ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

A+| A| A-

Fiscal Decentralisation to the Sub-State Level Governments

Even after more than a decade of decentralised governance, the fiscal decentralisation scenario is disturbing. There is a decline in the percentage of local government expenditure in relation to the total government expenditure and in the progress of expenditure decentralisation in 11 out of the 15 major states. The revenue decentralisation trend is also no better and the average rate of growth in the tax revenue of panchayati raj institutions as well as the urban local bodies in most of the states has been negative. It renders efforts to build autonomous local governments impossible.

Spacial articlas

Fiscal Decentralisation to the Sub-State Level Governments

Even after more than a decade of decentralised governance, the fiscal decentralisation scenario is disturbing. There is a decline in the percentage of local government expenditure in relation to the total government expenditure and in the progress of expenditure decentralisation in 11 out of the 15 major states. The revenue decentralisation trend is also no better and the average rate of growth in the tax revenue of panchayati raj institutions as well as the urban local bodies in most of the states has been negative. It renders efforts to build autonomous local governments impossible.


iscal decentralisation is a subset of decentralisation. Given the manifold ways decentralisation is interpreted and the vast diversity of country experiences, it has to be contextually defined and understood [Bird and Vaillancourt: 1998]. For the purpose of this paper, decentralisation is defined as the empowerment of the local people through the local governments. Fiscal decentralisation, therefore, is the fiscal empowerment of lower tiers of government which involves the devolution of taxing and spending powers along with the arrangements for rectifying mismatches in resources and responsibilities [Fukasaku and De Mello: 1999; Tanzi: 1996 and Oommen: 2004]. This definition is important as it is in broad agreement with the 73rd/74th constitutional amendments which seek to establish a third stratum of government in India. The local government (LG) has relevance not only because of its instrumental significance in providing an efficient delivery of public services and local goods, but also because of the failure of national and state governments in providing basic services of comparable quality to the citizens during the last half a century. On the basis of a detailed analytical study, Rao and Singh (2005) conclude that neither the union finance commission nor the Planning Commission nor centrally-sponsored schemes have made a substantial dent into regional disparities. In the contemporary world, only India constitutionally empowers the local governments to prepare “plans for economic development and social justice” along with the mandate to establish panchayats or rural local governments as institutions of self-government. (Articles 243 G, 243W and 243ZD of the Indian Constitution). Fiscal decentralisation is the key variable in this new dispensation of governance. This paper tries to analyse the trend in fiscal decentralisation in India focusing on the 15 major non-special category states based on the data set relating to panchayati raj institution (PRIs) and urban local bodies (ULBs) given as Annexure to Chapter 8 of the Twelfth Finance Commission (TFC) report. We are aware of the serious limitations of such a set of aggregate data reported by the various state governments. However, it is a matter of comfort that these data are canvassed through a common format prepared and collated by the TFC. This analysis is supplemented by a study of the second state finance commission (SSFFC) reports of five states.1 The state finance

commission (SFC) is a constitutional counterpart of the union finance commission (UFC) at the state level to mediate between the state and the local governments (Article 243 I and 243 Y).

Trend and Extent of Fiscal Decentralisation

The extent of fiscal decentralisation depends on the expenditure responsibilities and revenue assignments devolved to the lower tiers. The total expenditure of local governments (PRIs and ULBs), as a proportion of the combined expenditure of union, state and local governments works out to about 6.4 per cent in 1998-99 and 5.1 per cent in 2002-03.2 The decline in the expenditure of the PRIs (from 3.9 per cent in 1998-99 to 3.3 per cent in 2002-03) which covers nearly 73 per cent of the people, needs special mention because the decentralised governance is envisaged primarily to improve the quality of life in the rural areas. The PRIs expenditure in 2002-03 as a proportion of GDP works out only to 1.07 per cent. The own source revenue (tax

+ non-tax revenue) of local bodies as a proportion of the combined tax and non-tax revenue of the union, states and local governments for 1998-99 which was around 2.7 per cent, declined to 1.9 per cent in 2002-03. Reckoned in terms of GDP, in 2002-03, the own source revenue (OSR) of local governments is only 0.39 per cent, more than 82 per cent of which is accounted for by ULBs. The extent of fiscal decentralisation which was already very low has shown a pronounced declining trend. When we know that in most advanced countries local governments normally account for about 20-35 per cent of total government expenditure (in some countries like Denmark it goes as high as 45 per cent), India, with two major constitutional amendments ostensibly to transfer power, authority and resources to local governments, has very little to write about.

The trend in the overall scenario of decentralisation in India raises several questions. We may address some of them for the purpose of this paper: What has been the state-wise scenario? What interstate differences are in the structure and pattern of transfers by states to local governments? What role has the SFC constitutionally created to rationalise state sub-state level fiscal relations and transfers in the context of decentralisation played?

Economic and Political Weekly March 11, 2006

Third Strata of Government

Table 1 shows the state-wise progress in regard to expenditure and tax decentralisation as well as the changes in the relative magnitudes of these variables by comparing two years, 1998-99 and 2002-03. The proportion of local governments’ expenditure of all states to the expenditure of all states and local governments combined declined from 11.24 per cent in 1998-99 to 9.47 per cent. Among the 15 major states shown in Table 1, only Bihar, Haryana, Tamil Nadu and Uttar Pradesh seem to have made some progress. In all the other 11 states the percentage has declined. The progress of Bihar and in the other three states are due to their very low base in 1998-99. During this period, the percentage of local government expenditure to total expenditure comprising state and local governments ranged from 0.92 per cent in Bihar to 21.73 per cent in Karnataka, followed by 20.90 per cent in Kerala3 (18.76 per cent if RBI figures are used) and 20.36 per cent in Gujarat. In 2002-03, the corresponding range was from

