Maichew Weredas on regional government which affects the local self-governance.
Therefore, the existence of the problem required to conduct a research so as get a clear picture of the rationales behind the problem and their negative consequences as means to come up with possible recommendations.
1.3. Broad Purpose of the Study and Research Questions
Assessment of the causes and consequences of fiscal imbalance in Tigray is the core broad purpose of this paper. In getting the ultimate purpose of the research, the following specific and measurable research questions are considered:
- What are the causes of fiscal imbalance in Tigray in general and study Weredas in particular?
- What are the consequences of these fiscal imbalances in the study areas?
- Is there any mechanism to reduce or alleviate the challenges?
1.4. Research Objectives
The objectives of this study are:
- To analyze the causes of fiscal imbalance in the study areas.
- To examine the consequences of these fiscal imbalance in the study areas.
- To identify the possible ways of minimizing or alleviating fiscal imbalance in the study areas.
1.5. Significance of the Study
By investigating the causes and consequences of fiscal imbalance in Tigray, the researcher believes that, the study has the following benefits; first, it may contribute to a better understanding about the concepts of fiscal decentralization & intergovernmental fiscal transfer. Secondly, it helps all concerned government officials to get a better picture of the problem of fiscal imbalance so as deal with the matter to reduce the existing imbalance. Finally, it may also initiate other researchers and shed more light for further academic approach on the issue at hand. Identifying the revenue generating capacity of the study areas is another area of further research which is identified by the researcher.
1.6. Scope and Limitation of the Study
Decentralization includes the transfer of fiscal, political and administrative responsibilities to lower levels of government that are essential for promoting local self-governance system. However this research primarily focuses causes and consequences of fiscal imbalance. In line with this, there are two dimensions of fiscal imbalance i.e. deficit and surplus. Deficit fiscal imbalance occurs when the expenditure responsibility is better than the revenue generating power while surplus fiscal imbalance occurs when the revenue generating power is better than the expenditure responsibility. However, the research only assesses a deficit fiscal imbalance that occurs in the study areas. In line with this, geographically, the study only concentrate on Tigray region; focus on Wukro and Maichew Weredas, and the finding of this research may not represent the whole Weredas in Tigray.
1.7. Organization of the Study
The study has five chapters.Chapter onedeals with introduction which entails background of the study, statement of the problem, broad purposes of the research, research questions and significance of the study.Chapter twoalso deals with conceptual framework and specifically assesses theoretical and empirical findings on fiscal decentralization, vertical as well as horizontal fiscal imbalances and intergovernmental fiscal relations whilechapter threepresents fiscal decentralization in Ethiopia; specifically it deals with legal framework of decentralization, expenditure and revenue assignment under FDRE constitution and intergovernmental fiscal relation in Ethiopia context.Chapter Fourwill be research method. Accordingly it has have research design, data type and source, target population, methods of data analysis and ethical considerations.Chapter fourhas entail results and discussions, more specifically the causes and consequences of fiscal imbalance in the study areas. Finally,Chapter fiveprovides some concluding remarks and recommendations on fiscal imbalance of national regional state of Tigray in general and Wukro and Maichew Weredas in particular.
CHAPTER TWO: REVIEW OF RELATED LITERATURE
Initially this chapter has assessed the concepts, rationales and arguments of decentralization and goes through specifically to deeply analyses fiscal decentralization. A revenue and expenditure assignment has been reviewed using empirical findings and experiences of the world. Above all this chapter has reviews different research findings on the cause of fiscal imbalance throughout the world and has tries to assess intergovernmental fiscal transfer by taking the experience of some countries. Finally the chapter presents conceptual framework of the research which serves as a major guideline throughout the research.
2.1. The Concept and Essence of Decentralization
One of the most critical perquisites to translate decentralization from theory to practice is a clear understanding of the concept. To be able to better envision what decentralization means, how best it can be planned and implemented, what its intricacies are, and how its challenges can be overcome, development practitioners should be equipped with appropriate tools which could provide an analytical knowledge of decentralization from a conceptual viewpoint accompanied by real and field-tested examples of the concept in practice (UNDP, 1998). Accordingly decentralization in its broadest sense refers to division of multidimensional power (political, economic and administrative) between the center and sub national governments. The degree of transfer from the national government to regional government may vary starts from simply regulating workloads among different spans government to transferring all government from center to periphery (Eshetu, 1994). In addition to this, UNDP 1997 defines decentralization as a process of reorganizing of government power as a means to create a consolidated linkage among different levels of government so as to improve the quality and effectiveness of governance system vis-à-vis improving the capacity of sub national governments.
