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Decentralisation and Local Finance Issues–The Workings of State Finance

Commissions in India

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 Decentralisation and Local Finance Issues –
The Workings of State Finance Commissions in India

Dr. Ravikant Joshi1,2

Executive Summary

This study entitled Decentralisation and Local Finance Issues – The Workings of State Finance
Commissions in India, undertaken under the ADB’s Technical Assistance Project Policy Research
Networking to Strengthen Policy Reforms Thematic Cluster: State Government Budget Constraints
and Delivery of Social Services, examines the performance of State Finance Commissions of the
different states and seeks explanations for their differential performance. It also indicates policy
options to improve the functioning of the future State Finance Commissions in addressing local
finance issues and taking forward decentralisation. The highlights of study are given below –

Background of the Study

1. Decentralization in recent decades has become truly world wide movement. Rabinovitch
(1999) noted that more than 60 countries have adopted decentralisation initiatives and are in
process of strengthening it. Of the 75 developing countries with populations greater than 5
million, all but 12 claimed to have embarked on some form of transfer of fiscal authority from
central and provincial to local governments. This transfer of power has been occurring even
in inherently centralized countries.
2. India embarked on democratic decentralisation (giving status, more powers, functions and
resource to local governments) through 73rd and 74th Constitutional Amendment Act in 1992.
3. The Constitution 73rd and 74th Amendment Acts, 1992, have not changed the structure of
fiscal federalism in the county. The legislature of a state continues to enjoy absolute powers
to endow the municipalities with such authority, as it considers necessary to enable them to
function as institutions of self-government’. It implies that the municipalities do not possess
what referred to as general competency powers permitting them to take actions not explicitly
prohibited or assigned elsewhere; they possess the legally delegated powers and functions,
under the doctrine of ultra vires (Dillon’s Rule) that limit local choice and diversity. They are to
take nothing from the general sovereignty except what is expressly granted.
4. As a result, significant inter-state variations are witnessed in terms of functional and fiscal
domain of local governments. Broadly they fall into three groups, with each group presenting
a different order of financial requirements-
a. Those which have a comparatively large functional and an equally large fiscal domain.
Gujarat and Maharashtra are examples of this typology;
b. Those, which have a larger fiscal domain but a narrow functional jurisdiction. Rajasthan
and Manipur are typical examples of this group; and
c. Those that have a comparatively larger functional jurisdiction, but a narrower fiscal base.
5. The Constitutional Amendments provided an illustrative list of functions that are henceforth
considered appropriate for local government; among these functions are planning for
economic and social development, urban poverty alleviation, and even urban forestry. The
amendment also limited the degree to which state governments are able to suspend
democratic local government, and finally and most importantly provided for a revision of state-
local fiscal relations at regular interval through mechanism of State Finance Commission.
6. Under the new fiscal devolution system/framework every state government is required to
constitute, once in five years, a finance commission and entrust it with the task of reviewing
the financial position of local governments and making recommendations as to the principles
that should govern –
a. The distribution between the state and the local governments of the net proceeds of the
taxes, duties, tolls and fees leviable by the state;

1
Abhijaat, 31, Nirman Park Society, Vishwamitri, Vadodara, Gujarat, 390011, email: ravikant.joshi@gmail.com
2
This report was prepared by consultants for the Asian Development Bank. The views expressed in this report are the views of
the authors and do not necessarily reflect the views or policies of the Asian Development Bank (ADB), or its Board of
Governors, or the governments they represent. ADB does not guarantee the accuracy of the data included in this paper and
accepts no responsibility for any consequence of their use.
 b. The determination of the taxes, duties, tolls and fees that may be assigned to or
appropriated by the local governments; and
c. The grants-in-aid to local governments from the consolidated fund of the state.

Over and above recommending the principles that should govern state-local fiscal relations,
SFCs are expected to
• Undertake a review of the finances of municipalities;
• Estimate the future financial requirements of municipalities;
• Suggest measures for strengthening the finances of municipalities.

The new fiscal devolution system has simultaneously effected a major change (by inserting
Article 280(3) ©) in the scope of the tasks of the central finance commission. New Article now
requires the central finance commission to suggest measures need to augment the
consolidated fund of a state to supplement the resources of the local governments on the
basis of the recommendations made by the finance commissions of states.
7. In Indian Federal structure SFC created by 73rd and 74th CAA is the only channel to address
issues of state-local fiscal relations. SFCs thus acquire unique place in fiscal decentralisation
and local finance issues and therefore warrant critical examination.
8. This study is devoted to examination of workings of this very State Finance Commission
mechanism and resultant change in state-local fiscal relations in India. In order to assess the
role of SFCs and their contribution, one needs to examine the following issues –
a. The extent to which SFCs followed CAA provisions / mandate.
b. The extent of change in the pre-CAA situation for local bodies.
c. Approaches adopted by SFCs to address issues of state-local fiscal relationship.
d. Issues associated with workings of SFCs.
e. Issues associated with the implementation of SFC recommendations.

Current State of Local Finance

9. The data collected by the 12FC indicates that the share of own revenue (IRM) of the all tiers
of Panchayats was 6.40 per cent of their total revenues for the period 1998-99 to 2002-033.
This data suggests some improvement over earlier share of 4.17 per cent estimated for the
period 1990-91 to 997-98 by NIRD. The annual per capita IRM in some state was Rs. 8 only.
10. In 2001/02, the size of the municipal sector measured in terms of revenues that the
municipalities generate by way of levy of taxes, duties, fees and fines was estimated at
Rs.12,748 crore. These revenues formed 3.07 per cent of publicly-raised resources, the
shares of the central government and all state governments combined being 57.5 per cent
and 39.5 per cent respectively. As a per cent of the combined gross domestic product
(GSDP), own revenues of municipalities represented 0.63 per cent.
11. The share of transfers from state governments in the revenues of municipalities was 31.7 per
cent (2001/02). This is, however, the average; municipalities in several states are almost
entirely transfer-dependent for running of local services. The dependence of urban local
bodies was as high as 83.71 per cent in case of Jammu & Kashmir, 83.33 in case of
Rajasthan and 74.48 in case of Uttar Pradesh.
12. Average per capita expenditures (daily) by urban local governments’ ranges between Rs.0.20
and Rs.2.25 explains the extremely low level of services and consequently, the deplorable
service conditions in cities and towns.
13. This data clearly indicates miniscule size and impoverished status of local finance.
14. This scenario is a result of the following three factors –
a. The inferior local taxes which have low elasticity and buoyancy;
b. Poor administration of tax and other powers by local governments; and
c. Absence of autonomy for local governments in respect of tax rate setting, rate revision
and other spheres of their functioning.

Workings of State Finance Commission - Status

15. First State Finance Commissions - In all states, except in Bihar, the First SFCs have
submitted their report. The State Governments except Jammu and Kashmir have also
submitted the Action Taken Report to the Legislature.

3 th
Report of the 12 Finance Commission (2004) page no.147

2
16. Second State Finance Commissions - Out of 25 states4 liable to constitute SFC except six all
states have constituted the SSFCs. Out of constituted Finance Commission’s in three states
have submitted their reports. Thus in nine states either SFC is not constituted or constituted
but have not submitted report. Seven States have since submitted their Action Taken Report
on the SSFCs to the State Legislature. It is interesting to note that Andhra Pradesh, Kerala
and Punjab have appointed the Third State Finance Commission.
17. Thus there is sizeable experience now to undertake review of workings of SFCs in India.

Emerging Issues regarding functioning of State Finance Commissions

18. General Issues

In a way, the SFC mechanism was imposed upon the states by the Constitutional
Amendment Act. As a result, states have shown great apathy towards SFCs, in providing
them with administrative or technical assistance, information access and implementation of
SFC recommendations. The apathy manifested in following manner.
a. Lacklustre attitude/Response by the state governments: There are at least six states,
which have not yet set up their Second State Finance Commissions, and five states,
which have not yet submitted action taken reports. 12th FC observed, ‘…. most states are
yet to appreciate importance of this institution (SFC)….’5
b. Composition of State Finance Commission - The composition of SFCs has been found
wanting. In one state in service bureaucrat headed SFC. EFC also held composition of
SFC as one of the reason for the quality of SFC reports. 12th FC has categorically
observed regarding this issue.
c. Lack of Statutory mechanisms for ensuring continuity: the absence of statutory
mechanisms for monitoring the implementation of the recommendations of the SFCs and
lack of a permanent setup to ensure continuity between the SFCs. EFC has noted this
issue and has recommended setting up of a SFC Cell.
d. Lack of a reliable database: All the SFCs have univocally regretted and complained about
this aspect. Even EFC and 12th FC faced this problem. It hindered effective working of
SFC, but state governments did not make efforts to create database even though EFC
provided special funds for this purpose.
e. No synchronization in the award periods of SFCs with the Central Finance Commission
Award Periods and Five Year Plans- the 12th Finance Commission should have reviewed
the third generation state finance commission reports for basing its recommendations on
local finance but it received only second state finance commission reports that too from
one third of the states.
f. Minimal Impact of Finance of Local Bodies of SFC Recommendations: The
recommendations and devolution framework suggested by SFCs have failed to bring
about any perceptible change in the finances of urban local governments. the transfers
made by all the states to urban local bodies as per SFC reports or under other devolution
framework on an average amounted to 4.47 percent only during 1997-98 to 2000-01 of
State’s Own Revenues.

19. Policy and Structural Issues

a. Revenue/Tax Assignments: There is a clear trend in the reports of the SFCs favouring
revenue sharing and grants-in-aid rather than tax assignments.
b. Principles of Revenue Sharing: Different SFC has adopted different principles but there is
clear trend towards creating a divisible pool of resources at the state level by adopting
concept of global sharing and allocating it then to local bodies.
c. Quantum of Revenue Sharing: Two methods- first based on estimation of gross financial
requirements drawing upon past trends and the second is a normative approach. Except
Tamil Nadu and to some extent Karnataka most of the SFCs have followed first method.
d. Resource Sharing between Urban and Rural Segments: there is a definite move by SFCs
to create formulae based fiscal allocation framework. Also they have tried to create multi-
level fiscal allocation framework. But problem is creating just structure and most of the
SFCs have followed isolated approach for urban and rural local bodies.

4
Mizoram, Nagaland and Meghalay are not required to constitute SFC as traditional local institution of self government exists in
these Schedule VI States
5
Report of Twelfth Finance Commission Report

3
 e. Vertical/Horizontal Distribution among Local Governments: Again, we observe diametrical
opposite perception and recommendations by SFCs. SFCs have tried to form composite
index for distributing resources. The selection of indicators for this purpose is quite
debatable and needs serious consideration.
f. Tied Vs Untied Fund Concept: Except West Bengal and Karnataka SFCs, all the SFCs
under study have recommended fiscal devolutions in the form of Tied Funds.
g. Autonomy, Financial Management and Budgeting Issues: no clear recommendations
appear to have been made as to how and in what manner local government budgeting,
financial management and auditing procedures should be improved, these being
important components in any decentralisation programme.6
h. Confusion while sharing resources between tiers of rural local governments: village
panchayat vs. intermediate panchayats SFCs have taken different views
i. GP received less than 5 % against 25 % allotted in Karnataka
ii. WB allotted highest share to GP – 50 % to 60 %
i. Measuring Current and Future Spending Responsibilities - “the main deficiency of the
reports lies in the fact that their recommendations are not based on a clear statement of
the spending responsibilities of local bodies. Indeed, the absence of attention to the
elementary principle that expenditure assignment must precede any tax or revenue
assignment has turned most of the SFC exercises, a suspect.7
j. Absence of Equalisation Grant Mechanism
k. No attempt to measure non-formulae based devolution and total local expenditure
l. Uniform block grant without linkage to population, size or service responsibility
m. No input on policy of debt financing
n. No attention to performance or efficiency based criteria for fiscal allocation
o. No attention to create fiscal accountability

At policy level, we observe that SFCs have followed different approaches regarding various
aspects mentioned above. While variation in approaches is inevitable taking in to account the
vastly different local situations, its long term implications need to be carefully monitored. The
likely result of variation in approaches will be asymmetrical decentralisation in different states,
which will occur at different paces and through different routes.

20. Implementation Issues

a. Non Acceptance of SFC Fiscal Devolution Recommendations: Many state governments
have not accepted the primary recommendations for pooled sharing of state resources.
b. Inadequate Implementation of Other SFC Recommendations: Sate Governments did not
accept a large number of recommendations made by SFCs regarding matters other than
sharing of resources between state and local bodies.
c. Implementation in Contravention of SFC Recommendations: For example -
i. Treating Central Finance Commission Grant as part of SFC devolution
ii. Delayed devolution of Central Finance Commission Grant to local bodies
iii. Continuation of Non-Formula based Discretionary Devolution
iv. Change in Purpose of Devolution Grants.
v. Non implementation of Equalisation Grant Scheme
d. Mechanism for Making Deductions: Deductions for the outstanding dues from the ULBs
are made in a lump sum manner from the overall sum (gross SFC grant). Such a
mechanism is biased in favour of those local bodies, which have higher amounts payable.
e. Non- Implementation of Incentive Fund Scheme: The state governments have not
implemented the recommendations of the SFCs about reforms incentive schemes for
local governments to motivate them to undertake essential reforms.