0.93 per cent in Assam to 18.22 per cent in Karnataka and 14 per cent in Kerala (13.32 per cent with RBI figures) and Gujarat. Karnataka occupies the top position in expenditure decentralisation in both the years. It could be firmly confirmed from the table in Appendix A which gives the rate of growth of the total expenditure of each of the 15 states and that for all states for the period, 1998-99 to 2002-03 that the decline in the ratio is due to the lower growth rate of the expenditure of the local bodies. While the all-states average rate of growth of expenditure increased at 11.6 per cent during the period, the rate of growth in the total expenditure of PRIs was only 6.87 per cent and of ULBs 4.07 per cent. Actually the trend in Gujarat, Kerala and Orissa for PRIs and in Gujarat, Haryana, Karnataka, Madhya Pradesh and Maharashtra for ULBs is negative (Appendix A).

Turning to tax decentralisation, Table 1 shows that at the allstates level, the percentage of own tax revenue of local government as a percentage of state’s own tax revenue plus local tax revenue declined by 1.74 percentage points in 2002-03 compared with 1998-99. Only in seven states we see a marginal increase during this period. The decline ranges from 0.62 percentage points in Assam to 4.80 percentage points in Maharashtra with Gujarat closely following. The magnitude and the pathology of the own revenue situation may be captured better in the three tables given under Appendix B. Table (i) shows the per capita own tax (OT) and per capita OSR of PRIs along with the average growth rate from 1998-99 through 2002-03. Table (ii) shows the corresponding growth rate for ULBs. Table (iii) shows the ratio of OSR to total expenditure for PRIs and ULBs in the states under study for 1998-99 and 2002-03.

The per capita tax and per capita OSR of urban local bodies are several times higher than that of the PRIs in all the states (see Table (i) and Table (ii) of Appendix B). Appendix B Table (i) shows that in 2002-03, the per capita OT of PRIs is below Re 1 (zero in Bihar) or around it in five states. The highest per capita OSR among PRIs in all the five years consistently is reported in Kerala (as high as Rs 101.96 in 1999-2000). The per capita OSR of PRIs is below the all-state average in the nine states in 2002-03. The rate of growth for all states in regard to PRIs during the quinquennium 1998-99 to 2002-03 is over 7.7 per cent for tax and

5.7 per cent for own source revenue. The rate of growth in the tax revenue of PRIs, however, is negative in Gujarat, Orissa and Punjab. Although the level of OSR of ULBs is very high compared to PRIs and in 2002-03, the per capita OSR ranges from Rs 75.34 in Orissa to Rs 743 in Punjab, the overall rate of growth of OSR of ULBs for all states has been negative (–3.14 per cent per annum) during the period from 1998-99 to 2002-03. The growth rate of per capita taxes of ULBs is negative in Gujarat, Haryana, Karnataka, Maharashtra, Orissa and Rajasthan. Indeed, the OSR situation at the third tier of government, especially that of PRIs, does not seem to support a healthy decentralisation process in the country. The ratio of OSR to total expenditure which could be considered as a measure of the fiscal autonomy of the states (Appendix B Table (iii)) presents a somewhat misleading picture. The picture of ULBs is apparently encouraging and definitely better than that of the PRIs. If we assume that a local government raises 50 per cent of its expenditure through OSR, it could be considered as fairly autonomous. By this standard except in a few states the ULB scenario is in fairly good shape. The share of OSR to total expenditure for ULB is over 52 per cent in 2002-03 as against 6.7 per cent for PRIs for the same year. In the case of Assam and Punjab, the high OSR ratio of PRIs is presumably because of poor expenditure assignments.

Trends in Revenue Transfers to Local Governments

The effectiveness of fiscal decentralisation to the sub-state level governments depends on: (i) Appropriate expenditure assignments (illustrative guidelines follow from Schedule XI and XII of the Constitution) broken up into activities and sub-activities accompanied by the transfer of funds from the concerned state department head of accounts in the state budget to the local bodies;

(ii) appropriate revenue/tax assignments; and (iii) efficient design of the transfer system and its proper implementation. The latter, of course, is the primary responsibility of the state finance commission and the concerned state governments.

Table 2 presents the state-wise trend in the ratios of transfers (tax devolution plus grants-in-aid)4 to net state domestic

Table 1: Expenditure and Tax Decentralisation at the Statesub-State Levels (Major States) (1998-99 and 2002-03)

No States Local Government Local Government Own
Expenditure as Per Cent Tax as Per Cent of State
of State Expenditure + Own Tax Revenue +
Local Government Local Government
Expenditure Own Tax Revenue
1998-99 2002-03 1998-99 2002-03
1 Andhra Pradesh 18.12 18.05 3.07 3.90
2 Assam 1.08 0.93 2.07 1.45
3 Bihar 0.92 2.65 1.53 2.40
4 5 6 Gujarat HaryanaKarnataka 20.36 3.63 21.73 14.06 4.64 18.22 12.30 2.95 6.14 8.04 0.73 3.68
7 Kerala* 18.76 13.32 3.87 3.99
8 9 Madhya Pradesh Maharashtra 9.90 16.30 9.30 13.60 8.20 9.97 8.98 5.17
10 Orissa 3.33 3.13 3.54 0.55
11 12 13 PunjabRajasthanTamil Nadu 5.62 12.34 9.19 4.71 11.47 9.42 9.67 2.71 3.63 7.55 0.48 4.22
14 Uttar Pradesh 3.98 4.64 1.27 1.36
15 16 West BengalAll States 5.93 11.24 4.69 9.47 3.27 5.71 4.87 3.97

Notes: * State Expenditure figures are obtained from RBI’s State Finances: A Study of Budgets. From the state total expenditure, figures given inthe RBI document item IV of Appendix II i e, compensation andassignments to local bodies and panchayat raj is deducted. We havechecked with RBI sources and learn that all the payments to localbodies (ULBs + PRIs) are not included under this item. The realfigures have to be obtained from the ministry of finance as audited bythe C&AG. For Kerala, we have used the figures from C&AG reports.As per the report of C&AG, the figures for 1998-99 and 2002-03 areRs 1,309.78 crore and Rs 989.98 crore, respectively for Kerala.Hence, the percentage when reworked will be 20.9 for 1998-99 and

14.1 for 2002-03. Similar figures for other states are not readilyavailable and the given figures are possibly underestimates.

