Box 2.4 Mechanisms of financial compensation Financial compensation serves to adjust differences in financial revenue and expenditure between rich and poor cantons or communes. There are two main reasons why Switzerland has such a policy. First, supposing that people in mountain cantons do not wish to leave, we are confronted with the problem that these cantons cannot compete economically with the urban cantons, where the starting position for individual economic development is much better. The cantonal tax system can worsen the unequal starting position: tax revenues in the mountain cantons are very low whilst tax rates are rather high. Financial compensation helps to make the mountain cantons economically more attractive and increases their ability to compete with other cantons. Second, there is what economists call the 'externality problem'. Some cantons or communes carry out tasks for others. They offer infrastructural services (for example universities) which are used by residents of other cantons and communes. Instead of pricing these services for the individuals -- which is not always reasonable -- the cantons or communes provide direct mutual compensation. Financial compensation takes different forms:
- Horizontal financial compensation: compensation between bodies on the same level, for instance between 'rich' and 'poor' cantons.
- Vertical financial compensation: compensation of a superior body to a subordinate body, for instance provided by the federation to the cantons.
- Financial compensation of spillovers: subsidies to compensate externalities in the field of the infrastructure of cultural services.
- Block grants: unconditional financial transfers.
- Subsidies: appropriated transfers.