The message coming out from the case studies about SFCs is that SFCs are constrained by
various factors and, as a result, SFCs have failed to address issues of local finance and to
carry forward decentralisation.

Recommendations on Role and Working of SFCs

The primary issue associated with the working of SFCs is the absence or inadequate
implementation of SFC recommendations by the State governments. The commitment of the

6
Richard Bird. 1998 – Designing State – Local Fiscal Transfers for Uttar Pradesh - mimeo
7
O.P. Mathur - June 2000 – Decentralisation In India: A Report Card – UMP-Asia Occasional Paper No. 47

4
 state governments to implement the recommendations of SFCs also needs to be addressed.
The specific policy options in the context of various issues observed earlier are as follows:

21. Recommendations that can be implemented in the short-term - Following are some
recommendations that can be implemented within a time-frame of 1-2 years.
a. Creating a SFC Secretariat/Permanent Administrative Set up for Ensuring Continuity:
while some of the states have implemented this recommendation of setting up a
permanent SFC cell in the state government, many others are yet to implement the
recommendation. It is suggested that all the states constitute permanent administrative
units in state governments to deal with SFC matters, in line with the recommendations of
the 12th Finance Commission
b. Synchronisation of SFCs with the Central Finance Commission and Five Year Plans: It is
necessary to draw up a detailed calendar regarding various events and stages associated
with the SFC and this calendar should be followed meticulously to overcome problems of
non-synchronisation of the award periods of SFCs with those of the CFCs and five year
plans.
c. Enhancing the Impact of SFC Recommendations on the Finances of Local Bodies: Two
things, first acceptance and implementation of SFC recommendations in their entirety and
second, improvement in the fiscal health of the state, which will make enough resources
available so that it can devolve more resources to the local bodies, are essential and
must be ensured.
d. Quantum of Revenue Sharing: The policy decision is to decide the extent to which fiscal
gap is to be financed through revenue sharing. Most of the SFCs at present follow a
system of estimating gross financial requirements of local bodies based on past trends
and deciding on the percentage in the divisible pool. It is necessary that in the future
SFCs should increasingly adopt the normative approach to calculate the fiscal gap while
basing their recommendations on the quantum of revenue sharing. Along with their
recommendations, SFCs should provide fiscal accountability norms for local bodies.
e. Improving composition of SFCs: 12th CFC has made specific recommendation regarding
this issue –“It is necessary that the states constitute SFCs with people of eminence and
competence, instead of viewing formation of SFCs as a mere constitutional formality.
(Para 8.33, 12th CFC) In the matter of composition of SFCs, state may well be advised to
follow central legislations and rules which prescribe the qualifications for the chairpersons
and members and frame similar rules.”

22. Recommendations that can be implemented in the medium-term - Following are some
recommendations that can be implemented within a time-frame of 2-3 years.
a. Revenue / Tax Assignments - There is a clear trend in the recommendations of the SFCs
favouring revenue sharing and grants-in-aid rather than tax assignments. This is a soft
approach and certainly not a healthy trend. Tax assignments should be given adequate
importance in the context of two realities one, deteriorating fiscal health of state finances
and two, tax assignments being a better instrument of decentralisation.
b. Principles of Revenue Sharing - It is necessary that there is broad uniformity about the
principles of revenue sharing adopted by the SFCs. It can be said that in future SFCs
should adopt as a uniform pattern the concept of global sharing to form the divisible pool
on the basis of NLGORR (Karnataka model) coupled with 5 to 10 percent share in central
devolution to the State (Tamil Nadu model).
c. Resources sharing between urban-rural local bodies and between tiers of local bodies -
Various SFCs have different methods for arriving at the share of urban and rural local
bodies’ in the divisible pool. It is difficult to suggest policy options or definite answers
regarding the ideal set of indices. Specific research is required on the merits and demerits
associated with using these and other indicators for inter-se distribution of resources.
d. System of performance based incentive grants
e. Equalisation concept to correct distortions in horizontal resource sharing

23. Recommendations that can be implemented in the Long-term

a. Creating statutory mechanisms for monitoring implementation of the recommendations of
SFCs
b. Capping non-formula based devolution by SFCs - System of non-formula based grants
throws the local fiscal devolution system out of gear. Since it may not be possible to curb
completely non-formula based transfers in a democratic setup it is suggested that the

5
 state finance commissions consider capping the extent of non-formula based grants to
local bodies
c. Fiscal responsibility norms and index of self reliance for local bodies
d. Hard budgetary constraints on local bodies
e. Improving own fiscal health by state governments
f. Separate inter-governmental transfer system for urban and rural local governments

Centralised
Data base
Permanent Statutory
Administrative Mechanism
Set up for SFC to monitor
Implementation
Making SFC of SFCs
Mechanism
Focal Point of
Fiscal
Decentralisation
Synchronisation
Creating convention of SFCs with CFC
Of accepting SFC and five year plans
Recommendations,
Public opinion Professional,
building independent
approach by
SFCs

Summing Up
24. State Finance Commission, a new mechanism to structure the fiscal devolution framework
and state-local fiscal relations has by and large turned out to be inadequate and ineffective
due to various reasons including policy, implementation and general administrative issues.
Though we find flashes of creativity and policy innovations, most of the SFC reports have
turned out to be unsatisfactory and have failed to live up to their constitutional role.
25. At the same time it can also be said that the reports of the Second SFCs show that the new
system of fiscal arrangement envisaged by Constitutional Amendments more than a decade
ago is coming of age in spite of a host of infancy blues and if the third generation SFCs of the
other states which are being set up or would be set up in the near future improve upon the
pragmatism and professionalism shown by the SSFCs while effectively dealing with policy
weaknesses reviewed in this paper.
26. The 11th and 12th Central Finance Commissions have elaborately noted the weaknesses in
the working of SFCs and their reports. Though SFC reports were short on policy aspects the
real reason for the failure of the SFC mechanism in terms of bringing about a paradigm shift
in the state-local fiscal relationship was a weakness in implementation. States were never
ready for such a mechanism (it was thrust upon them through constitutional amendments) to
determine the sharing of resources with local governments. As a result, states have shown
gross apathy in setting up SFCs, accepting their reports and in implementing their
recommendations. It is now high time for all states to come together, with the central
government in the lead, to pay attention to the institution of SFC and to evolve a national
consensus regarding the role, working, composition of the SFC and regarding the moral
commitment of state governments to implement the recommendations of SFCs. If these
measures are not taken urgently, there is a danger of jeopardizing the entire fiscal devolution
mechanism.

6
Framework for making State Finance Commission Mechanism Meaningful and Effective in addressing
Decentralization and Local Finance Issues

General / Administrative Aspects (To be ensured by the State Governments)

• Evolve National Consensus regarding role of SFC in Decentralization and Fiscal Devolution
Mechanism.
• Permanent Secretariat/administrative set up along with central database.
• Timely constitution of SFC synchronized with Central Finance Commission and Five Year
Plans
• Statutory Mechanism for monitoring and implementation of SFC awards – there must be
strong State or Independent Regulator ability to monitor and evaluate intergovernmental fiscal
system.
• Improving composition of SFC by giving adequate representation to subject experts and
academicians of international and national stature. State to formulate rules by following
guidelines used for appointments to Central Finance Commission

Implementation Aspects (To be ensured by the State Governments)

• Minimum recourse to non-formula based resource sharing
o It may not be possible to completely curb non-formula based transfers in a
democratic setup but State Government should accept some cap/limit
• Improving Own Fiscal Health by State Governments
o The real crux is paucity of funds with State Government to devolve to Local
Governments to bring in perceptive change in their finances. States will have to abide
by FRBM Act recently passed by Parliament and will have to improve their own fiscal
health
• Hard Budgetary Constraints on Local Governments
o State Finance Commission should carry in-depth study and suggest appropriate Hard
Budget Constraints for Local Governments
o State Government should impose such Hard Budget Constraints on all types of Local
Governments impartially and strictly

Policy Aspects (To be observed by the State Finance Commissions while structuring devolution
mechanism)
• Separate Inter-governmental transfer system for Urban and Rural Local Governments
o Urban and Rural Local Governments have different resource bases, expenditure
responsibilities and governing capabilities and therefore need separate inter-
governmental transfer systems.
• Revenue vs. Tax Assignments
o Due importance, if not more, should be given to instrument of Tax Assignments by
SFC while drafting fiscal devolution system
o But success of Tax Assignments as an instrument of decentralization depends on
maturity of local government institutions.
o Appropriate capacity and opinion building strategy should be formulated by SFC and
State commensurate to tax assignments initiatives
• Principles of Resource Sharing between State and Local Governments
o There is need to evolve uniformity in principles of Resource sharing between State
and Local Governments.
o Variation in approaches will lead to asymmetrical decentralisation in different states
which will occur at different paces and via different routes
o Concept of global sharing should form foundation for resources sharing between
State and Local Governments
o Sharing of State Resource with Local Governments on the basis of ‘Non Loan Gross
Own Revenue Receipts’ will provide broad and buoyant base.
o States should also share certain percentages of Central devolution with local
governments to make resource sharing comprehensive.
• Principles for Determining Quantum of Resource Sharing
o Quantum should be determined by normative approach as follows –
ƒ Identification of the core/ essential services,
ƒ Establishing standards/ norms for the provision of services,

7
 ƒ Calculating gaps between actual service provision and needs (service gap)
and then
ƒ Estimating the costs to fill service gap to find out fiscal gap.
o Deciding extent to which fiscal gap to be financed through revenue sharing.
o Linking it with local resource mobilisation and fiscal accountability norms to be
attained by local governments
• Principles for Resource Sharing between Rural and Urban Local Governments or amongst
the different tiers of Local Governments –
o Composite index/formula made of different types of indicators (demographic,
economic, social etc) should be adopted in place of single criteria like population or
area
o It is difficult to suggest ideal set of indices, as their selection will depend on specific
context and situation prevailing in the State.
o Still there are indices which must form part of any such composite formulae for
sharing of resources amongst different types of Local Governments –
ƒ Population
ƒ Area
ƒ Per Capita Income or People living below poverty line
ƒ People living in Slums
ƒ Literacy Rate
• Principles for Incentive Grants
o Incentive grants should be sizeable, motivating and performance linked
o Performance Covenants to be identified after careful assessment of weaknesses of
Local Governments in question
• Principles for Equalisation Grants
o Local Governments differ in their economic base and in terms of constraints. Certain
Local Governments suffer from weak economic base or other constraints.
o Above framework, though comprehensive, can not take care of such local
governments.
o Appropriate framework of equalisation grants to uplift such weaker local governments

8
 Decentralisation and Local Finance Issues –
The Workings of State Finance Commissions in India

Preamble

….just as it is wrong to withdraw from the individual and to commit to the community at
large what private enterprise can accomplish, so it is like-wise unjust and a grave
disturbance of right order to turn over to a greater society of higher rank functions and
services which can be performed by lesser bodies on a lower plane. This is a
fundamental principle of social philosophy, unshaken and unchangeable.8

Introduction
Decentralization in recent decades has become truly world wide movement. Rabinovitch (1999) noted
that more than 60 countries have adopted decentralisation initiatives and are in process of
strengthening it. Of the 75 developing countries with populations greater than 5 million, all but 12
claimed to have embarked on some form of transfer of fiscal authority from central and provincial to
local governments. This transfer of power has been occurring even in inherently centralized
countries. The World Development Report on ‘Entering the 21st Century’ notes that localization – the
desire for self-determination and the devolution of power is the main force “shaping the world in which
development will be defined and implemented” in the first decade of this century.9 For similar
initiatives in developing countries, see Annexure I

Across the world, decentralisation is pursued for different reasons and in order to attain different
objectives. According to Robert Ebel, the western world sees decentralisation as a means to provide
public services in a more cost-effective way. Developing countries are pursing decentralisation
reforms to counter economic inefficiencies, macroeconomic instability and ineffective governance.
Post communist transition countries are embracing decentralisation as natural step in the shift to
market economies and democracy. African states view decentralisation as a path to bridge the social
divide and bring about economic justice and equity.

Thus, the nature of these decentralisation policies varies tremendously – from incremental changes in
protocols of intergovernmental relations on the one hand to major constitutional amendments or even
new constitutional forms on the other. Three large countries –Brazil (1988), India (1992) and South
Africa (1996) gave new constitutional powers to local governments during 1990s.

In India, an important constitutional amendment (73rd and 74th ) in 1992 (see Annexures II & III)
provided and illustrative list of functions that are henceforth considered appropriate for local
government; among these functions are planning for economic and social development, urban
poverty alleviation, and even urban forestry. The amendment also limited the degree to which state
governments are able to suspend democratic local government, and finally and most importantly
provided for a revision of state-local fiscal relations at regular interval through mechanism of State
Finance Commission. This paper is devoted to examination of workings of this very State Finance
Commission mechanism and resultant change in state-local fiscal relations in India.