Source: Twelfth Finance Commission and State Finances: A study of Budgets by RBI, for the relevant years.

Economic and Political Weekly March 11, 2006

product (NSDP), to state’s total revenue, as well as to state’s total expenditure excluding loans and interest payments. Besides that, Table 2 contains a column (No 3) which shows the ratio of tax devolution to local governments as a percentage of state’s own tax revenue. All these are different ways to measure the magnitude of transfers.

Table 2 which focuses on the magnitude of transfers made by the major state governments to local governments has to be seen along with the poor revenue and expenditure decentralisation noted in Table 1 and Appendix B. The transfers to local governments as a percentage of SDP have declined in the country as a whole. However, it improved in 10 states in 2002-03 albeit marginally compared to 1998-99. SDP is not a good fiscal variable to measure the magnitude of transfers. The best way is to reckon transfers with reference to the state’s expenditure and revenue. We have also examined the tax component of the transfers vis-à-vis the own tax revenue of the state. In nine states the total transfers have registered a decline as a proportion of the total state expenditure. This includes such prominent states upholding decentralisation like Karnataka, Kerala, Madhya Pradesh, Rajasthan and West Bengal. An important measure of fiscal decentralisation is the percentage of tax revenue devolved (eg, tax assigned, plus state taxes shared) to total state tax revenue. In 1998-99 it ranges from zero in Bihar to 52.63 per cent in Karnataka and in 2002-03, the same pattern continues except that Karnataka’s share has fallen to 42.62 per cent. Karnataka is followed by Tamil Nadu and Madhya Pradesh in 2002-03. The transfers as a percentage of state revenue declined in nine states as well as for all states. Table 2 clearly shows that only Karnataka has above all-state average in regard to all the four measures in all the years. Maharashtra and Rajasthan fall in the second-best category as they qualify for all measures except tax devolution as percentage of state’s own tax revenue. In brief, the record of fiscal decentralisation, to the substate level governments through transfers has been very poor. As regards Karnataka, it is important to note that the transfers are linked to the schemes transferred by the state government. The system that prevailed in 1993 continues. The local governments do not have any autonomy to determine priorities, discontinue schemes or change the composition of expenditures. Moreover, the gram panchayats in the state account for only 5 per cent of the total allocation of state funds to PRIs in 2002-03 and in 200001 as low as 3.5 per cent [Karnataka Second SFC Report (2002), p 27]. In all other states the share of village panchayats is high. Indeed, the efficiency of resources use and the quality and effectiveness of the delivery of basic services depend on the quantum of expenditure at the cutting-edge level.

Before we conclude this discussion, we may try to discern the pattern in the structure of transfers to local governments. Table 3 juxtaposes the state-wise distribution of per capita state revenue and per capita transfers in 2002-03 to PRIs and ULBs for the 15 states. One important aspect to be noted from the table is the higher per capita transfers to the rural areas (PRIs) than the urban areas for the country as a whole. By and large this is true in the case of most of the states. This is a healthy trend. But there are significant exceptions. Assam makes no transfers to PRIs.5 It is very significant that Madhya Pradesh and Orissa which are admittedly backward states with a very high tribal population, the per capita transfers to PRIs is way below that to ULBs. In West Bengal, the per capita transfers to PRIs is only Rs 24.126 as against Rs 232.37 for ULBs. Although Tamil Nadu’s case is not that glaring as West Bengal, Madhya Pradesh or Orissa, the hiatus is very conspicuous.

The figure seeks to illustrate the association between per capita state revenue and the transfers made to the local bodies. The per capita state revenue is shown in the x-axis and per capita transfers in the y-axis with the median lines relevant to these two variables being drawn making the whole figure into a box with four quadrangles identified as A, B, C and D.

In the figure Quadrangle A represents the case of states with low per capita revenue (less than the median level of per capita

Table 3: Per Capita State Revenue and Per Capita Transfers toPRIs and ULBs (2002-03)

(In Rs)

No State Per Capita Per Capita Per Capita Per Capita Revenue of Transfer Transfers Transfers State (Combined) to PRIs to ULBs

1 Andhra Pradesh 2941.78 623.78 775.43 219.87 2 Assam 2464.25 4.54 0.00 35.53 3 Bihar 1318.96 31.57 34.21 8.97 4 Gujarat 3382.16 565.45 835.44 112.60 5 Haryana 3882.39 150.18 188.00 57.18 6 Karnataka 2955.19 813.14 1175.61 110.33 7 Kerala 3274.34 256.02 293.29 149.16 8 Madhya Pradesh 2114.19 134.29 65.23 325.92 9 Maharashtra 3073.10 518.57 816.05 114.69 10 Orissa 2225.93 82.08 56.54 227.43 11 Punjab 4369.67 44.84 47.72 39.25 12 Rajasthan 2190.99 221.84 250.56 127.62 13 Tamil Nadu 3266.99 269.74 231.31 318.52 14 Uttar Pradesh 1593.29 25.39 32.04 0.00 15 West Bengal 1729.35 82.36 24.12 232.37 16 All States 2656.85 238.04 269.55 152.10

