example, due to the particular administrative framework11 that allowed budget overruns and a
political situation that encouraged bail-outs. But it serves to illustrate that, if central
government is intent on maintaining the level of key public services, sub-central governments
can exert real pressures on central government to increase vertical transfers, unless these are
explicitly prohibited by law. This is particularly the case where there are overlapping
competencies in the provision of some public services, or where central government is seen
by the electorate as responsible for the delivery of key services. Of course, central
government can always resort to using earmarked grants, thereby further eroding local
accountability. In essence, there appears to be a real trade-off between equity in the provision
of public services and the accountability of devolved government.
The trade-off between equity and accountability is not only evident in countries like Italy that
are trying to move towards a more federal structure. It is also apparent in counntries with
mature federal systems, such as Germany. Post-war Germany has had in place a system of
horizontal equalisation aimed at equalising revenues between poorer and richer Lander (or
states). This system of equalisation, the Finanzausgleich, has been very successful in
maintaining a high degree of uniformity in public services throughout Germany. In 1997,
following the incorporation of the East German Lander into the system, €6.1 bn was
transferred from the richer to the poorer Lander, compared to only €1.5 bn in 1994. In
addition to these horizontal transfers, in 1997 a number of federal grants were made to
fiscally weaker Lander (€7.2 bn). Overall, 20% of Lander income came from grants,
including transfer payments from the equalisation system. In 2001, a new agreement was
11 There are loopholes in sub-central borrowing limits in Italy, particularly in health and transport (see Bibbee
and Goglio, 2002). In addition, central governments have been unwilling to harden budget constraints for
electoral reasons, and because it is widely recognised that the Southern regions and municipalities have poor
administrative capacities, and may not be able to cope. This has resulted in the recent decision in 2000 to
introduce a rule-based system of horizontal equalisation but to phase this in over a period of fourteen years. A
counter to this point is that a persistence of moral hazard simply provides no incentives to these regions and
municipalities to improve their capacity to manage their affairs.
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