Structure of Local Governments in India

rd th
The Constitutional 73 and 74 Amendment Act, 1992, essentially contains provisions to address
three issues –
i. The constitution, composition and the structure of the panchayats and municipalities;
ii. Institutional arrangements for planning of economic and social development, and
iii. The functional and fiscal powers of the panchayats and municipalities.

8
Pius XI. Quadragesimo Anno 1931. pp203
9
William Dillinger 1994. Decentralization and its Implications for Urban Service Delivery. The World Bank, Washington, D. C.

9
Constitution and composition of the Panchayats and Municipalities
Similarly, there are three types of municipalities namely Nagar Panchayats, Municipal Councils and
Municipal Corporations, which are classified depending on factors such as population, functions,
economic base and like.

The Constitution now also contains a specific provision for the representation of women and other
disadvantaged groups in order to impart greater participation of those sections of local communities,
which have been outside the mainstream of development.

Thus, the Constitutional Amendments have put an end to the state government’s discretion in
constituting or not constituting local bodies or in deciding their structure or composition. However,
deviations from the provisions of the Eleventh Schedule of the Constitution have been noticed.

Institutional arrangements for planning of economic and social development

The Constitutional Amendment provided for the constitution of district planning committees (DPCs)
and metropolitan planning committees (MPCs) for purposes of planning and development at the local
level. The DPCs are envisaged to consolidate plans prepared by the panchayats and the
municipalities of the district and to prepare a draft development plan for the district while MPCs are
expected to perform a similar exercise for the metropolitan areas. The constitution has left the
composition and functions of DPCs and MPCs to the legislature of states.

Financial and Fiscal Powers of the Panchayats and Municipalities

Fiscal relations between the 28 states, over 4,600 municipalities and over 2, 50,000 panchayats in
India are diverse and complex. Much of this complexity is rooted in the Constitution itself, which lays
down neither an expenditure jurisdiction nor a fiscal domain for municipalities. These are defined by
state governments, and encoded in state laws. The constitution provides in the seventh schedule,
three lists, namely – a union list, a state list and a concurrent list. Out of the state list, the legislature of
a state is expected, by law to endow the panchayats and municipalities, with such powers and
authority as it may consider necessary to enable them to function as institutions of self government,
and such law may contain provisions for the devolution of powers upon panchayats and
municipalities. The constitutional amendments contain two schedules, viz., schedule XI (243G) and
schedule XII (Article 243 W) which comprise of a list of functions considered appropriate for
devolution to panchayats and municipalities (See Annexure IV & V).

The state governments, out of the powers and responsibilities enumerated in the seventh schedule,
have assigned certain functions and duties to the panchayats and municipalities which historically
have consisted of public health, sanitation and communications, i.e., roads, bridges etc. not specified
in list, I, subject to the provisions of Entry 56 of list I, markets and fairs, libraries, museums and other
similar institutions, and burial and cremation grounds. The main services with which the local bodies
(panchayats and municipalities) are associated and which are generally, though not uniformly,
performed by them, are water supply, sewerage and drainage, conservancy and sanitation, street
lighting, and local roads. In addition, the panchayats and municipalities are vested with a large
number of regulatory functions.

The Constitution 73rd and 74th Amendment Acts, 1992, while laying down the procedures for the
constitution of panchayats and municipalities and providing safeguards against their arbitrary
suspension or dissolution, has not changed the structure of fiscal federalism in the county. The
legislature of a state continues to enjoy absolute powers to endow the municipalities with such
authority, as it considers necessary to enable them to function as institutions of self-government’. This
arrangement implies concurrency of functions between state’s panchayats and the state’s
municipalities. It implies that the municipalities do not possess what referred to as general
competency powers are permitting them to take actions not explicitly prohibited or assigned
elsewhere; they possess the legally delegated powers and functions, under the doctrine of ultra vires
(Dillon’s Rule) that limit local choice and diversity. They are to take nothing from the general
sovereignty except what is expressly granted.10 The functional domain of municipalities has also
witnessed periodic shifts and changes, because of the withdrawal of functions from municipalities or

10
The rule known as the Dillon’s rule was not accepted by all the judges. However, the Supreme Court of the US upheld it and
opined that the relationship between state and local government was not contractual in nature (thereby implying equality) but
was one of a superior (the creator) and the inferior (the created). For further discussion, see Advisory Commission on
Intergovernmental Relations. State and Local Roles in the Federal System. Washington D.C. 1982.

10
entrusting them with such responsibilities as poverty alleviation. These features have a direct impact
on the volume and structure of municipal finances.

The state governments determine the fiscal options of municipal governments. The state laws specify
the taxes that the municipalities can levy and collect. Like in the case of functional responsibilities, the
state governments, out of the tax powers listed in the seventh schedule, devolve certain tax powers to
municipalities, which typically have included taxes on lands and buildings, taxes on the entry of goods
into a local area for consumption, use or sale therein; taxes on animals and boats; tolls; taxes on
professions, trades, callings, and employments; and taxes on entertainment. Significant inter-state
variations are witnessed here. Taxes on the entry of goods, which are among the most buoyant and
elastic of the local taxes, are currently levied in Gujarat, Maharashtra, Manipur, Orissa, and Punjab.
The inclusion or exclusion of this tax has an overwhelmingly large impact on the revenue base of
municipalities. Similarly, there are inter-state differences in respect of taxes on entertainment, and
taxes on professions, trades, callings, and employment. These tax objects are less mobile, not easily
exportable, and thus fit into the model that says that the choice of tax instruments should conform to
the rule that each jurisdiction pays for its own benefits.

In its totality, municipalities in India would seem to fall into three groups, with each group presenting a
different order of financial requirements-
iv. Those which have a comparatively large functional and an equally large fiscal domain.
Gujarat and Maharashtra are examples of this typology;
v. Those, which have a larger fiscal domain but a narrow functional jurisdiction. Rajasthan and
Manipur are typical examples of this group; and
vi. Those that have a comparatively larger functional jurisdiction, but a narrower fiscal base.

The state-municipal fiscal relations are complex, with state laws limiting the autonomy of municipal
government in laying down local tax policies, including policies relating to the choice of tax rates or
determining who to include or exclude from payment of taxes. States stipulate the purposes for which
funds may be spent, fix salaries, and impose limits on the amount of debt, the purpose for which debt
may be incurred, procedures for repayment and the like. Absence of autonomy in matters relating to
tax rate fixation, or a low discretion coefficient as it is often referred to, is one of the most serious
handicaps of municipal governments in managing their finances and spending responsibilities. In
many ways, it has meant increasing dependence of municipalities on the state governments.11

The Constitution (seventy third and seventy fourth) Amendment Act, 199212 and Article 280 (3) (c)
have altered the erstwhile fiscal devolution system and framework between the states and
municipalities. Under the new fiscal devolution system/framework every state government is required
to constitute, once in five years, a finance commission and entrust it with the task of reviewing the
financial position of local governments and making recommendations as to the principles that should
govern –

• The distribution between the state and the local governments of the net proceeds of the
taxes, duties, tolls and fees leviable by the state;
• The determination of the taxes, duties, tolls and fees that may be assigned to or appropriated
by the local governments; and
• The grants-in-aid to local governments from the consolidated fund of the state.

The constitutional amendments have placed crucial responsibilities on the new institution of the
finance commission of states. Over and above recommending the principles that should govern state-
local fiscal relations, SFCs are expected to

• Undertake a review of the finances of municipalities;

• Estimate the future financial requirements of municipalities;
• Suggest measures for strengthening the finances of municipalities.

The new fiscal devolution system has simultaneously effected a major change in the scope of the
tasks of the central finance commission which until the insertion of Article 280(3) © (See Annexure VI)

11
State limits on local revenue raising authority are neither new nor only a feature of India’s federal structure. In the USA,
property tax rate limits began in the last century, originating in Rhode Island in 1870.
12
Please see Annexure 1 and 2.

11
was confined to the distribution of divisible taxes between the Union and the States and of grants-in-
aid to states under Article 275 of the Constitution. The new fiscal devolution system/framework now
requires the central finance commission to suggest measures need to augment the consolidated fund
of a state to supplement the resources of the local governments on the basis of the recommendations
made by the finance commissions of states.

Local Government Finances in India

There are not many of national and very exhaustive level studies about state of local finance in India
but there are various regional level or state level studies are available regarding state of local finance.
In fact, there has been great void of data base about local finance but in recent year, some data base
is getting created due to emergence of Institution of State Finance Commission and special mandate
and funds allocated by the EFC.

Before looking at the macro picture of local finance in India, an attempt is made to present
dependency of local governments on higher governments emerging from the SFC reports taken for
case study.

Dependency of Local Governments / Finance on Higher Governments

Along with a quick look at the structure of local governments in India, it will be appropriate to take
stock of the dependency of local government on state or higher level government to know the ground
realities of fiscal relations between local and state governments. For this purpose, figures/data
contained in the reports of the state finance commissions reviewed under this study have been used.

Dependency of Local Bodies on the State Government in Karnataka

The Karnataka second SFC has provided detailed analysis of finances required by the various
categories of local governments. As per this SFC (in the year 1996-97) the ratio of own revenue to the
total revenue in case of Gram Panchayats was 22.4 %, which was only a marginal increase over the
past years. For the year 2000-01, this ratio was 23.75 %. This ratio fluctuated between 22.4% and
26.0% during the five year period. Gram Panchayats thus have been mobilising less than 1/4th of their
total revenue. (Para 2.34 of SSFC-Karnataka) As Taluk Panchayats (intermediary local government)
and Zilla Panchayats (District local government) do not have taxation powers, they were completely
dependent on state government transfer and grants-in-aid.

The share of grants/devolutions in the total revenue of city corporations on an average was 39.11
percent in the year 2000-01, that is, municipal corporations were dependent on state devolution to the
extent of 60.0 per cent; but there were wide variations in dependency among various municipal
corporations. Mangalore Municipal Corporation generated almost 89 % of its total revenue from
internal sources that is it was dependent to the extent of 11 per cent on grants and devolutions from
the state government, while Belgaum Municipal Corporation generated only 30.54 per cent of its
revenue internally and Gulbarga Municipal Corporation generated 38 per cent of its revenue
internally. Bangalore Municipal Corporation, the biggest in Karnataka, generated 66 per cent of its
total revenue by internal sources and thus depended on state devolutions to the extent of 34 per cent.
(Para 4.11and 4.12 of SSFC Karnataka)

There are 41 municipalities in Karnataka. In case of municipalities, grants and devolutions constituted
63.10 per cent of revenue in 2000-01. Thus, municipalities generated only 36.90 per cent of total
revenue from internal sources. Yelhanka municipality reported the highest dependency (93.58 %) on
revenue coming from grants and devolutions and next in order was Byataranapura municipality with
82.88 per cent dependency on grant-in-aid from the state government. At the other extreme was the
Channapatna municipality, which generated 92.66 per cent revenue internally, and grants constituted
only 7.34 per cent of its total revenue. (Para 4.31 of SSFC-Karnataka)

There are 82 Town Municipal Councils in Karnataka. The dependence of the town municipal councils
on grants / devolutions in 2000-01 was on an average 47.43 per cent. Chitaguppa TMC was
dependent on grants and devolutions to the extent of 91.18 per cent. At the other extreme was
Gundlpet TMC, which generated 97.27 per cent of its revenue from internal or own sources and thus
was dependent on grants and devolution by just 2.73 per cent. (Para 4.49 of SSFC Karnataka)

There are 93 Town Panchayats or Municipal Councils in Karnataka. In case of town panchayats,
grants and devolutions constituted 49.37 per cent of their total revenue in 2000-01. The highest

12
dependent town panchayat was Gudibande, which depended on grants to the tune of 92.61 per cent
while least dependent town panchayat was Bankapura, which generated 93.88 per cent of its revenue
from own sources. (Para 4.61 of SSFC-Karnataka)

Dependency of Local Bodies on State Government Funds in Tamil Nadu

In the case of Tamil Nadu overall dependency of all types of local governments put together on the
assigned revenues, was 55 % during the period 1997-98 to 2001-02. In other words, own revenue of
local governments covered only 45 per cent of their funds requirements. Among the local
governments district panchayats were completely dependent on state government funds while village
panchayats were dependent for 80 per cent of their funds on the state government. Surprisingly in
Tamil Nadu, municipalities and municipal corporations were equally dependent on the state
government for about 38 – 39 per cent of their fund requirements.
Table A
Statement of Revenue Income of Local Governments in Tamil Nadu during 1997/98 to 2001/02
_____________________________________________________________________________________________________
Type of Local Body Own Revenue Assigned SFC Total Own Reve
Revenue Devolution Revenue as % of
Total Rev.
Village Panchayat 45269 47700 131788 224757 20.14
Interm Panchayat 48224 2602 99699 150525 32.03
Zilla Panchayat ----- ------ 17658 17568 00.00
Nagar Panchayat 61581 33675 49860 145116 42.43
Municipalities 129849 44147 36367 209863 61.03
Municipal
Corporations 206655 68835 54445 329935 62.03
_____________________________________________________________________________________________________
Total 490578 196959 390317 1077354 45.01
Source – First and Second Tamil Nadu SFC

During the second SFC’s (SSFC’s) award period (2002-2007), the situation is not expected to change
much. As estimated by SSFC the own revenue of all local bodies put together will fall short by 60 per
cent in comparison to their revenue requirements. Thus it appears that SSFC projections indicate
increased dependency but it is not so. This increase in dependency projections is on account of
calculating revenue and expenditure needs the SSFC has included additional O & M, debt servicing
and non-debt servicing liabilities which were not accounted for and paid by local bodies earlier. The
brake up of the revenue requirements of various categories shows that district panchayats will
continue to depend 100 per cent on state government funds while village panchayats will be able to
improve marginally by reducing their dependence to 76 per cent from 80 per cent. There will not be
much change in the dependency of town panchayats but the dependency of municipalities and
municipal corporations is expected to increase substantially in the projected period. Table A above
and Annexure VII provides detailed data about the finances of local bodies in Tamil Nadu and their
dependence on state government funds.