Table 2: Select Indicators of Revenue Transfers to Local Governments by Major States (1998-99 and 2002-03)

No State Transfers as Per Cent of NSDP Transfers as Per Cent of Tax Devolution as Per Cent Transfers as Per Cent of State Revenue of State’s Own Tax Revenue State Expenditure

(1) (2) (3) (4) 1998-99 2002-03 1998-99 2002-03 1998-99 2002-03 1998-99 2002-03

1 Andhra Pradesh 2.68 3.39 19.54 21.20 4.44 4.54 15.33 16.48 2 Assam 0.03 0.04 0.17 0.18 0.27 0.29 0.16 0.16 3 Bihar 0.03 0.54 0.13 2.39 0.00 0.00 0.10 1.77 4 Gujarat 3.49 2.61 24.57 16.72 2.08 1.24 17.54 12.62 5 Haryana 0.27 0.58 1.88 3.87 0.88 2.59 1.28 3.43 6 Karnataka 4.81 4.43 33.74 27.52 52.63 42.62 27.34 21.01 7 Kerala 1.67 1.17 11.88 7.82 3.86 2.71 8.70 5.40 8 Madhya Pradesh 1.31 1.19 7.07 6.35 15.54 10.44 5.41 5.12 9 Maharashtra 1.71 1.99 15.05 16.87 0.36 0.31 11.41 12.07 10 Orissa 0.59 0.80 4.03 3.69 5.09 6.51 2.38 2.84 11 Punjab 0.13 0.17 1.12 1.03 1.28 1.24 0.68 0.76 12 Rajasthan 1.73 1.76 13.21 10.13 1.95 1.97 8.49 6.96 13 Tamil Nadu 1.09 1.27 8.12 8.26 12.03 12.00 6.50 6.68 14 Uttar Pradesh 0.58 0.25 4.45 1.59 9.58 2.99 2.83 1.25 15 West Bengal 0.44 0.45 4.97 4.76 0.09 0.66 3.16 2.92 16 All States 1.19 1.12 10.76 8.96 8.35 6.25 7.92 6.86

Note: NSDP – Net Domestic Product. Source: Twelfth Finance Commission, State Finances: A Study of Budgets, RBI and Economic Survey 2004- 05, Government of India.

Economic and Political Weekly March 11, 2006

Figure: Per Capita Revenue of States and Per Capita Transfersdecentralisation regime, the responsibilities of a SFC in ensuring

Received by LGIs, 2002-03

vertical and horizontal equity and balance are very high. Eco-

Median Per Capita Revenue Andhra Pradesh Assam Bihar Gujarat Haryana Karnataka Kerala Madhya Pradesh Maharashtra Orissa Punjab Rajasthan Tamil Nadu Uttar Pradesh West Bengal A B CD Median Per Capita TransferPer Capita Transfers to ULBs and PRIs (in Rs)0 200 400 600 800

nomically, poor gram panchayats and municipalities will have to be helped in providing comparable services through equalising allocations (grants) which will compensate for genuine revenue raising problems and cost disadvantages such as distance, mountainous or marshy regions and the like. In what follows we examine very briefly how five second generation SFCs (Karnataka, Kerala, Punjab, Rajasthan and Tamil Nadu) have tried to improve vertical and horizontal imbalances in their respective states.

The size of vertical transfers logically depends on the goals to be achieved and the needs of local governments which certainly will have to take into account the magnitude of the mismatches in resources available and the expenditure responsibilities. All the SFCs under study except Kerala have made estimates of vertical gaps. But none has made this exercise with reference to functional assignments and needs following from that. Actually

1000 2000 3000 4000 5000

Per Capita Revenue of State (in Rs)

a clear demarcation of functional domain is not available in most

revenue, or states with per capita revenue less than the middle 50 per cent, when the states are arranged in order of increasing per capita revenue), and low per capita transfers to the LGs (less than the median level of per capita transfers). Quadrangle B represents the case of states with high per capita revenue (greater than median level of per capita revenue) and low per capita transfers to LGs (less than median level of per capita transfer). Quadrangle C represents the case of states with high per capita revenue and high per capita transfers to LGs. Quadrangle D represents those cases with low per capita revenue but high per capita transfers.

What the figure shows is that though higher transfers are mostly seen to be made by the richer revenue states, it is not true in all cases. Punjab with the highest per capita revenue has the lowest per capita transfer. More or less the same story is narrated in the case of Haryana. The highest per capita transfer is made by Karnataka which is a state with per capita revenue in the middle 50 per cent of states when they are ranked by their per capita revenue.

It may also be seen that most of the states with low per capita revenue devolves less or even nil to LGs with Rajasthan standing out as an exception. Though a low per capita revenue state, Rajasthan devolves funds to LGs in much larger magnitude in per capita terms than that of Punjab, Haryana or West Bengal. This is shown by it being the sole state in Quadrangle D.

Role of SFCs: Study of Five Second SFCs

Interalia the poor progress of fiscal decentralisation may be considered as reflecting the ineffectiveness of the institution of the SFC. It is as well be due to the failure of the states in implementing SFC recommendations. The primary task of the union finance commission is to mediate in the sharing of revenues between the centre and the states by rectifying the mismatches between responsibilities and resources as well as to reduce the horizontal fiscal imbalances between states in an equitable manner. The SFC which is a counterpart of the UFC at the state level is mandated to perform these tasks at the state sub-state level. The task is probably more complex and onerous for the SFCs because of the lack of clarity in regard to expenditure responsibilities in many states. Except in a few states like Kerala, where the responsibilities of the panchayats and urban local bodies are broken down into activities and sub-activities, every function of the LG is state-concurrent and, therefore, administratively complex. Because the local governments are constitutionally required to create institutions of local self-government and prepare plans for economic development and social justice under the cases. All the five SFCs agree in regard to the need for providing basic public services of comparable quality at the level of rural and urban local bodies. Tamil Nadu, Punjab and Rajasthan SFCs estimate the fiscal gap including capital requirements mostly taking civic functions into account. The Rajasthan SSFC takes the view that investment requirements for providing civic services are “large and ought to be met from plan funds including cess and externally funded projects” (Rajasthan SSFC Report: p 82).

