The concept of ‘equalization’ is considered to be a guiding principle for fiscal transfers as it promotes equity as well as efficiency in resource use. Equalization transfers aim at providing citizens of every state a comparable standard of service provided their revenue effort is also comparable. In other words, equalization transfers neutralize deficiency in fiscal capacity but not in revenue effort. Under such an approach, transfers are determined on normative criteria in contrast to gap filling based on projected historical trend of revenue and expenditure.
Twelfth Finance Commission made use of the concept and recommended ‘Equalisation Grants’ to achieve partial equalization of expenditure of services in two sectors, namely education and health across different states. Since full equalisation of expenditure would have required steep step up in grants, the Commission restricted itself to partial equalization. The grants were fixed on the basis of two-stage normative measure of equalisation. In the first stage, states with low expenditure preference (i.e. states which had lower expenditure on education/health as proportion of total revenue expenditure) were identified and benchmarked to average expenditure on education/health (as proportion of adjusted total revenue expenditure) incurred by respective groups, i.e., special and general category states. In the second stage, states which had lower per capita expenditure than the group average, even after adjustment made in first stage, were identified and grants to the extent of 15 per cent of the difference between per capita expenditure of the state on health and average per capita expenditure of the group and to the extent of 30 percent of the difference between per capita expenditure of the state on health and average per capita expenditure of the group were provided.
Accordingly, equalization grants were provided under education to eight States and under health to seven States, where level of revenue expenditure was lower relative to average expenditure http://fincomindia.nic.in/ShowContentOne.aspx?id=8&Section=1.