Dependency of Local Bodies on State Government funds in West Bengal

Both the SFCs of West Bengal have not provided much relevant data on this aspect. The reports of
their bodies have not calculated the total amount of transfers to local bodies or total expenditure
(revenue and capital) responsibility of local bodies or the resultant revenue or fiscal gap. As per the
SSFC report which has provided some data (table B) about the own income mobilised and grants
received by the municipalities during the period 1993-94 to 1997-98, municipal bodies have been
dependent on grants-in-aid or transfers by the state government almost to the extent of 71 per cent to
take care of their salary and other revenue expenditure.

SSFC stated as follows : ‘During our visit to the districts, we observed that essential maintenance
work has been neglected in almost all the ULBs, and no ULB was capable of taking any new
development activities on their own’. (Para 3.23 Karnataka SSFC)

13
 Table B
Finances of Municipalities of West Bengal
Rs. In Lacs
Year Tax Revenue Non-tax Total Own Own Grants Total
revenue Income income as Received
% of total
income
1993-94 2568.75 1121.16 3689.91 27.44 9753.13 13443.04
1994-95 2800.95 1159.61 3960.56 24.02 12523.24 16483.80
1995-96 3004.93 1828.06 4832.99 26.33 13313.59 18146.58
1996-97 5555.71 3215.97 8771.68 33.55 17368.19 26139.87
1997-98 6823.28 3433.67 10256.95 33.68 18490.09 28747.04
Source – Second State Finance Commission of West Bengal

Regarding Panchayats (rural local bodies), SSFC has noted that, ‘Data regarding resources of the
different tiers of the Panchayats were not available at the State level. In view of this, we circulated a
questionnaire to all the Panchayats. Responses to this questionnaire were not uniform.’ From the
limited data received and presented by SSFC it appears that Panchayats (rural local bodies) are
dependent on state transfers and grants-in-aid almost by 80 per cent.

Dependency of Local Bodies on State Government Funds in Andhra Pradesh

Andhra Pradesh SSFC report has provided detailed information about the finances of local bodies.
(Annexure VIII)As per SSFC report, Gram Panchayats own income from all the sources accounted for
15.53 per cent of their total income in 2001-02. In other words, gross dependency of gram panchayats
on state devolutions and grant-in-aid is around 85 per cent. SSFC has provided further bifurcation of
gram panchayats total income. As per the SSFC assigned revenues accounted for 18.68 per cent
while grants-in-aid accounted for 12.92 per cent (Para 5.13.1, 5.14 and 5.15 Karnataka SSFC).

In the case of Mandal Parishads (Taluka Panchayat/Intermediary level) and Zilla Parishads income
from own sources accounted for a meagre 0.68 per cent of total receipts and the remaining 99.32 %
of income was derived from assigned revenues and grants.(Para 5.19.1Karnataka SSFC)
In the case of municipal bodies income from own sources accounted for 34.81 per cent of their total
income in 2000-01, thus municipal bodies depended on government grants and devolutions to the
tune of 65 per cent. (Para 5.26.3 Karnataka SSFC)

In the case of municipal corporations income from own sources accounted for a much higher %age.
On an average it accounted for 49.61 per cent of total income thus municipal corporations were
dependent on state transfers and grants-in-aids to the tune of 50 per cent.

Dependency of Local Bodies on State Government funds in Gujarat

No specific data is available on this issue from the First State Finance Commission Report.
Consequently, data collected by National Institute of Rural Development – Hyderabad and Eleventh
Finance Commission has been used to get the picture on the dependency of local bodies in Gujarat.
Also, data collected by National Institute of Public Finance and Policy was also referred for this
purpose. The consolidated picture is presented in the Table C below.

The picture emerging about the dependency of local governments on state government to the extent
of grants from the SFC reports under study and other additional information narrated above can be
summarised as follows –

14
 Table C
Dependency of Local Governments on State Devolutions/Grants-in-Aid - Summarised
(In percentage)
Types of National
13
Local Body Karnataka T.N. A.P Gujarat West Bengal Level
14 15
Studies
G. P. 22.4 80 85 96.09 80 93.66
Taluka
Panchayat 100 100 99 98.14 100 97.28
Zilla (District)
Panchayat 100 100 99 97.55 100 98.94
16
Town Panchayat 50 N.A. N.A. 26.77 94.86 47.57
17
Municipalities 63 38 65 44.76 71.00 59.76 47.43
18
Muni Corporations 60 39 50 24.72 66.58 74.34
---------------------------------------------------------------------------------------------------------------------------------------
Source – SSFC Reports of respective states, Eleventh Finance Commission Report (1996) and NIRD Study (2000)

Current State of Local Finance in India

The macro and micro level picture of current state of local finance in India is very weak, unaugmented
and not befitting to biggest democracy of world trying to achieve high economic growth rate. Recently
12th Central Finance Commission report has become available which provides current state of local
finance. Also 12th CFC commissioned NIPFP and NIRD to do studies on finances of urban local
bodies and finances of rural local bodies respectively. Following write up on current state of local
finance in India is based on 12th CFC report and two studies commissioned by it.

The NIPFP Study for 12th Finance Commission19

The earlier discussion regarding dependency of local finance on higher level governments clearly
pointed out a very high level of dependence of all types of local governments on, transfers and grant-
in-aids from state governments. The negligible share of local own source revenues (tax and non tax)
is evident from the following observations made by O.P. Mathur in his paper on ‘Decentralisation in
India: A Report Card20 and in the NIPFP study on Municipal Finance for the 12th Finance Commission.

In 1991-92, revenue raised by the municipalities formed 4.6 per cent of the revenue raised by the
central government and 8.05 per cent of the revenues raised by the state governments.
In 2001/02, the size of the municipal sector measured in terms of revenues that the municipalities
generate by way of levy of taxes, duties, fees and fines was estimated at Rs.12,748 crore. These
revenues formed 3.07 per cent of publicly-raised resources, the shares of the central government and
all state governments combined being 57.5 per cent and 39.5 per cent respectively. As a per cent of
the combined gross domestic product (GSDP), own revenues of municipalities represented 0.63 per
cent. Among the states, it varied between the highest levels of 2.16 % of GSDP in Maharashtra to
0.07 % of GSDP in Bihar.
Over the five-year period, the size of the municipal sector has registered a marginal expansion, both
in terms of its share in the total publicly-raised revenues and combined GSDP. Municipal share in the
total revenues of the three tiers of government has risen from 2.84 per cent in 1997/98 to 3.07 per
cent in 2001/02, while relative to GSDP; its share has increased from 0.61 to 0.63 per cent during the
same period. Municipal own revenues (nominal terms) have risen at an annual average growth rate

13
Dependency data for Gujarat was not available from FSFC report hence this data is as per EFC and NIRD mentioned in
footnote 7 & 8 below
14
The data regarding dependence of three tiers of rural local governments in percentage share is as per study done by
National Institute of Rural Development – Hyderabad of 20 states for the period 1999-93 to 1997-98 in March 2000.
15
The data regarding dependence of three tiers of urban local governments in percentage share is for the period 1990-91 to
1997-98 as per Eleventh Finance Commission as reported by Gangadhar Jha in his paper on Municipal Finance Resource
Mobilisation : Status, Concerns and Issues – submitted in National Seminar on Municipal Finance – December 2003.
16
As per National Institute of Rural Development Study mentioned above.
17
Karnataka classified its municipalities in to two categories City Municipal Councils and Town Municipal Councils. Hence, two
separate figures have been provided.
18 th
As per study carried out on Municipal Finance by National Institute of Public Finance and Policy – New Delhi for the 12
Finance Commission presented in National Seminar on Municipal Finance – December 2003.
19
India’s Municipal Sector – A Study for Twelfth Finance Commission (TFC) – O.P.Mathur with Sandeep Thakur – (September
2004 ) – National Institute of Public Finance and Policy – New Delhi
20
UMP-Asia Occasional Paper No 47 – July 2000

15
of 10.32 per cent. The same conclusion emerges when we look at the aggregated expenditure levels
of municipalities. As a proportion of the combined gross domestic product of states (GSDP),
municipal expenditures have risen gradually from 0.74 per cent in 1997/98 to 0.75, 0.77 and 0.75 per
cent respectively in the successive years.

Transfers are an important constituent of the finances of municipalities in India, their share in the
revenues of municipalities being 31.7 per cent (2001/02). This is, however, the average;
municipalities in several states are almost entirely transfer-dependent for running of local services. In
this category are those that have historically been dependent on state transfers such as Bihar,
Himachal Pradesh, Jammu & Kashmir, Uttar Pradesh, West Bengal, and Tripura; and those whose
dependency on state transfers has risen in recent years, e.g., municipalities in Haryana, Orissa and
Rajasthan. Second: the importance of transfers in the finances of municipalities has risen over the
past five years. The dependence of urban local bodies was as high as 83.71 per cent in case of
Jammu & Kashmir, 83.33 in case of Rajasthan and 74.48 in case of Uttar Pradesh while dependence
was as low as 10.1 percent in case of Punjab, 13.82 percent in case of Maharashtra and 17.81
percent in case of Gujarat.

Table D
Revenue Significance of Municipalities21

21
International comparisons of local government revenues are usually hazardous; however, following figures on the position of
local government revenues relative to other tiers of government and relative to the country’s GDP will provide some idea about
international scenario. ? footnote reference is in bold not consistent with other footnotes

16
 Year Municipalities Per cent of GDP Relative shares of own revenues (%)
own revenue Municipalities State Central
(Rs. crore) governments governments
1997/98 8,434.9 0.61 2.84 33.4 63.8
1998/99 9,451.7 0.59 2.97 34.3 62.7
1999/00 10,372.7 0.59 2.80 34.4 62.8
2000/01 12,018.4 0.63 2.98 35.1 61.9
2001/02 12,748.1 - 3.07 39.5 57.5
Note: Figure for municipal own revenues are adjusted to reflect the revenues for all statutory towns and cities.
Source - India’s Municipal Sector – A Study for Twelfth Finance Commission (TFC) – O.P. Mathur with Sandeep Thakur –
(September 2004 ) – National Institute of Public Finance and Policy – New Delhi

The transfers made by all the states to urban local bodies as per SFC reports or under other
devolution frameworks on an average amounted to 4.47 percent during 1997-98 to 2000-01 of State’s
Own Revenues.

The performance of municipalities on the criterion of expenditure levels runs along the same track as
that of own revenues. Estimated at about 0.75 per cent of the gross domestic product (GDP),
municipal expenditure levels are extremely low. Maharashtra, Punjab, Gujarat, and Goa post
relatively high per capita municipal
and higher expenditure ratios to the gross domestic product of states (GSDP). The states that show
medium levels of expenditures comprise Andhra Pradesh, Kerala, West Bengal, and Tamil Nadu.
Expenditure on establishment (salaries and wages) accounts for 54.2 per cent of the total municipal
expenditure. It is as high as 80.4 per cent in Madhya Pradesh, 69.7 per cent in Haryana, 50.6 per
cent in Orissa, 65 per cent in Uttar Pradesh, leaving fewer resources for operations and maintenance.

On average, municipal under spending in relation to Zakaria Committee norm is 130 per cent. This
and the average per capita expenditures (daily) ranging between Rs.0.20 and Rs.2.25 explain the
extremely low level of services and consequently, the deplorable service conditions in cities and
towns. With the exception of Maharashtra and Gujarat, there is no state where municipalities are able
to raise revenues that are adequate for meeting local expenditures.