In Appendix C we present a broad outline of the scheme of vertical transfers of the five SSFCs which shows the magnitude of transfer, the instrument of transfers and the basis of vertical distribution between PRIs and ULBs. The size of transfers ranges from 2.25 per cent (this includes 0.05 per cent as an incentive grant for raising additional revenue) of state’s own net tax revenue in Rajasthan to 40 per cent of non-loan gross own revenue receipts (NLGORR) in Karnataka. All SFCs except Karnataka consider net tax revenue as the instrument and source of transfer. The Kerala SSFC which endorses the prevailing practice of giving one-third of plan outlay to the LGs, as plan grants-in-aid, additionally recommends the devolution of a maintenance grant (5.5 per cent of net own tax revenue of state) based on a current cost of replacement and a general purpose grant to the tune of 3.5 per cent of the net own tax revenue.

We also see from Appendix C that the basis of vertical distribution between PRIs and ULBs is population in most cases. Besides population, Karnataka takes illiteracy rate and population per hospital bed into consideration and the ratio works out to

Appendix A: Average Rate of Growth in the Total Expenditureof State, PRI and ULBs (1998-99 to 2002-03)

No States Growth Rate of Growth Rate of Growth Rate of
State Expenditure Expenditure of PRIs Expenditure of ULBs)
1 Andhra Pradesh 12.83 11.92 15.44
2 Assam 13.53 2.25 10.07
3 Bihar 4.93 96.20 12.57
4 5 6 Gujarat Haryana Karnataka 8.95 6.92 12.41 -1.65 26.72 5.86 -5.68 -9.41 -3.81
7 Kerala 10.04 -2.09 3.46
8 9 Madhya Pradesh Maharashtra 2.94 10.42 2.04 11.09 -1.50 -0.25
10 Orissa 10.88 -3.37 19.45
11 12 13 Punjab RajasthanTamil Nadu 12.60 10.22 9.70 9.70 5.67 7.73 5.47 9.48 8.30
14 Uttar Pradesh 7.01 5.14 11.32
15 16 West Bengal All States 12.45 11.59 5.52 6.87 4.00 4.07

Economic and Political Weekly March 11, 2006

80 per cent for PRIs and 20 per cent for ULBs. Tamil Nadu takes besides population (50 per cent weight) needs (operation and maintenance, capital and debt) and resource potential, and the rural-urban proportion works out to 58:42. It is clear that the choice of criteria and the weightage given to them which in turn depends on the objectives and priorities underlying the design of transfer of the concerned SFC assume significance in determining the vertical share of PRIs and ULBs.

Turning to horizontal distribution, we may make some general observations based on the five SSFC reports. We have noted in Table 3 that in 2002-03 (see the figure) that Karnataka has the highest per capita transfer. This is obviously due to the high vertical transfers through the transfer of schemes of the state government as we have already mentioned. The real question is whether it also results in higher horizontal equity or not. The answer is in the negative. For one the allocation to gram panchayats7 in Karnataka as we have already noted is only around 5 per cent of the total allocation to PRIs in 2002-03. The criteria for interse distribution such as population, area, illiteracy rate, the ratio of population per bed and so on are applicable only in the case of zilla panchayats and taluka panchayats. The gram panchayats get only a fixed amount (Rs 3.5 lakh per GP). In the case of the other states, the tax shares recommended to gram panchayats range from 60 per cent of the share of PRIs in Tamil Nadu to 100 per cent in Punjab. The Kerala SSFC besides giving nearly 70 per cent plan grant share to GPs, 78.5 per cent of general purpose grant is also earmarked for them.8 While in Kerala the interse distribution among the municipalities and corporations should be entirely on the basis of population, as regards GPs, a corpus of Rs 100 million is recommended to be set apart as horizontal gap filling to cover the gap between obligatory expenses and own revenue plus general purpose grant of GPs. A 100 per cent gap filling in the case of second and third grade GPs, 50 per cent in the case of first grade GPs and 25 per cent in the case of special grade GPs are recommended. The balance is to be distributed on the basis of population.

Appendix B: Table (iii) – Percentage of OSR to Total Expenditure

States Percentage of PRIs Percentage of ULBs
1998-99 2002-03 1998-99 2002-03
Andhra Pradesh 3.93 3.34 64.09 60.81
Assam 99.86 98.83 69.55 67.67
Bihar 20.15 2.27 59.65 56.84
Gujarat 2.65 2.72 72.57 74.62
Haryana 45.35 20.82 77.94 94.00
Karnataka 1.67 1.45 70.00 56.48
Kerala 9.44 12.67 31.47 50.87
Madhya Pradesh 26.50 36.68 39.50 49.50
Maharashtra 7.88 9.98 73.01 49.68
Orissa 5.40 3.02 76.68 24.88
Punjab 66.33 55.32 100.78 113.85
Rajasthan 2.38 2.17 34.90 23.60
Tamil Nadu 14.68 12.39 41.11 46.61
Uttar Pradesh 11.60 10.62 25.11 28.96
West Bengal 16.89 17.64 39.53 60.21
All States 6.34 6.77 57.11 52.58

