During periods of fiscal consolidation, governments must balance tighter budgets with equitable service delivery. This balance is a particular challenge in devolved countries, where central fiscal authorities might be inclined prioritize macroeconomic balance and fiscal discipline over the public sector’s equity and service delivery objectives.
A recent OECD working paper, Intergovernmental fiscal transfers and fiscal equalization in a time of consolidation, (by Sean Dougherty, Andoni Montes Nebreda, and Nerea Urrutia) examines how selected OECD countries have adapted their fiscal equalization systems under such pressures in recent years, identifying design features that preserve inter-regional fairness while maintaining efficiency.
The report has two main objectives. First, it aims to update previous OECD work on fiscal equalization with new data and recent reforms. Second, the report explores new perspectives on fiscal equalization that have gained importance, including the political economy dynamics shaping fiscal equalization, and the institutional frameworks surrounding it. The focus is not only on regional equalization, but also on equalization at the local level and in broader transfer schemes beyond classical fiscal equalization. It finds that well-designed equalization arrangements can support consolidation efforts without undermining local fiscal discipline.
The report first discusses the political economy and institutional factors that influence fiscal equalization systems, drawing on country examples (e.g. Canada, Italy, Spain) to illustrate how politics and governance affect equalization outcomes in an era of fiscal consolidation.
It then examines the state of fiscal equalization in a sample of eight representative countries, evaluating the redistributive impact of their equalization arrangements and highlighting recent evolution, external shocks and reforms. These in-depth case studies – Canada, Germany, Spain, Switzerland, United States, Mexico, Estonia and Sweden – cover a mix of federal and unitary systems and both regional and local equalization mechanisms.
Key findings
Fiscal consolidation pressures threaten intergovernmental transfer programs. High public debt and deficit reduction efforts are forcing central governments to reconsider spending, including intergovernmental fiscal transfers. Many countries are witnessing debates on scaling back transfers, which could weaken the redistributive impact of equalization and risk widening regional disparities. In a context of tighter budgets, ensuring fiscal equalization mechanisms are optimized is critical to prevent lower-income regions from falling further behind (OECD, 2023). Yet, political appetite for large redistributive programs tends to diminish when fiscal resources are scarce. This tension between consolidation and cohesion is a central challenge.
Political economy factors critically shape fiscal equalization outcomes. The design and effectiveness of equalization systems are heavily influenced by politics. The allocation of IFTs is not purely technocratic – it emerges from negotiation between central and subnational governments, reflecting bargaining power, regional alliances and public sentiment. Decentralized countries where regions have greater political weight often see greater resistance to changing equalization formulae that might reduce any region’s share. Wealthier regions tend to lobby to limit contributions whereas most try to tweak formulae in their favor. Conversely, regions with less influence struggle to secure adequate funding, and their needs may be underrepresented. Political cycles and inter-party dynamics also play a role, as subnational governments that are aligned with central government might receive more discretionary transfers (as seen in countries like Argentina and India). The public perception of fairness – whether taxpayers in donor regions feel they are paying a “fair share”, and whether recipient regions use funds effectively – can bolster or erode support for fiscal equalization.
Fiscal equalization mechanisms reduce fiscal disparities, but to varying degrees. All eight country systems analyzed show that intergovernmental transfers lower subnational fiscal inequalities compared to a no-transfer scenario. However, the magnitude differs: among federal countries with formal equalization, Spain and Germany achieve the strongest redistribution of fiscal capacity disparities, whereas Switzerland’s equalization effect is the smallest. In unitary but decentralized cases, Sweden’s municipal equalization substantially equalizes outcomes, while Estonia’s largely needs-based grants yield a more modest effect. Mexico (without a dedicated fiscal equalization system) stands out: it begins with the highest pre-transfer inequalities but also achieves one of the largest reductions in inequality through general transfers. Even so, Mexico’s post-transfer disparities remain higher than in the other cases, indicating limited residual equalization in absolute terms. In contrast, countries like Germany, Spain and Sweden emerge with some of the lowest post-transfer inequality levels.
Recent reforms often moved toward less redistribution. A worrying trend is that many recent reforms or adjustments to equalization systems have diluted their redistributive impact. In almost all surveyed countries, the equalizing effect of transfers has diminished in the last decade. Notably, Germany’s 2020 reform and Switzerland’s post-2020 adjustments scaled back equalization outcomes, and Spain’s system has maintained stable redistributive outcomes while pending reform. An exception is found in the United States and Mexico, where transfers increased through broader fiscal packages, incidentally boosting redistribution. These two countries lack formal fiscal equalization schemes, but their larger general grant programs (e.g., U.S. federal stimulus funds, Mexico’s social and infrastructure funds) have started to play a pseudo-equalizing role. Still, these gains may be temporary or incidental without an institutionalized equalization framework. Overall, most countries have not enhanced equalization despite growing regional needs – a trend that raises concerns for territorial equity.
Shifting policy priorities are influencing intergovernmental fiscal transfer designs. There is a gradual integration of environmental and social criteria into intergovernmental financing. For example, a few countries (France, Portugal, China) have introduced Ecological Fiscal Transfers – transfers that incentivize environmental conservation by allocating funds based on ecological indicators. While still nascent, such measures signal a broadening of equalization objectives beyond fiscal capacity and service costs, aligning intergovernmental fiscal transfers with sustainability goals. Likewise, some transfer systems are incorporating social factors (poverty rates, aging population) more explicitly to address social cohesion. These innovations remain limited in scale but point to an evolving role for intergovernmental fiscal transfers in advancing national priorities (green, social) alongside traditional equity aims.
Recommendations
In light of the findings and challenges outlined above, the following policy recommendations are proposed for discussion among government delegates. These recommendations aim to safeguard the redistributive impact of intergovernmental fiscal transfers and improve the effectiveness of fiscal equalization in times of fiscal consolidation:
- Protect equalization mechanisms during consolidation
- Foster expenditure needs equalization alongside revenue equalization
- Strengthen subnational tax autonomy (with accountability)
- Avoid over-conditioning general transfers
- Enhance transparency and predictability of transfer systems
- Incorporate incentives for environmental and social outcomes
- Invest in better data and regular evaluation of fiscal equalization systems
- Bolster institutional frameworks for consensus-building
Concluding thoughts
These key findings and recommendations set the stage for a deeper discussion of the political and institutional landscape of equalization and a closer look at how different countries are managing the balance between fiscal consolidation and territorial equity.
S. Dougherty, A. Montes Nebreda, and N. Urrutia. 2025. Intergovernmental fiscal transfers and fiscal equalization in a time of consolidation, OECD Working Papers on Fiscal Federalism, No. 50, OECD Publishing, Paris, https://doi.org/10.1787/4853a4d0-en.