The NIRD Study for 12th Finance Commission

Twelfth Finance Commission commissioned The National Institute of Rural Development (NIRD) to
study the recommendations of the SFCs, their impact and financial health of rural local governments
(Panchayats). The findings of the study have reaffirmed data presented about dependency of local
government in the Table C above. The NIRD study for 12thFC summarised findings are as follows22 –

1. The size of the own resources of Panchayats are extremely limited in relation to their needs.
During 19990-91 to 1997-98 the Internal Resource Mobilisation (IRM) of Panchayats at all

Revenue Importance of Three Levels of

Government, 1993-1996
Country % of local % of local
government government
revenues revenues to GDP
Australia....................................... 5.21 0.02
Austria.......................................... 17.43 0.10
Brazil............................................ 4.31 0.05
Canada......................................... 12.15 0.10
Germany...................................... 13.42 0.10
Mexico......................................... 5.58 0.01
South Africa................................ 10.55 0.04
Spain............................................ 10.61 0.06
.
Switzerland.................................. 20.72 0.10
United States of America.......... 15.87 0.09
Source: Robert Ebel in Freire Mila and Richard Stren (Eds.), 2001.
The Challenging of Urban Government: Policies and Practices,
World Bank Institute, Washington D.C., USA.
Source: India’s Municipal Sector – A Study for Twelfth Finance Commission
(TFC) – O.P.Mathur with Sandeep Thakur – (September 2004 ) – National
Institute of Public Finance and Policy – New Delhi
22 th
Report of the 12 Finance Commission (2004) page no.143

17
 levels in 23 states constituted 4.17 % of the total revenue. In Bihar, Rajsthan, Manipur and
Sikkim there was virtually no IRM. The annual per capita IRM in some state was Rs. 8 only.

2. There has been phenomenal dependence of Panchayats on revenue transfers from Union
and State Governments. In 1997-98, the panchayats mobilised 0.04 per cent of GDP and
incurred the expenditure of 1.38 per cent of GDP.

3. Though State assistance to Panchayats amounts to more than 80 per cent of the total
resources of Panchayats, most of it is in the form of tide grants. The system of grants has not
been rationalised in many states and the quantum to be made available is often not
predictable.

The Data Collected by 12th Finance Commission

The data collected by the 12FC in this respect indicated that the share of own revenue (IRM) of the all
tiers of Panchayats was 6.40 per cent of their total revenues for the period 1998-99 to 2002-0323.
Thus, the data suggests some improvement over earlier share of 4.17 per cent estimated for the
period 1990-91 to 997-98 by NIRD.

This scenario is a result of the following three factors –

• The inferior local taxes which have low elasticity and buoyancy;
• Poor administration of tax and other powers by local governments; and
• Absence of autonomy for local governments in respect of tax rate setting, rate revision and
other spheres of their functioning.
Annexure XI lists views of 12th Finance Commission and Ministries regarding responsible factors for
today’s sorry state of local finance in India.

CFCs and SFCs in the Context of Decentralisation and Local Finance Issues
As a result of the 73rd and 74th Constitutional Amendment Acts, 1992 and amendment of Article 280
(3) © to Constitution of India the entire framework of state-local relations was poised to undergo a
paradigm change through the SFC mechanism and various other provisions. In order to assess the
role of SFCs and their contribution, one needs to examine the following issues –

• The extent to which SFCs followed CAA provisions / mandate.

• The extent of change in the pre-CAA situation for local bodies.
• Approaches adopted by SFCs to address issues of state-local fiscal relationship.
• Issues associated with workings of SFCs.
• Issues associated with the implementation of SFC recommendations.

Before taking stock of the workings the of state finance commissions in the context of the above
issues, it will be worthwhile to look at the changes, which have taken place at the central finance
commission level.

The Working of Central Finance Commissions Post 73rd & 74th CAA

Report of the Tenth Finance Commission 1996

The 10th Finance Commission (TFC), which looked in to sharing of resources between the Union and
the States for the period 1996-2000, had very little time to do justice to provisions of Article 280 (3) ( C
) as it was amended just before the expiry of its terms. But commission felt that it was obliged to deal
with the issues in the terms of amended Article 280 (3) ©. Consequently it recommended a grant Rs.
100 per capita of rural population as per the 1971 census for the Panchayats and Rs. 10000 million
for urban local governments (municipalities) to be distributed among the states on the basis of the
1971 ratio of the inter-state slum to urban population even though it was part of its TOR. The TFC
stipulated that the grant of Rs. 10,000 million was conditional upon the preparation of detailed
schemes and guidelines regarding utilisation by the states and provision by local governments of a
matching contribution and was useable for properly identified projects.

23 th
Report of the 12 Finance Commission (2004) page no.147

18
Report of the Eleventh Finance Commission June 2000
For the first time, it was the Eleventh Finance Commission (EFC), which was required to suggest, as
per its TOR the measures to augment consolidated fund of the state to enable them to supplement
the resources of local bodies. The TOR of EFC Clearly required it to make recommendations to
augment the consolidated fund of the states to supplement the resources of local bodies on the basis
of SFC recommendations. The EFC however, was, asked to make to its own assessment if the
recommendation of the SFCs were not available.

The Eleventh Finance Commission (EFC), which submitted its report in June 2000, found itself unable
to adopt SFC reports as the basis to formulate its recommendations because of
1. Non-synchronisation of the period of recommendations of SFCs and the Central Finance
Commission.
2. Lack of clarity in respect assignment of powers, authority and responsibilities of local bodies.
3. absence of time frame within which the state governments are required to take action on the
recommendations of SFCs, and
4. non-availability of reports of SFCs
In the light of these constraints, EFC recommended an amendment to the Constitution to delete
words “on the basis of the recommendations made by the Finance Commissions of the State”.

Finally using its own assessment EFC recommended a grant of Rs. 20000 million per annum for local
governments (Rs. 4000 million for municipalities and Rs. 16000 million for PRIs per annum) for a
period of five years beginning with 2000-01 to 2004-05. The recommended grant of Rs. 20000 million
per annum by the EFC is meant to supplement the funds that would normally flow from the state
governments to municipalities during the period 2000-2005. It would also supplement the amounts
that may accrue to municipalities because of the implementation of the recommendations of the
finance commissions of states. This grant is dedicated to improving the maintenance of civic services
such as primary education, primary health care, safe drinking water, street lighting, sanitation,
maintenance of cremation and burial grounds, public conveniences and other common property
resources, and is not expected to be used for payment of wages and salaries. The grant includes a
sum of Rs. 29.4 million for the creation of databases relating to the finances of municipalities and
such sum as may be needed by municipalities for proper upkeep and maintenance of their accounts
and audit.

The EFC has not only recommended the amount of the grant but has established a comprehensive
framework for the allocation of state grants to local governments. The framework consists of a set of
multiple criteria with each criterion being assigned a weight.
(Pl. refer Annexure IX and X)

The principle underlying the framework is that apart from the size represented by population and
geographical area, which is a major determinant of the financial requirement of municipalities and
which consequently commands a larger weight, the grant should be allocated on the basis of a set of
complementary criteria of efficiency, measured by the revenue raising efforts of local
governments/municipalities and equity represented by the distance of the state’s average per capita
non-agricultural gross domestic product from the highest average per capita non-agricultural GSDP.
The former is meant to serve as an incentive for municipalities to boost their revenue effort, while the
latter provides funds for the fiscally disadvantaged municipalities. An important criterion that
commands a 20 % weight in the grant allocation relates to decentralization as envisioned in the
Constitution Amendment Act, 1992. EFC report has formulated an Index of decentralization for
measuring decentralization.

Application of the comprehensive framework has changed allocation of grants to state governments
considerably. The comparative data regarding State share for local government grant as per TFC,
EFC and 12th FC is presented in Table E.

EFC has also suggested, recognizing that the financial requirements of local governments are
phenomenal and can not be met by the grant component alone, a string of measures for the
augmentation of the consolidated fund of the state, which in turn could supplement the resources of
local governments while strengthening their revenue base. Measures for augmenting the consolidated
fund include levy of land taxes by states, surcharge/cess on state taxes, which could devolve on local
bodies, and fuller use of profession tax as provided for under Article 276 of the Constitution. Similar
proposals have been advanced for improving local resource mobilization and include reforming

19
property taxation, substitution of octroi by a tax, which is buoyant, and fixation of user charges, which
are able to cover full operations and maintenance cost.

Table E
State Share of Municipalities as per Tenth & Eleventh Finance Commission Award
State Tenth Finance Eleventh Share of States as per Twelfth Increase/ Decrease
th th
Commission Finance Finance Commission % between 10 & 11
% Commission PRIs Municipalities FC
%
Andhra Pradesh 7.4 8.2 7.935 7.480
Arunachal Pradesh Neg. Neg. 0.340 0.060
Assam 1.4 1.1 2.630 1.100
Bihar 6.7 4.7 8.120 2.840
Chattisgadh NA NA 3.075 1.760
Goa 0.2 0.090 0.240
Gujarat 6.7 6.6 4.655 8.280
Haryana 1.7 1.8 1.940 1.820
Himachal Pradesh 0.2 0.2 0.735 0.160
Jammu and Kashmir 1.2 0.8 1.405 0.760
Jharkhand NA NA 2.410 1.960
Karnataka 7.0 6.2 4.440 6.460
Kerala 2.5 3.8 4.925 2.980
Madha Pradesh 6.2 7.8 8.315 7.220
Maharashtra 13.3 15.8 9.915 15.820
Manipur 0.2 0.2 0.230 0.180
Meghalaya 0.1 0.1 0.250 0.160
Mizoram Neg. 0.2 0.100 0.200
Nagaland 0.1 Neg. 0.200 0.120
Orissa 1.9 2.0 4.015 2.080
Punjab 3.1 2.7 1.620 3.420
Rajasthan 4.3 5.0 6.150 4.400
Sikkim 0.1 Neg. 0.065 0.020
Tamil Nadu 11.6 9.7 4.350 11.440
Tripura 0.1 0.2 0.285 0.160
Uttar Pradesh 12.1 12.6 14.640 10.340
Uttaranchal NA NA 0.810 0.680
West Bengal 12.0 9.9 6.355 7.860
Total 100.00 100.00 100.00 100.00
Source: Reports of the Tenth Finance Commission 1996, Eleventh Finance Commission 2000 and Twelfth Finance
th
Commission 2004. As 12 Finance Commission has given separate percentage share for rural and urban local bodies it is not
possible to compare increase or decrease in share of states due to change in formulae.

Recommendations of Twelfth Finance Commission

The 12th Finance Commission which submitted its report recently in November/December 2004 and
th
which was tabled in the parliament by finance minister with budget on 28 February, 2005 got
opportunity to take birds eye view regarding workings and recommendations of SFCs and the
recommendations of TFC and EFC on the issue of state-local fiscal relationship post 73rd and 74th
Constitutional Amendment Acts. It provides most recent data and analysis of local finance issues. The
recommendations made in report are going to rule local finance scenario in a considerable way in
coming years 2005 to 2010. In light of all this, the observations and recommendations of 12th Finance
Commission constitute great importance for this policy paper on decentralisation and local finance
issues.

12th Finance Commission has dwell upon its role in the contexts of constitutional provisions (73rd &
74th Constitutional Amendments and Article 280 3 ©. It rejected notion these provisions are meant
only to be a mechanism for additional resource transfers from the centre to the states. It felt the
purport of the constitution provisions is two fold –
1. there may be a case to augment the consolidated fund of the states through additional grants
from the centre keeping in view special circumstances of the states which may justify such
assistance; and
2. certain recommendation of SFCs for augmenting revenues of state may require decision
making by central government as they may have centre-state or inter-state ramifications. The
central government may benefit from the expert advice of central finance commission on such

20
 recommendations. Measures that central finance commission may choose to recommend
after taking into account recommendations of SFCs will be a substantial fulfilment of its
constitutional mandate.

The important recommendations regarding local bodies and SFCs of 12th Finance Commission are
summarised as follow -

1. Like EFC, 12th FC was forced to use its own assessment due to lack of reliable data and
SFCs recommendations to decide quantum of grant to supplement the consolidated fund of
the states to supplement resources that would normally flow from the state governments to
municipalities during the period 2005-2010. 12th FC has recommended grant of Rs. 500000
million per annum (Rs. 400000 million for rural local governments and Rs. 100000 million for
urban local governments). It estimated that this would be equivalent to 1.24 per cent of the
sharable tax revenues and 0.9 per cent of gross revenue receipts of centre during 2005-10.
2. It has retained 80:20 ratio adopted by EFC for sharing of resources between rural and urban
local governments.
3. 12th FC has recommended that the grants to the PRIs should be utilised to improve service
delivery especially of water supply and sanitation.
4. In case of urban local bodies, it has recommended that 50 per cent of the grant should be
earmarked for the schemes of solid waste management through public-private partnership. It
has also recommended to exclude six metros from allocation 12th FC grant.
5. It has introduced Index of Deprivation as a criterion for inter-se allocation of grant-in-aid to the
states. (please refer Annexure IX)
6. 12th Finance Commission has taken note of the shortfall in the release of EFC Grant to the
States. This is due to a) not utilisation/under utilisation of the amount already released and b)
the inability of the state/local bodies to raise match contributions. It specifically noted that
condition of matching contribution was not recommended by EFC. It felt that though concept
of matching revenue efforts is important, should not be applied to Central Finance
Commission Grant, as this grant is largely in nature of a correction in vertical imbalance
between centre and states. It has therefore not recommended any condition of matching
contribution and has asked centre not to impose any conditions other than those
recommended by 12th Finance Commission.
7. 12th Finance Commission has also taken note of the fact that the finance commission grants
take much longer time to reach local bodies even after release from central government as
state governments use these amounts for their ways and means comfort and show no sense
of urgency in passing them on to the rightful recipients. In light of 12th FC has recommended
centre to take serious view of any delay beyond 15 days in passing on these grants by state
government from the date of release of the grants by centre.