Appendix B: Table (i) – State-wise Distribution of Per Capita Own Tax and Per Capita Own Revenue with Average Growth Rate

State Panchayati Raj Institutions 1998-99 1999-2000 2000-01 2001-02 2002-03 Growth Rate Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Own Own Own Tax Own Own Tax Own Own Tax Own Own Tax Own Own Tax Own Tax Revenue Revenue Revenue Revenue Revenue Revenue (OSR) Andhra Pradesh 12.03 23.83 12.11 24.92 13.46 27.37 13.56 28.66 13.65 30.05 3.72 6.23 Assam 3.12 3.14 3.12 3.15 3.13 3.16 3.13 3.16 3.14 3.17 0.16 0.18 Bihar 0.00 0.84 0.00 0.42 0.00 1.04 0.00 0.47 0.00 0.85 0.00 1.33 Gujarat 22.52 25.48 22.34 25.80 20.99 23.95 19.50 22.14 18.48 21.10 -5.18 -5.17 Haryana 5.07 40.67 3.71 39.70 4.91 46.76 4.88 49.44 5.43 49.43 4.17 6.29 Karnataka 15.30 15.30 16.69 16.69 19.15 19.15 14.75 14.75 16.47 16.47 0.25 0.25 Kerala 38.08 72.68 42.84 101.96 49.16 93.08 48.08 81.36 51.27 94.07 7.36 2.94 Madhya Pradesh 28.24 29.26 28.01 29.61 28.38 32.00 27.46 31.33 33.34 37.55 3.17 5.71 Maharashtra 29.46 44.54 32.31 52.15 36.64 58.78 48.08 67.39 59.48 80.65 19.75 15.53 Orissa 0.16 2.05 0.15 2.81 0.15 2.89 0.15 2.77 0.07 1.71 -15.95 -3.70 Punjab 0.77 42.61 0.58 52.94 0.72 50.11 0.70 39.64 0.52 59.08 -5.64 3.71 Rajasthan 0.74 7.76 1.12 8.69 1.10 8.52 1.08 8.34 1.06 8.23 6.96 0.77 Tamil Nadu 10.09 15.26 11.26 17.24 13.10 16.39 14.51 17.68 13.64 18.34 8.95 4.01 Uttar Pradesh 0.75 3.70 0.90 4.15 0.89 4.47 0.81 4.39 0.80 4.57 0.07 4.89 West Bengal 1.24 5.28 1.22 5.26 1.56 5.64 1.62 5.69 1.63 5.17 8.71 0.37 All India 8.86 16.34 9.34 18.40 10.18 19.15 10.72 18.95 12.03 21.29 7.77 5.74
OSR – Own Source Revenue (Own Revenue). Appendix B: Table (ii) State Urban Local Bodies 1998-99 1999-2000 2000-01 2001-02 2002-03 Growth Rate Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Per Capita Own Own Own Tax Own Own Tax Own Own Tax Own Own Tax Own Own Tax Own Tax Revenue Revenue Revenue Revenue Revenue Revenue (OSR) Andhra Pradesh 92.32 238.22 105.20 249.17 125.53 302.48 153.36 340.70 203.78 401.53 21.66 14.53 Assam 42.18 95.92 45.06 89.55 52.15 104.85 54.81 105.34 59.49 122.41 9.23 6.72 Bihar 50.51 54.38 54.35 59.68 57.75 64.37 54.88 63.10 73.84 82.29 8.00 9.24 Gujarat 552.34 657.72 623.06 739.95 632.15 745.69 605.95 719.49 390.85 494.48 -6.94 -5.81 Haryana 151.92 237.66 116.82 255.57 95.20 205.84 104.31 207.39 50.37 144.50 -20.71 -11.34 Karnataka 231.29 304.34 223.15 263.54 215.85 241.43 225.49 254.80 182.57 188.49 -4.52 -9.44 Kerala 121.31 187.07 149.09 223.39 172.58 252.14 153.28 269.85 213.04 350.17 12.23 15.52 Madhya Pradesh 220.66 300.23 251.78 350.20 288.23 364.68 242.49 327.51 270.38 361.76 3.76 3.11 Maharashtra 359.65 475.89 346.02 470.11 391.62 542.61 412.15 577.41 209.14 247.00 -8.69 -10.47 Orissa 101.45 136.01 22.94 60.38 27.24 67.80 28.71 72.67 27.69 75.34 -21.12 -9.48 Punjab 435.54 584.61 556.58 732.49 590.99 818.83 559.81 807.82 540.27 743.80 4.46 5.97 Rajasthan 85.29 150.27 11.49 64.44 15.66 82.23 17.80 126.45 18.17 123.42 -23.32 2.84 Tamil Nadu 122.13 221.31 180.36 277.91 172.28 309.81 187.59 328.02 207.50 356.40 11.62 11.84 Uttar Pradesh 28.18 55.97 31.85 60.00 35.81 67.15 40.30 80.89 45.40 90.88 12.63 13.52 West Bengal 72.25 140.23 79.42 150.11 85.08 158.37 121.54 198.87 149.28 253.76 20.64 15.81 All States 182.59 263.91 193.71 277.53 206.91 304.25 212.33 207.80 174.59 260.06 0.02 -3.14
Economic and Political Weekly March 11, 2006 901