Thus, it is important, for a better understanding of the decentralization process, to identify the four major types of decentralization according to classification made by UNDP 1997: Political, administrative, fiscal and market decentralization. Political decentralization is the relocating of authority to a sub national body (UNDP, 1997). The major rationale of political decentralization is to devolve power from central government to sub-national governments (DDSMS & UNDP, 1997). In other words, administrative decentralization refers to the reorganization of authority for the planning, financing and management of certain public functions from the central government and its agencies to ground units of government agencies, subordinate units or levels of government, semi-autonomous public authorities or corporations, or area-wide, regional or functional authorities (UNDP 1997). Economic or market decentralization is the passing over to the private sector of the functions exclusively performed by government. While fiscal decentralization is one element of decentralization that gives authority to local governments to collect revenue through taxes and responsibility over spending decisions (Edson & Tendayi, 2010).
Even though countries of the world began to adopt decentralization as their doctrine of socio-economic and political activity, there is still a hot argument regarding the need to decentralize political, administrative and fiscal powers till the lowest span of government. There are advocators and opponents of decentralization. A possible argument in support of decentralization includes: Decentralization may consolidate diversity in unity at which it can preserve socio-economic and political diversities (Solomon, 2008). Decentralization can be a best means to effectively and efficiently manage economic development through discretion of multidimensional powers and responsibilities to lowest levels of government (Eshetu, 1994). Despite of the above pros of decentralization, there are still arguments against it. These include: decentralization may give central government a good opportunity over income distribution and it may adversely affects national unity and leads to disintegration and conflicts (Boex, 2001). In addition to this, Poorer regions may be at a further disadvantage in delivering efficient policies, are more likely to promote a lower quality of government decisions and more corruption (Ahmad and Tanzi 2002). According to Roeder (1991) and Snyder (1999) also, decentralization or federalism was the main cause for disintegration and led to the emergence of new independent states.
2.2. Fiscal Decentralization
Intergovernmental fiscal relations and fiscal decentralization deal with how public expenditure is organized between different levels of government and how it is financed (UNDP, 2005). Fiscal decentralization, however, is not merely an issue of transferring resources to the different levels of local government. It is also about the amount to which local governments are empowered, about how much authority and control they exercise over the use and management of devolved financial resources.
The satisfactory resolution of these policy elements plays a key role to the success of any decentralization program. This idea is supplemented by UNDP (2005). Accordingly there are three basic building mainstay of fiscal decentralization. These are:
- Expenditure responsibility to different levels of government.
- Revenue responsibility from tax and non-tax mechanisms.
- Intergovernmental fiscal transfer.
If sub national governments do not carefully balance their annual expenditures with revenues and transfers, this will result in sub national faults and the incurrence of debt. Intergovernmental fiscal transfers are frequently used to achieve diverse objectives, including minimizing vertical fiscal gaps, addressing horizontal fiscal inequities, providing reimbursement for benefit spill outs, and influencing sub national policies in taxing, spending, and regional and local economic stabilization (UNDP, 2007). In addition to this, the way intergovernmental fiscal relations are organized varies from country to country based on historical and geographical characteristics, the degree of heterogeneity of the population and the extent of government intervention in the economy (Fjeldstad, 2001). According to Oates (2001), federal fiscal structure holds (1) the assignment Expenditure responsibilities, (2) the alignment of revenue responsibility, and (3) a system of intergovernmental transfers.
2.2.1. Expenditure Assignment
Expenditure assignment is the first step in an intergovernmental fiscal system (Vazquez, 2001). Accordingly designing revenue and transfer components of a decentralized intergovernmental fiscal system in the absence of concrete expenditure responsibility would adversely decentralization process. The lack of clarity in the definition of sub national responsibilities has a negative impact on some important aspects. First, if the responsibilities are vague, the parallel revenues will remain poorly defined. Second, without clear responsibilities, sub national government officials might prefer to invest in populist projects which benefit them in the short run rather than in projects with long run impact on region's economy. Third, there will be confusion whether sub national expenditures request local priorities or centrally determined programs (World Bank, 2003).
2.2.2. Revenue Assignments
According to Niña (2009), if fiscal decentralization is to be a reality, sub-national governments must control their own sources of revenue. Sub-national governments that lack independent sources of revenue can never truly enjoy fiscal autonomy. The question, then, is which revenue sources (including taxes) can and should be assigned to sub-national levels of government and how these assignments are to be effected. Each level of government should be assigned taxes that are related to the benefits of its spending. Thus, the proper assignment of taxes that are related to benefits depends on the assignment of expenditure functions. In general terms, the central government should be responsible for expenditures having benefits that extend across sub-national boundaries or that are characterized by economies of scale not realized at the sub-national level.