The Workings of State Finance Commissions

The primary objective of Article 243 I and 243 Y of the Constitution Amendment Acts, 1992 is to bring
about an improvement in the delivery and performance of local bodies. The aim of the various
provisions of the 73rd and 74th CAA regarding evolving fiscal devolution framework by SFCs is to
ensure achievement of the objective of both the CAAs. As per the provisions of both the 73rd and 74th
CAA, a SFC is required to do the following while reviewing state-local fiscal relationships and devising
a fiscal devolution framework for PRIs and ULBs.24

Regarding the Fiscal Package

Review the macro-economic environment within which the municipalities in India operate
• Functions, powers, and authority;
• Limits and constraints within which the municipalities are permitted to function; and
• Degree of autonomy granted to municipalities.

Undertake an appraisal of the finances of municipalities

• Changes and shifts in the fiscal health of municipalities, referring to revenue and expenditure
growth and performance;

24
Approach to State-Municipal Fiscal Relations – options and perspective – Om Prakash Mathur – National Institute of Public
Finance and Policy – New Delhi – 2001

21
 • Trends in the volume and nature of transfers; and
• Key issues in making fuller use of revenue resources and reordering expenditure priorities.

Estimate the revenue gap of municipalities

• Trends in gaps between revenue-raising capacity and expenditure needs; and
• Assessment of the level of municipal under spending.

Project the expenditure needs into the future

• Assumptions in respect of the expenditure responsibilities;
• Norms and standards for services and activities;
• Accounting for revenue gaps and level of under spending; and
• Needs arising out of the fiscal disabilities of municipalities.

Determine a fiscal package for financing future expenditure needs

• Principles for assignment of taxes, duties, tolls and fees;
• Principles for revenue-sharing and grants-in-aid;
• Degree of access of municipalities to the divisible pool of state resources;
• Supplementing revenue resources with grants-in-aid; and
• Pre-conditions for making the fiscal package productive.

Beyond the Fiscal Package

The scope of Article 243 Y of the Constitution is not limited to determining the constituents of the
fiscal package for municipalities. It extends to evolving measures that would improve the financial
position of municipalities. It extends to developing strategies that would contribute to the sound
finance of municipalities. In many ways, Articles 243 Y (b) and (c) are by far the most important as
these permit an examination of the functioning of municipalities with a view to suggest measures that
would result in the long term, a sustainable improvement in the finances of municipalities. The
Constitutional amendment implies that the efficiency of the fiscal package can be significantly
enhanced if it is accompanied by supplementary measures for improving the finances of
municipalities.
These provisions have afforded an opportunity for determining the-
• Soundness of the existing system of property taxation;
• Appropriateness of the existing system of municipal accounting, i.e., whether it is able to
adequately capture the expenditure and receipts of municipalities and the need and relevance for
introducing double entry, accrual based accounting system; and
• Feasibility of privatisation of municipal services and activities.

The present status of state finance commissions in various states is provided in Annexure XII while
information about the share of Municipalities in State’s Resources as recommended by the first
Finance Commission of States is provided in Annexure XIII.

First State Finance Commissions

It can be observed that in all states, except in Bihar, the First SFCs have submitted their report. The
State Governments except Jammu and Kashmir have also submitted the Action Taken Report to the
Legislature. The devolution package recommended by the First Finance Commission of the states
consisted of transfer of resources to municipalities by way of sharing of a pool of states resource
sharing of specific state taxes and a system of grant- in-aid. The recommended composition of the
pool varies among the SFC reports, some example are as follows
b. Sharing of Net Proceeds of State Taxes – Rajasthan (21.8%); Tamil Nadu (8% increasing in
successive years by 1%), Uttar Pradesh (7%), West Bengal (16%)
c. Tax and Non-tax Revenue – Andhra Pradesh (39.2%); Madhya Pradesh (8.70%)
d. Tax Revenue only – Assam (2%) and
e. Non-loan Gross Own Receipts – Karnataka (5.4%)
f. Others
i. Kerala – 1% of state revenues (excluding those from certain sources).
ii. Maharashtra – 25% to 100 % of entertainment taxes collected from municipalities of
different grades, 25% of vehicle tax and 10 % of professional tax.

22
 iii. Punjab – 20% of the net proceeds of 5 taxes (stamp duty, motor vehicle tax, electricity duty,
entertainment tax and cinematograph tax) and the projected gap of Rs. 3220 million
recommended to be met by the Central Finance Commission.

In sum, there is a large variation in the recommended shares of municipalities in the different states.
Many of these constitute marginal adjustments to the shares or amounts that municipalities were
receiving in the pre-amendment period, and do not display any fresh review of the finances of
municipalities.25

Contrary to the central government in principal accepting all the recommendations of successive
central finance commission, not all state governments have accepted the primary recommendation
about a shared pool of state resources.

Second State Finance Commissions

Out of 25 states26 liable to constitute SFC except six all states have constituted the SSFCs. Out of
constituted Finance Commission’s in three states have submitted their reports. Thus in nine states
either SFC is not constituted or constituted but have not submitted report. Seven States have since
submitted their Action Taken Report on the SSFCs to the State Legislature. It is interesting to note
that Andhra Pradesh, Kerala and Punjab have appointed the Third State Finance Commission.

rd
Box - Constitution of 3 State Finance Commission by the States
Andhra Pradesh January 16, 2003
Kerala September 19, 2004
Punjab September 19, 2004

Thus there is a sizeable experience on the functioning of the SFC mechanism, consequently it is now
possible and appropriate (as states will be going through the third round of SFCs) to examine the
workings of SFCs to know how far they have been successful in carrying forward decentralisation
rd th
envisaged by the 73 and 74 CAA and how far they have been successful in addressing local
finance issues.

In order to understand the role-played and the workings of the state finance commissions it is
necessary to evaluate their recommendations against the above-mentioned tasks or roles envisaged
for them by the constitutional amendment acts. Thus, various points mentioned above under the
heading regarding the fiscal package and beyond the package, together form the framework for
evaluating the working of SFCs. Annexure IXV provides summarized evaluation of SFCs under study
using this framework. The SFC reports of the five states namely Karnataka, Tamil Nadu, Andhra
Pradesh, Gujarat and West Bengal have been analysed in the light of the above framework and
placed at the end of this paper.

Emerging Issues on the Functioning of the SFCs –

The 73rd and 74th Constitutional Amendment Acts (CAAs) were the real efforts towards democratic
decentralisation. These amendments were undertaken to achieve local government level (grass root
level) decentralisation and provided a broad framework for the same. Along with decentralisation of
functions and powers, both CAAs tried to provide a mechanism for fiscal decentralisation in order to
resolve various long-standing local structural finance issues and the adhocism prevailing in state-local
fiscal relations.

In order to examine the role played by SFCs in achieving fiscal decentralization for local bodies, the
reports of five SFCs were analyzed. At the outset it can be said that the reports of the Second SFCs
show that the new system of fiscal arrangement envisaged by Constitutional Amendments more than
a decade ago is coming of age in spite of a host of infancy blues and if the third generation SFCs of
the other states which are being set up or would be set up in the near future improve upon the

25
Approach to State-Municipal Fiscal Relations – options and perspective – Om Prakash Mathur – National Institute of Public
Finance and Policy – New Delhi – 2001
26
Mizoram, Nagaland and Meghalay are not required to constitute SFC as traditional local institution of self government exists
in the Schedule VI States

23
pragmatism and professionalism shown by the SSFCs while effectively dealing with policy
weaknesses reviewed in this paper.

The comparative analysis of workings of SFCs of five states reveals the following –

General Issues
In a way, the SFC mechanism was imposed upon the states by the Constitutional Amendment Act. As
a result, states have shown great apathy towards SFCs, in providing them with administrative or
technical assistance, information access and implementation of SFC recommendations.

Lacklustre Attitude/Response by State Governments

Time is now ripe for the constitution of the third SFCs, even though only three states have constituted
their third SFC’s. Bihar is yet to constitute the Second Finance Commission, and Gujarat has recently
constituted the second SFC. Even the first SFC of Gujarat took four years to submit its report and
using that delay the Government of Gujarat did not constitute the second SFC for another five years.
The Government of Gujarat (GOG) has shown great apathy in the implementation of the
recommendations of the First SFC.

There are at least six states, which have not yet set up their Second State Finance Commissions, and
five states, which have not yet submitted action taken reports. This list includes the Government of
Maharashtra and Karnataka sitting.

12FC commission has observed this lacklustre attitude/response of states towards SFCs and has
noted downed in following apt words –

“We find that most states are yet to appreciate importance of this institution (SFC) in terms of its
potential to carry the process of democratic decentralisation further and evolve competencies at the
cutting edge level by strengthening PRIs and the municipalities. The delays in the constitution of
SFCs, their constitution in phases, frequent reconstitution, submission of reports and tabling of ATR in
the legislature have in many cases defeated the very purpose of this institution.” (Para 8.33 12th CFC)

It recommended that the states should avoid delays in the constitution of SFCs, their constitution in
phases, frequent reconstitution, and submission of reports and tabling of ATR in the legislature. (Para
8.55 (ii) 12th CFC)

Composition of State Finance Commission

The composition of SFCs has been found wanting. In one state in service bureaucrat headed SFC.
EFC also held composition of SFC as one of the reason for the quality of SFC reports. 12FC has
categorically observed regarding this issue as follows –

“It is necessary that the states constitute SFCs with people of eminence and competence, instead of
viewing formation of SFCs as a mere constitutional formality. (Para 8.33 12 CFC) In the matter of
composition of SFCs, state may well be advised to follow central legislations and rules which
prescribe the qualifications for the chairpersons and members and frame similar rules.”

Lack of Statutory Mechanisms for Ensuring Continuity

In the review of SFCs of five states important aspects that emerge are the absence of a statutory
mechanism to monitor the implementation of the SFC recommendations and the absence of a
permanent set up to ensure continuity between two SFCs. These issues come to the fore in the
recommendations of SFCs itself or as a reason for inadequate implementation of the SFC
recommendation, or because of delays for the constitution of SFCs or formulation of their
recommendations and overall quality of the SFC reports. The Eleventh Central Finance Commission
has also noted this issue and has recommended setting up of a SFC Cell (Para 12.9 & 12.10 of
Chapter 12 of EFC ) to ensure continuity. Certain States like Kerala, Haryana and Goa have set up
administrative cells for SFCs to ensure continuity in the functioning of the SFCs. All the five states
reviewed have not set up such a cell or have not gone for a statutory mechanism to monitor the
implementation of SFC recommendations and state-local fiscal relationships.

24
Lack of a Reliable Data Base
All the SFCs have univocally regretted and complained about this aspect. In fact, Karnataka SSFC
explicitly noted the lack of reliable data for disbanding the normative approach adopted by the FSFC
and for selecting the second string of preference indicators in place of ideal indicators for horizontal
and vertical distribution of resources among local governments.
Michael F Carter, World Bank Country Director for India, on June 14, 2004 said “Neither the
panchayats nor SFCs nor GOI know the actual amount of funds available to panchayats or their
expenditure pattern” while sharing the recent World Bank Report on ‘Fiscal Decentralisation to Rural
Governments’.

The West Bengal FSFC Report had indicated in their report the constraints under which they had to
formulate their recommendation in the absence of any reliable data base, particularly at the sub-
district level. The SSFC of West Bengal observed, “availability of quality data has not improved much
in the intervening period’. (Para 5.02 West Bengal SSFC)

EFC faced same problem of lack of reliable data and therefore it provided special allocation of Rs.
2000 million for creation of central data base regarding finances of local bodies and Rs. 9861 million
per annum for maintenance of accounts of village and intermediate level panchayats. But not much
has happened and even 12th Finance Commission faced the problem of lack /unreliable data. It
observed that “Both the EFC as well as this commission were hampered by the absence of credible
data”. (Para 8.35 12th CFC) “Even after considerable persuasion, the response (data) received from
different states, barring a few exceptions was found to be rather sketchy. The data furnished by the
states did not facilitate quantification of the required augmentation of the consolidated fund on the
basis of the SFC recommendations.”

Non Synchronisation of SFCs with Central Finance Commission and Five Year Plans
By this time the 12th Finance Commission should have been reviewing the third generation state
finance commission reports for basing its recommendations on local finance but it has received only
the second state finance commission reports only from one third of the states. Right from the
beginning, there is no synchronisation of the award period of SFCs with the award period of Central
Finance Commission and the duration of the Five Year Plans.