The most rational horizontal distribution is to give adequate weightage to the equity and efficiency. For interse allocation among GPs, all SFCs other than Karnataka use population as the dominant criterion followed by area, tax efforts and some indicators of backwardness. The choice of a relevant backwardness criteria with appropriate weightage, incentivising revenue efforts and ensuring delivery of quality of services assume significance. On this score most of the SSFCs require improvements and need to incorporate better efficiency and equity elements. Besides the horizontal gap filling recommendations of Kerala SSFC, two recommendations of the Tamil Nadu SSFC need special mention: one relates to the introduction of the report card system for the interse distribution of incentive funds. Five per cent of the total devolution is set apart for providing incentives to local bodies for the efficient resource mobilisation as well as for the delivery of quality public services. The report card system is a way of assessing the quality of public services from the perspective of citizens or users of civic services. The users can provide feedback on the quality, efficiency and adequacy of the services through various entries in the card. The other is the equalisation fund to compensate for fiscal disabilities. Any GP with less than Rs 17 per capita tax (which is the state average for all GPs) is considered a weak village panchayat deserving this fund. The shortfall from Rs 17 is made good from the equalisation fund. It may be noted here that one may do well to compare fiscal capacity at a given average tax rate rather than the actual per capita tax, which may be low due to lower tax effort. Even so the promotion of equalisation is a relevant effort towards horizontal equity. A great weakness of the Tamil Nadu SSFC is that it left 20 per cent of devolution to be discretionary and only 80 per cent as formula-based. A rational devolution mechanism should be fully formula-based which, of course, should be operationally simple.

Appendix C: Scheme of Vertical Transfers of Five SSFCs
Name of Instrument of Transfer and Basis of Arriving at the Basis and Proportion Remarks
State Per Cent to be Transferred Divisible Pool of Vertical Distribution
between PRIs and ULBs





Tamil Nadu

40 per cent of non-loan gross own revenue receipts (NLGORR).

Plan: Grant-in-aid – 33 1/3 per cent of the state plan. Non-Plan: (i) 5.5 per cent of own tax revenue for maintenance of assets, (ii) 3.5 per cent of own tax revenue as general purpose grant (unconditional) 10 per cent of plan grants (excluding special component plan and tribal sub-plan) to be distributed as incentive fund (in proportion of additional revenue collected by GPs and ULBs). 4 per cent of net collection of own taxes.

2.20 per cent of own tax revenue plus 0.05 per cent as incentive for resource mobilisation (total 2.25 per cent).

  • 15 per cent of net proceeds from entertainment tax.
  • 1 per cent of net receipts from royalty or mineral in gram panchayat of the districts where these activities are carried on.
  • Net own tax revenue. 8 per cent in the first two years (2002-03 and 2003-04), 9 per cent in the next two years (2004-06) and 10 per cent in the last year (2006-07). 5 per cent of central devolution for vertical and horizontal devolution. Horizontal distribution for village panchayats: Population (60 per cent), SC/ST population (10 per cent), agricultural labourers (10 per cent), area (10 per cent) and asset maintenance (10 per cent). Out of 100 per cent global sharing, 13 per cent set apart for reserve, equalisation and incentive funds.

    Normative estimate to provide minimum public/civic services of comparable quality in rural and urban areas.

    Maintenance grant based on current cost of replacement. (Details spelt out.) General purpose grant based on normative assessment of establishment cost and office expense requirements for district and block panchayats. The balance is distributed as Gram panchayat – 78.5 per cent Municipalities – 8.5 per cent Corporations – 13 per cent Normative projection of income and expenditure and estimating vertical gaps of PRIs and ULBs.

  • Assessment of minimum requirements based on additional responsibilities
  • Gap to be filled by the additional revenue efforts
  • Sharing of royalty on the basis of collection.
  • Resource gap on the basis of normative assessment of needs for providing minimum basic services.

    Population, SC/ST, illiteracy rate and population per hospital bed. PRIs – 80 per cent, ULBs –20 per cent Population of urban and rural areas.

    PRIs – 67.5 per cent ULBs – 32.5 per cent Interse distribution among ULBs: Population (70 per cent), SCs (15 per cent) and shortfall of per capita tax as compared to average per capita tax of all ULBs. Interse distribution: population (65 per cent), shortfall of per capita own income as compared to per capita own income of GPs in the state (15 per cent), population of SCs (15 per cent), population in mountainous areas (5 per cent). Population the basis

    PRIs – 76. 6 per cent ULBs – 23.4 per cent

    Population: 50 per cent Needs: 25 per cent (Operative and maintenance, capital debt) Resource potential: 25 per cent Raised NLGORR ratio from 36 per cent recommended by the first SFC to 40 per cent by the SSFC. It may be noted that the general purpose grant is in lieu of assigned taxes, shared taxes and various statutory and nonstatutory grants-in-aid.

    Income includes additional resource mobilisation also and expenditure includes capital needs and quality of services.

    Incentive scheme of a matching allotment by state for tapping taxes and non-tax sources. District-wise distribution of PRIs: population (80 per cent), area (10 per cent), BPL families (5 per cent), Illiteracy (5 per cent), ULBs 85 per cent population. 15 per cent for less developed municipalities. Quantitative and qualitative aspects of civic needs considered in resource gap estimates. Capital needs also considered. Zero base budgeting recommended. Several measures to ensure fiscal responsibility recommended. 80 per cent formula-based 20 per cent left to discretionary decisions.

    Economic and Political Weekly March 11, 2006

    By and large, the SSFC reports are better than their first generation counterparts in terms of analytical content and quality of recommendations. Despite the innumerable shortcomings of the first series of SFC reports, pointed out by the Eleventh Finance Commission (EFC) and those raised by the TFC about SFC reports they examined, that SSFCs raised the magnitude of vertical devolution compared to the previous regime cannot be gainsaid. However, the pertinent question is the cavalier fashion in which most state governments have treated the recommendations of the SFCs. All the five SSFCs under study have reviewed the progress the respective states have made in implementing the first SFC, devolution packages and recommendations. All of them report very serious lapses on the part of the state governments. The constitutional provisions contained in Article 243 (4) that “The governor shall cause every recommendation made by the commission under this article together with an explanatory memorandum as to the action taken thereon to be laid before the legislature of the state” have been violated by almost all the states. By dishonouring and soft-peddling on the recommendations of successive SFCs most state governments have put the fiscal decentralisation process in reverse gear.