One problem regarding the assignment of revenue sources in manydeveloping countriesis that while sub-national governments need to have at least some revenue discretion in order to fully benefit from fiscal decentralization reforms, central governments often seem unwilling to provide a significant degree of real revenue autonomy to sub-national governments – e.g. in setting tax rates or pursuing defaulters. In addition, revenue decentralization often causes increased sub-national fiscal inequality; with wealthier regions being able to collect more revenues than poorer ones. In these cases, equalization grants or other intergovernmental fiscal transfer schemes become necessary to ensure that sub-national governments have adequate revenues to fulfill their expenditure responsibilities (UNDP, 2005).
In line with above finding, according Izabela (2012:17), as the very long decentralization histories inItaly,Spain, and some other countries likeAustraliashow; decentralization tends to be slow, incremental, and can experience setbacks. Declining VFI is difficult to achieve, as revenue devolution is sometimes resisted in decentralized spending settings. Some of the obstacles to devolution of revenue to sub-national governments include:
Loss of “cheap” resources: Less populous and poorer local governments are sometimes halfhearted with respect to devolution of revenue responsibilities, as they fear a decline in equalization grants and associate it with higher disparities.
Inadequate tax base: Some taxes with broader bases are less adequate for sub-national governments as are those with re-distributive properties and mobile.
Weak administration: Administrative capacities for carrying out increasing revenue responsibilities had not existed. Administration and poor data quality and accounting practices have been considered obstacles to greater decline in the VFI in Italy during the 1990s and beyond.
Tax competition: The international tendency towards lowering the tax burden, and the need to support the economy during downturn, coupled with the threat of fiscal mobility, do not bode well with the need to exercise increasing fiscal autonomy by raising sub-national taxes.
2.3. Fiscal Imbalance
Fiscal imbalance seems intrinsic in almost all federal states. As a regulation federal governments tends to collect most taxes while sub-national governments are often responsible for more expenditure than can be financed from sources of revenue directly under their control. The resulting difference between expenditure and revenue of different level of government is called fiscal imbalance (Richard & Andrey, 2002). It occurs when there is a lack of coordination between public expenditures and public revenues. There are two kinds of fiscal imbalance, namely: vertical and horizontal fiscal imbalances. Before we are going to comparative analysis of the next section, we shall therefore discuss these two points and the role of intergovernmental fiscal transfer in dealing with them, at somewhat in detail.
2.3.1. Vertical Fiscal Imbalance (VFI):Vertical fiscal imbalance occurs when there is insufficiency between the expenditure responsibilities assigned to each level of government and the fiscal resources available to them to carry out those responsibilities (Boex, 2004). Ebel and Yilmaz (2002) also try to clarify vertical fiscal imbalance as a mismatch between expenditure responsibilities and revenue rising power of the two tiers of government. The revenue rising power of the lowest level of government is affected by poor tax collection and administration. In line with this, the most common source of vertical imbalance is the lack of revenue autonomy at the sub national level including the perception of the central authorities that most significant taxes should be centrally managed (Vazquez, 2004).
2.3.2.Horizontal Fiscal Imbalance (HFI):The problem of horizontal fiscal imbalance is common in all systems of multi-tiered government since sub national governments at the same level will almost never possess the same fiscal capacity. Horizontal fiscal imbalance arises because governmental entities at the same level must often provide essentially the same services but enjoy different revenue capacities and face different cost differentials in the provision of these standard services for inevitable and ‘unavoidable’ exogenous reason (Brain, 2008). In addition to this, Richer and Tarasov (2002) also defines horizontal fiscal imbalance as a disparity of resources of among different provinces at which some are rich and others are poor.
2.4. Causes of Vertical and Horizontal Fiscal Imbalances
Empirically according to the research conducted by Niña (2009), there are different factors that cause vertical fiscal imbalance in developing countries, especially in sub Saharan Africa:
- Exaggerated focus on the revenue side:The decentralization movement in many developing countries over the past decade made the mistake of designing a system of decentralized finances, revenue assignments and transfers, in the absence of a clear expenditure assignment, which is to put the car before the horse.
- Focus on the political dimensions: In many African countries, expenditures have been assigned to local governments and elections held but the availability of financial resources is lagging behind.
- Capacity constraints:Local governments often lack the necessary capacities to effectively make use of the available resources and competencies assigned.
- Imbalances due to External Shocks: external financial crises add another layer of complexity, altering the balance of the economy and creating fiscal pressure for both central and local governments.