Synchronisation of SFCs with CFC aside, the 12 FC has to recommend, “The SFC reports should be
readily available to the central finance commission, when the latter is constituted so that an
assessment of the state’s need could be made by central finance commission on the basis of uniform
principles.”

Minimal Impact on Finance of Local Bodies of SFC Recommendations

The SFC recommendations and devolution framework suggested by SFCs have failed to cause any
perceptible change in the finances of urban local governments. It can be observed from Table F that
the transfers made by all the states to urban local bodies as per SFC reports or under other
devolution framework on an average amounted to 4.47 percent only during 1997-98 to 2000-01 of
State’s Own Revenues. Thus, State Governments are sharing after two rounds of SFCs or after a
period of more than decade from CAAs less than 5 percent of their resources with the local
governments. Over this period, the percentage of state resources shared with local governments has
remained more or less the same.
Table F
Transfers as a % of State’s Own Revenues
Rank States 1997/98 1998/99 1999/00 2000/01
1 Andhra Pradesh 2.91 3.88 3.91 3.08
2 Assam 0.66 0.53 0.48 0.66
3 Bihar 3.96 3.37 4.37 2.39
4 Chattisgarh - - - 10.83
5 Goa 1 0.76 - 0.67
6 Gujarat 1.99 2.14 2.62 2.8
7 Haryana 1.13 0.69 1.4 1.74
Rank States 1997/98 1998/99 1999/00 2000/01
9 Karnataka 2.69 3.62 4.06 4.49
10 Kerala 3.17 3.74 3.65 2.58
11 Madhya Pradesh 6.78 8.28 8.76 8.13
12 Maharashtra 2.19 2.21 3.35 2.82
13 Orissa 1.68 2.01 3.14 2.73

25
 14 Punjab 1.07 1.91 1.25 1.27
15 Rajasthan 2.25 5.91 6.48 6.53
16 Tamil Nadu 7.77 8.08 6.85 6.05
17 Uttaranchal - - - 14.24
18 Uttar Pradesh 5.26 7.26 6.21 5.52
19 West Bengal 9.01 10.37 15.25 11.95
20 All States Average 3.76 4.52 4.93 4.47
Source - India’s Municipal Sector – A Study for Twelfth Finance Commission (TFC) – O.P. Mathur with Sandeep Thakur –
(September 2004 ) – National Institute of Public Finance and Policy – New Delhi

Similarly, the grants-in-aid provided by the central finance commissions (10th and 11th) from the
resources of Union Governments have caused a miniscule impact on the finances of urban local
governments. It can be observed from Table G that the total impact of central finance commissions on
the finances of urban local governments was less than 3.35 percent.

O.P. Mathur and Sandeep Thakur observed that the ‘transfers to municipalities form 3.85 per cent of
the combined own resources of states. Between 1997/98 and 2001/02, these have risen by 0.54
percentage points which, in a crude way, could be said to be additional strain or the finances of state
governments. The SFCs have preferred to maintain the status quo, instead of examining de novo the
inter-governmental fiscal relations in relation to the requirements of the 1992 amendment’.27

Table G
Municipal Own Revenue and Distribution of Finance Commission Grant or Rs. 400 crore (in Rs. Lakh)
th
States Municipal own Municipal share of 11 FC grant as a
revenue 2001-02 Rs. 400 Cr. percent of municipal
own revenue
(Rs. Lakh) (Rs. Lakh) (%)
Andhra Pradesh 71745.71 3293.20 4.59
Assam 3825.81 430.80 11.26
Bihar 3408.44 1878.00 32.61
Chattisgarh 11599.83 - -
Goa 1858.772 92.80 4.99
Gujarat 144849.22 2650.40 1.83
Haryana 12106.95 732.80 6.05
Himachal Pradesh 1978.93 78.00 3.94
Jammu & Kashmir 1199.02 313.20 26.12
Jharkhand 2351.23
Karnataka 53448.98 2496.40 4.67
Kerala 22432.79 1504.80 6.71
Madhya Pradesh 29437.00 3120.40 7.60
Maharashtra 587058.29 6325.20 1.08
Orissa 10176.83 799.20 7.85
Punjab 68551.18 1094.40 1.60
Rajasthan 10339.68 1988.40 19.23
Tamil Nadu 88079.00 3867.20 4.39
Uttaranchal 2320.61 - -
Uttar Pradesh 26551.00 5032.80 17.43
West Bengal 442201.69 3949.60 9.36
Arunachal Pradesh - 136.00 -
Manipur - 88.00 -
Meghalaya - 776.80 -
Mizoram - 35.60 -
Nagaland - 4.00 -
Sikkim - -
All States total/average 1195520.92 40000.00 3.35
Source - India’s Municipal Sector – A Study for Twelfth Finance Commission (TFC) – O.P. Mathur with Sandeep Thakur –
(September 2004 ) – National Institute of Public Finance and Policy – New Delhi

Policy / Structural Issues

Revenue / Tax Assignments

Overall, the recommendations of SFCs regarding tax assignments reveal that the SFCs have broadly
recommended maintenance of the status quo in respect of tax powers of local bodies. There appear
to be two reasons for this approach, one, there is limited scope for innovation in tax assignments to
local government beyond making small changes to the existing assignments; and two, inadequate

27
India’s Municipal Sector – A Study for Twelfth Finance Commission (TFC) – O.P. Mathur with Sandeep Thakur – (September
2004 ) – National Institute of Public Finance and Policy – New Delhi

26
use of taxes and other assigned duties that already vest with the local bodies and the consideration
that any additional assignment may not be effectively used by the local bodies. There is a clear trend
in the reports of the SFCs favouring revenue sharing and grants-in-aid rather than tax assignments.
However, the SFCs certainly suggested better use of the existing tax jurisdiction, by reforming the
system of property taxation and giving greater autonomy to local bodies in matters relating to tax rate
setting.

Notwithstanding the Constitution (seventy-fourth) Amendment Act, 1992 that envisioned a change in
fiscal relations between the state governments and municipalities, the tax jurisdiction of municipalities
has not undergone any noticeable shift even with their changing functional portfolio.28

Principles of Revenue Sharing

Because of the competing demands on the available resources, state-local government sharing of
allocations are crucial. In reality, whilst a wholly rational and normative approach is not always
feasible, an ad-hoc and subjective approach is not desirable. The Karnataka SFC has been
innovative in this regard. It adopted a ‘pragmatic normative approach’ in the sense that both
administrative feasibility and the norms of services were taken into consideration for estimating the
financial requirements of local bodies. The SFC maintained that this differs from the traditional
approach of gap filling, which the Central Finance Commission follows normally.

The concept of global sharing is gaining ground in India, which is also evident from the reports of the
SFCs. Nine SFCs have recommended adoption of this concept for sharing of resources. This involves
the creation of a divisible pool at the state level. The definition of the divisible pool is debatable and,
in fact, varies from state to state. Ideally, this should include the net proceeds of all taxes, fees, tolls,
etc., levied by the respective state governments. But the SFCs have interpreted the concept
differently. The variation in the definition of divisible pool by various SFCs is indicated in the following
tables. For instance, the Karnataka SFCs included all the ‘non-loan gross own revenue receipts’ of
the state government but excluded the state’s share of the central revenue transferred through the
Central Finance Commission, Planning Commission and the loans. The SFCs of Andhra Pradesh
interpreted this concept as the sum of tax and non-tax revenues of the sate government. The Tamil
Nadu FSFC interpreted it to constitute net proceeds of all State taxes, excluding entertainment tax
while SFCs of West Bengal have recommended total tax receipts of the State excluding entertainment
tax receipts. Tamil Nadu SSFC maintaining the FSFC definition of net proceeds of all state taxes as
divisible pool went one step forward and recommended 5 % share of central devolution to the state in
the divisible pool. Punjab SSFC has recommended net tax revenue of the state arrived after
deducting the cost of collection of tax from the total tax revenue. The Kerala SFC recommended
separate State Level Urban and Rural Pools. The former was to consist of various non-statutory non-
plan grants, basic tax (100%) and 25 percent of the proceeds of the surcharge on stamp duty.

It can be observed that the approaches/principles recommended by SFCs for dealing with the sharing
of resources with local governments by states are varied. While variation in approaches is inevitable
taking in to account the vastly different local situations, its long term implications need to be carefully
monitored. The likely result of variation in approaches will be asymmetrical decentralisation in different
states, which will occur at different paces and through different routes.

Along with global sharing and other approaches there appears to be a clear preference for creating a
divisible pool of resources at the level of states and allocating a proportion of the same to local
bodies. The size of the pool and the criteria for its allocation to local bodies, which forms the
mechanisms for revenue sharing, may vary depending on a number of factors, including spending
responsibilities of local bodies.

Quantum of Revenue Sharing

It is important to have clear allocation criteria for the sharing of revenues both vertically and
horizontally between different levels of government. In view of the different methods being adopted
for constituting state level divisible pools, there is no commonality as to the percentage share of the
local bodies. There are primarily two methods. The first is based on estimating gross financial
requirements based on past trends and thus calculating the percentage share in the divisible pool.

28
India’s Municipal Sector – A Study for Twelfth Finance Commission (TFC) – O.P.Mathur with Sandeep Thakur – (September
2004 ) – National Institute of Public Finance and Policy – New Delhi

27
Whilst the Kerala SFC recommended fixing the non-plan non-statutory grants at one percent of state
revenue, the state government rejected this on the grounds of it being an arbitrary estimation without
any rational justification. Similarly, the SFC in Andhra Pradesh recommended that 39.24 percent of
the state tax and non-tax revenues be transferred to local bodies based on past trends. The
government is yet to take a decision on this recommendation.

The second method is normative in approach. This involves identification of the core/ essential
services, establishing standards/ norms for the provision of services, calculating gaps between actual
service provision and needs, and estimating the costs of service provision at certain minimum levels
or as per the norms. This exercise should be undertaken for each local government and the
Karnataka FSFC used this approach. Here allocations were calculated on the total estimated
requirements of the local government. The Karnataka FSFC thus estimated a 36 percent requirement
(of the divisible pool, i.e., non-loan gross own revenue receipts of the state) for rural and urban local
government. Interestingly, this closely approximated the prevailing level (34.27 percent).

The Tamil Nadu SSFC approach has differed significantly. This has recommended an allocation
based on a share of the revenues of state taxes as a proportion of the divisible pool after calculating
service gap and fiscal gap on the basis of normative approach. Along with it, SSFC has
recommended fiscal accountability norms for local bodies. It has calculated and provided how much
resource improvement local bodies should undertake to improve revenue from their own resources
and to improve cost efficiency to address their fiscal gap. The SFC also recommended the creation of
equalisation and incentive grants representing 15 percent of the proceeds from the divisible pool.

Resource Sharing between Urban and Rural Segments

Once the local government share is decided, the next step is to sub-divide the pool into urban and
rural components. The Kerala SFCs recommended separate rural and urban pools. The Karnataka
and Tamil Nadu SFCs have recommended sub division based on different methods. The Tamil Nadu
SFCs recommended a simple population basis. Accordingly, the ratio for distribution of funds between
rural and urban local bodies was fixed at 60:40. But in practice, the government decided to allocate
funds in the ratio of 55:45 between rural and urban local government. The Karnataka SFCs, on the
other hand, recommended a composite formula (Table H) as follows:

The Karnataka SFC allocated 15 percent to urban local government and 85 percent to the Panchayat
Raj institutions from the divisible pool from 1996 – 97 onwards. Although the state government
accepted this in principle, it was decided to achieve the ratio of 15:85 between urban and rural local
government by the year 2001 – 2002.
Table H:
Formula for Resource Sharing Recommended by the SFC of Karnataka
Criteria FSFC SSFC

Population - 33.33% 30.00%

Area - 33.33% 30.00%
Illiteracy - 11.11% 15.00%
No. Of persons per hospital bed - 11.11% 10.00%
Road length per sq km - 11.11%
SC/ST Population 15.00%
Source – First and Second Finance Commission Report of Karnataka

West Bengal SFCs adopted a very unique approach, instead of going for urban and rural categories
for sharing resources available for local governments, it opted for the district as the primary unit for
sharing resources from the district fund, FSFC recommended three ways of sharing among municipal,
panchayat and special areas. SSFC the retained three way sharing but in place of ambivalent special
areas it specified it as hilly area and recommended setting aside of 0.4 of total devolution to local
bodies before distributing it among districts as per formulae. Having set aside the special fund for hilly
areas the SSFC of West Bengal recommended sharing of the district fund between rural and urban
areas based on the proportion of rural and urban population in the district.

Vertical / Horizontal Distribution among Local Governments

The next stage in the sharing process is vertical and horizontal distribution between different levels of
local government. Karnataka SFCs recommended composite formulae made up of five indicators for
distribution across urban local governments as shown in the box above. The Tamil Nadu SFC
recommended vertical devolution within urban local governments in the ratio of total population of

28
respective tiers based on the last census. For the horizontal distribution, a composite formula was
recommended with percentages varying across tiers. This consists of total population (40 to 45%),
SC/ST population (10 to 20%), per capita receipts of own revenues (15%) and per capita expenditure
on core services (20 to 35%). The state government accepted these proposals but, the formula
recommended for horizontal distribution was modified for the first year due to administrative reasons
and the weightage in respect of the service indicator was transferred to the total population and
SC/ST population of urban local government.