    Presumably, the most striking mistake in regard to the transfer system emerging at the state sub-state level following decentralisation reforms is treating the transfers to LGs as an additional financial allocation. Yes, there is a need for extra resources. But the basic principle that as part of decentralisation of funds,9 the budgetary provision of an item of expenditure responsibility that has been transferred to the LGs should be followed with corresponding reduction in the concerned departmental budget of the state has not been followed in most states. So long as the necessary adjustments are not made, the entire state transfers to the LGs become an additional burden on the state. It is a grave mistake on the part of the SFCs that they have not taken into account this in arriving at the vertical gaps. Economic efficiency and efficiency in governance are enhanced by the division of governmental functions among different levels depending on their comparative advantage or what is called the principle of subsidiarity. Although the Kerala assembly has made functional demarcations between the state and the LGs and the LGs, interse, and Kerala government introduced a separate budget document for panchayats and ULBs as appendix IV to the budget papers, there was no pro tanto reduction at the state departmental level except in the case of a very few departments. So decentralisation resulted in an additional burden on the state exchequer even in Kerala. There is also a need to insure local government from the impact of the fiscal imprudence of the state governments.

    To conclude, after more than a decade of decentralised governance the emerging fiscal decentralisation scenario is disquieting. The percentage of local government expenditure in relation to total government expenditure has declined significantly during the period 1998-99 to 2002-03. The progress of expenditure decentralisation in 11 out of the 15 states appears to be on the decline. The revenue decentralisation trend is also no better. That the average rate of growth in the tax revenue of PRIs and ULBs in most of the states in the country had been negative or declining provides a wrong signal. It renders impossible any effort towards building autonomous local governments. As regards transfers to the local governments, reckoned in terms of the SDP, state revenue and state expenditure, the overall trend has been very discouraging, although there are significant exceptions. Again, while by and large, the per capita transfers to rural governments are higher than that of the ULBs, the per capita transfers to the ULBs are very high in the states like Madhya Pradesh, Orissa, Tamil Nadu and West Bengal. The performance of SFCs which have the responsibility to mediate in the revenue sharing between the state and the LGs leaves many things to be desired. The functional mapping with reference to state and LGs on the one hand and that among the three tiers of PRIs has not made much progress in most states. Sometimes functions are transferred without making any change in the budgetary head by way of devolution to local bodies. This makes transfers an additional burden on the state exchequer. Needless to say, economic and political efficiency is best ensured when the functions among the different levels are organised on the basis of comparative advantage followed by the corresponding transfers. The design of the transfer system at the state sub-state level needs drastic reform. SFC recommendation is one thing, but implementation is the responsibility of the state. It is the state governments who should bear the major responsibility about the poor progress of fiscal decentralisation in the country.




    [I wish to acknowledge the helpful comments of D K Srivastava on the first draft of this paper.]

    1 They are Karnataka, Kerala, Punjab, Rajasthan and Tamil Nadu.

    2 The expenditure data for local governments are from TFC report and that for union and state governments are from Economic Survey, government of India for the relevant years.

    3 For details, see footnote to Table 1.

    4 Transfers consist of tax assignment plus tax devolved plus grant-in-aid transferred to local governments (PRIs and ULBs). The TFC data contain an item ‘Others’, other than own source revenue and tax devolution and grants-in-aid. As it is a mixed category we have not included it in the transfers.

    5 This cannot be a case of non-reporting because it is zero in all the five years. 6 In West Bengal in the year 2001-02, the per capita transfers to PRIs was above Rs 70.

    7 Moving the 73rd Amendment on December 1, 1992 in the Lok Sabha the then minister for rural development said: “The Constitution (73rd) Amendment Bill casts a duty on the centre as well as the states to establish and nourish the village panchayats so as to make them effective selfgoverning institutions”. This basic objective must be a governing consideration in the state sub-state level transfer system.

    8 The GPs share is determined after allotting a one-time share for the district and block panchayats in the general purpose grant based on their establishment cost and office expense requirements.

    9 For the whole process to be complete, logically the functionaries also should be transferred to the lower tiers. This is a serious deficit in the democratic decentralisation underway in the country.


    Bird, Richard M and Francios Vaillancourt (1998): Fiscal Decentralisation in Developing Countries. Cambridge University Press, Cambridge. Fukasaku Kichiro and L R De Mello Jr (1999): Fiscal Decentralisation in

    Emerging Economies, Development Centre OECD, Paris.

    Oommen, M A (2004): ‘Fiscal decentralisation in Kerala’ in Geeta Sethi (ed), Fiscal Decentralisation to Rural Governments in India, Oxford University Press.

    Rao M G and Nirvikar Singh (2005): Political Economy of Federalism in India, Oxford University Press. Report of the Second State Finance Commissions of Karnataka, Kerala,

    Punjab, Rajasthan and Tamil Nadu. Reserve Bank of India, State Finances: A Study of Budgets for different years. Tanzi, Vito (1996): ‘Fiscal Federalism and Decentralisation: A Review of

    Some Efficiency and Macroeconomic Aspects’ in Michael Bruno and Boris Plesrovic (eds), Annual World Bank Conference on Development Economics 1995, World Bank, Washington.

    Economic and Political Weekly March 11, 2006

    Dear Reader,

    To continue reading, become a subscriber.

    Explore our attractive subscription offers.

    Click here

    Back to Top