All in all, according to the above empirical finding, unclear expenditure assignment, weak revenue power, limited human capacity and external financial crises are the core rationales for the existence of fiscal imbalance in developing countries, especially Africa. More practically, a research conducted in Nepal by Bharat (2008) clearly reveals that, weak revenue generating power, vague and comprehensive expenditure responsibility, and low fiscal capacity of local governments, low political commitment and absence of political elected officials are the core reasons behind the problem of vertical fiscal imbalance in Nepal local districts.
A finding of the research by Izabela (2012) under IMF also supports the above findings that, the large VFI in Belgium, between 60 and 70 percent over the last two decades, stems from strong revenue centralization at the federal level. Transfers comprise a limited number of grants. Communities do not have own taxes; they are financed mainly through general-purpose grants. Regions enjoy taxing power and receive federal grants. Yet nearly 80 percent of their funding consists of transfers, and only 20 percent from own taxes. In the same fashion to Belgium, in Norway, The evolution of the VFI was affected by the devolution and subsequent recentralization of health care, although other factors like increase in expenditure decentralization have also been important.
Another research which was conducted by Bob (2001) also clearly indicates that, in addition to the vertical fiscal imbalance, there is also a considerable degree of horizontal fiscal imbalance (HFI) between the Australian States. Variation in capacities arising by revenue generating power of different districts has the causes of horizontal fiscal imbalance in Australian. However, because measurements of these differences are done within each State and are not calculated on a fully uniform basis, it is not possible to give an accurate measure of the extent to which revenue capacities and costs of services differ between authorities.
Another research which was conducted by Ravindra (2005) in India also associates horizontal fiscal imbalance with geographic variations among different districts within a federal forms of government. Accordingly geographically vast countries like India face the problem of horizontal fiscal imbalance because natural endowment, climate, and physical conditions have significantly differed across different Indian districts. As a result, economic opportunities are not uniformly available to population residing in different districts of India. This can be manifested through significant difference among regions in the level of per capita income, levels of unemployment rate, physical quality of life etc.
A research finding by Ebel & Yilmaz (2002) also associates the problem of fiscal imbalance with tax administration. Accordingly, the lack of a modern tax administration has hampered both the day-to-day implementation of revenue assignments, and adversely affected general government revenue collections in many transition countries like in Russia. In Baltic’s, Russia, and Other countries of the former Soviet Union, the tax administration is a central government agency exclusively responsible for collecting taxes at all levels of government. Regional and local governments do not have their own tax administrations. However, the lack of effective control over the regional and local offices of the central tax administration and the de facto dual subordination of tax administrators to the central tax authorities and to sub national government officials has had an important impact on tax collections at all levels of government. Regional and local officials may be more interested in preserving the economic viability of local enterprises which provide employment and a tax base for sub national taxes than ensuring that federal taxes get paid. They may, therefore, pressure tax officials to be selective in their collection efforts. Furthermore, sub national officials may press tax administrators to employ more resources to the collection of sub national taxes than the low yield of these taxes may warrant. Even among the more advanced reformers, local capacity in tax collection is generally low, which reduces the effectiveness of tax collections
More specifically in Ethiopia case, a research which was conducted by Melkamu (2004) clearly reveals that, the main factors contributing to vertical fiscal imbalance in Benshangul region are explained by narrow revenue base of the region, which largely depends on direct personal income tax, weak administrative and planning capacity, and high fiscal needs of the region resulting from inherent low economic and social development. As a result, the fiscal capacity of the region has remained far below its expenditure requirements. The weak fiscal position of the region, as opposed to its high fiscal needs, has resulted in high vertical fiscal imbalance.
A research finding by Berhanu (2009:6) supports the above empirical finding that, the major reasons for the existence of both vertical as well as horizontal fiscal imbalance in Ethiopia can be generalized as fellows;
Weak Revenue Base of Regional States and local governments and lack of incentives to raise revenue for local governments: weak revenue/tax sources and that the most productive and lucrative sources of revenue remained under Federal Government control.
Inadequate Institutional and Human Resource Capacity of Regional States to Raise Revenue: Many Regional States in Ethiopia lack adequate institutional and skilled personnel to collect revenue; the more so in relatively less developed and border area States - ‘emerging Regional States’.
Lack of reliable and up-to-date data on the Grant Formula: the problems on the grant could be resolved if the current grant formula is based on reliable data.
In line with this, inequality of regional states and growing demand for financial resources by relatively less developed Regional States and nationalities is among the core factors for existing fiscal imbalance in Ethiopia.