In Kerala, the municipal corporations were kept outside the urban pool, only municipalities were taken
into consideration, and a composite formula was suggested for horizontal allocation. This consists of
80% population (1991 Census) 5% for SC/ST population, 10% financial need and 5% tax collection.
A separate method was recommended for plan funds consisting of 75% population, 10% SC/ST
population and 15% for total workers, excluding workforce engaged in manufacturing, processing,
services etc. Contrary to these recommendations, the state government preferred a simple,
measurable and objective formula consisting of population (90%) and area (10%) in both the cases
for distributing plan grants and funds in the urban pool.

Tied Vs Untied Fund and Block Grant Concept

Except West Bengal and Karnataka SFCs, all the SFCs under study have recommended fiscal
devolutions in the form of Tied Funds. West Bengal SFCs recommended entire fiscal devolution to be
treated as untied entitlement while Karnataka SFCs suggested small block grants to Gram
Panchayats. West Bengal SFCs have come up with the concept of untied fund to foster democratic
decentralisation.
The comparative picture emerging about the policy issues get corroborated by another evaluation
study of the report of the SFCs of Uttar Pradesh by Richard Bird. Some of the observations relevant to
these case studies are as follows –

“There is no evidence in the report of any attempt to cost out standard local services or to rationalize
on either need or cost grounds the population /area formula employed”.29

“The SFC report does not discuss the appropriateness of the assignment of expenditure to different
classes of local government. It does not recommend real changes in local revenue sources. On the
30
other hand, it recommends removal of all local discretion in revenue-raising”. “In doing so, the SFC
has removed local accountability and hence any chance of establishing effective and democratically
accountable local government bodies.”31

Autonomy, Financial Management and Budgeting Issues

The case studies of SFCs reports also indicate that SFCs have paid far less attention to issues of
autonomy, and financial management including accounting and audit procedures though they did
mention that the existing system is in shambles. Richard Bird made similar observations about the
Uttar Pradesh SFC report. The Uttar Pradesh SFC report observed that the “present system of orders,
regulations, procedures and paperwork governing local government in Uttar Pradesh is a complete
and unenforceable mess”. Richard while agreeing with the observation made in the SFC report has
rightly expressed surprise that no clear recommendations appear to have been made as to how and
in what manner local government budgeting, financial management and auditing procedures should
be improved, these being important components in any decentralisation programme.32

Measuring Current and Future Spending Responsibilities

The observation made by O. P. Mathur in an earlier study for reviewing several FSFCs reports is still
valid and appropriate about the SSFC reports of the various states barring the Tamil Nadu SSFC
report. The Karnataka FSFC tried to adopt a normative approach to measure current and future
spending responsibilities but SSFC of Karnataka dropped that approach due to want of data and
difficulties in formulating normative standards. O.P. Mathur observed, “The main deficiency of the
reports lies in the fact that their recommendations are not based on a clear statement of the spending
responsibilities of local bodies. Indeed, the absence of attention to the elementary principle that
expenditure assignment must precede any tax or revenue assignment has turned most of the SFC

29
Richard Bird. 1998 Designing State – Local Fiscal Transfers for Uttar Pradesh - mimeo
30
ibid
31
ibid
32
ibid

29
exercises, a suspect.33 Richard Bird observed similarly about Uttar Pradesh SFC report saying, “there
is no evidence in the report of any attempt to cost out standard local services or to rationalize on
either need or cost grounds the population / area formula employed”.34

12FC observed, “While estimating the resource gap, the SFCs should follow a normative approach in
the assessment of revenues and expenditure rather than make forecasts based on historical trends. A
careful examination of the SFC reports reveals that few SFCs have followed this approach.”

Absence of Equalisation Grants in SFC recommendations

In the wake of absence of formulae or norms based fiscal devolution mechanism between state and
local bodies for more than five decades there is huge baggage of distorted horizontal resource
sharing among local bodies. States have devolved resources to local bodies on political and other
extraneous basis rather than on the basis of population, area, economic potential, developmental
requirements, performance etc. This past baggage everybody is finding difficult to put of and therefore
has been main stumbling block in implementing formulae based devolution recommended by SFCs.

We will have to accept this political reality and the fact that situation can not be altered in day.
Equalisation grants can be a solution, wherein each local body first gets resources as per formulae
and the local bodies, which stand to get less resource through formulae based allocation than what
they were getting earlier get those resources from equalisation fund. Under a well planned out time
bound programme such local bodies are required to step up their resources and allocation through
equalisation fund is withdrawn in phased manner.

Except SFCs of Tamil Nadu, other SFCs have not given enough though to equalisation grants to
correct distortion in horizontal resource sharing among local bodies.

Implementation Issues

Non-acceptance of SFC Fiscal Devolution Recommendations

Not all state governments have accepted the primary recommendations for pooled sharing of state
resources. Systematic analysis has not been undertaken in this regard but there are a number of such
instances, which include the following:
• Government of Madhya Pradesh shared only 0.67% of tax and non-tax revenue as compared
with a recommended share of 8.67%.
• Government of Karnataka was unable to implement fully the recommended allocation criteria,
being primarily concerned with ensuring that the grant received by each urban local authority
is sufficient to pay salaries. It only attended to the overall share of NLGOR recommended by
SFC but for inter-se, (horizontal) distribution it continued with the earlier non-formulae based
devolution.
• Government of Tamil Nadu accepted the main recommendation of global sharing at the rate
of 8 per cent but failed to increase the local government share annually by the recommended
1 per cent.
• In the case of Andhra Pradesh SFC out of the additional devolution of Rs.9791.60 million
recommended by the first SFC, only 44.37 per cent was accepted by the Government of
Andhra Pradesh.

Inadequate Implementation of Other SFC Recommendations

State Governments not only failed to accept and implement SFC recommendations pertaining to fiscal
devolution but they also did not accept a large number of other recommendations made by SFCs
regarding improvement of local governments, system and procedural improvements, devolution of

33
O.P.Mathur June 2000 – Decentralisation In India: A Report Card – UMP-Asia Occasional Paper No. 47. O.P.Mathur has to
th
repeat similar observation after conducting exhaustive study of municipal finance for 12 Finance Commission. He observed
that ‘this study is not the platform for making a critical review of the reports of the finance commission of states (SFCs). Two
points, may however, be made. One: there are serious drawbacks in many of the reports in that they have not even estimated
the revenue gap faced by municipalities. It is not evident as to how a devolution package could be formulated without any
reference to gap in resources. Two: the reports of the second SFCs appear, in most cases, an updated version of the first
reports, without containing a fresh review of the finances of municipalities.
34
Richard Bird. 1998 – Designing State – Local Fiscal Transfers for Uttar Pradesh - mimeo

30
administrative and functional powers, etc. Further, they also failed to implement various
recommendations pertaining to the above aspects, which were accepted in principle. Some such
glaring instances are as follows –
• First SFC of Tamil Nadu in all made 462 recommendations out of which 100
recommendations were not accepted. Though the acceptance/ recommendations ratio of the
Government of Tamil Nadu (GOTN) is much higher in comparison to other states, more than
20 percent of the recommendations were not accepted.
• In Andhra Pradesh out of 84 recommendations made by the first SFC, 24 recommendations
were not accepted while 5 recommendations were accepted with modifications. Thus, almost
one-third of the recommendations were not accepted by the Government of Andhra Pradesh
without recording reasons for non-acceptance. Several recommendations accepted by
Government of Andhra Pradesh were not implemented.

Implementation in Contravention of SFC Recommendations

Treating Central Finance Commission Grant as part of SFC devolution
The SSFCs have evolved devolution frameworks for inter-se allocation of Eleventh Finance
Commission Grants but in actual practice, this grant is counted as a part of the SFC grant of the
Government of Karnataka. This is in contravention of the recommendations of the SFCs and the
Eleventh Finance Commission.

Delayed devolution of Central Finance Commission Grant to local bodies

In many cases there is inordinate delay in devolving CFC grant to local bodies by the states as a
result it remain unutilised or under-utilised. 12th Finance Commission observed that states are not
devolving grant received from centre to local bodies in reasonable time as it uses these amount to
solve their ways and means position. It has also urged centre to take serious view of this
phenomenon.

Continuation of Non Formula Based / Discretionary Devolutions

In Karnataka, the actual overall devolution for ULBs also include those made on a non-formula basis,
though such mechanisms as the Chief Minister’s Special Development Grant. These amounts are
distributed to local bodies solely based on the discretion of the chief minister. The Same system exists
in Andhra Pradesh, and a lot of these amounts are devolved in a discretionary manner to local bodies.
The Tamil Nadu story is also similar.

Mechanism for Making Deductions

Deductions for the outstanding dues from the ULBs are made in lump sum manner from the overall
sum (gross SFC grant) available for ULBs, before dividing it among individual ULBs.
The practice of deducting the entire amount of dues (towards the above items) pertaining to all Urban
Local Bodies put together from the total devolution amount is biased in favour of those local bodies
which have higher amounts payable. Because of this practice the local bodies, which have borrowed
less, or consume less resources are paying for the inefficient local bodies, which have higher amount
payables.

Like GOK, GOTN also deducted at source dues pertaining to the debt repayment payable by local
bodies to other institutions from the devolution amount.

Non Implementation of the Incentive Fund Scheme

Every SFC contained provisions and recommendations about an incentive scheme for local
governments to motivate them to undertake essential reforms. But state governments have not
implemented them in the right spirit. The West Bengal government did not develop the criteria for
release of the incentive funds recommended by the FSFC. The Tamil Nadu Government utilised the
incentive fund like an equalisation fund in a discretionary manner. Andhra Pradesh SFCs have not
recommended a comprehensive incentive fund scheme.

Change in Purpose of Devolution Grants

The first SFC recommended specifically that the devolution should cover maintenance of the assets at
the time of the award as also of those assets, which would be created during the award period, the
salary and wages of the Local Bodies. But in practice, the GOTN set apart a sizeable sum for works
with a view to improve basic amenities both in rural and urban areas.

31
Equalization Fund
As mentioned earlier it is only Tamil Nadu SFCs, which recommended equalisation fund to correct
past baggage of distortion in horizontal resource sharing among local bodies, but GOTN utilised this
fund to help select local bodies on discretionary basis sometimes even for creation of capital
infrastructure. No norms have been evolved regarding this fund by GOTN.

In sum, the message coming out from the detailed review of SFCs is that SFCs are constrained by
various factors and, as a result, SFCs have failed to address issues of local finance and to carry
forward decentralisation. The results of workings of SFCs in past decade can be summarised as
follow -
• Improved marginally budgetary certainty and a degree of predictability of flow of funds from
state to local bodies
• Increased devolution to local bodies to some extent
• Not much improvement in finances of local governments,
• No new tax assignments to local bodies
• No attempt to create rural-urban partnership
• Inadequate incentives for expenditure efficiency
• No improvement in budgetary and financial autonomy of local bodies
• No improvement in accounting system of local bodies. In Karnataka ULB budgets fail to
reflect deduction made at state level
• No granting of significant legal autonomy to local bodies
• Soft approach by SFCs towards State Government’s attitude of gross neglect towards local
bodies

Recommendations on Role and Workings of SFCs

The first and foremost important issue associated with the working of SFCs is the absence or
inadequate implementation of SFC recommendations by the State governments. States have not
accepted this mechanism willingly to address local finance issues and to carry forward
decentralisation envisaged by the constitutional amendments. It is now high time that all states come
together with the central government in the lead to take a serious view of the institution of SFC and
evolve a national consensus on the role, working and composition of the institution of SFC. The
commitment of the state governments to implement the recommendations of SFCs also needs to be
addressed. If these steps are not taken on, an urgent basis there is a danger of jeopardizing the entire
fiscal devolution mechanism.

The specific policy options in the context of various issues - general, policy or structural and
implementation observed earlier could be as follows:

Recommendations that can be implemented in the short-term -

Following are some recommendations that can be implemented within a time-frame of 1 to2 years.

Creating a SFC Secretariat/Permanent Administrative Set up for Ensuring Continuity

SFCs experience several administrative difficulties, which translates into delays in submitting the
reports of the SFCs. Some of the difficulties include the time taken for allocation of resources for the
functioning of the SFCs. Also, there is no institutional memory in the SFC, which compels SFCs to
start their work de-novo. This leads to avoidable delays and wastage of resources. Many SFCs have
therefore recommended the setting up of a permanent SFC cell in the state government. While some
of the states have implemented this recommendation, many others are yet to implement the
recommendation. It is suggested that all the states constitute permanent administrative units in state
governments to deal with SFC matters.

12th Finance Commission has also recommended creation of permanent cell in the finance
department of state governments. (Para no 8.55 (x))

Synchronisation of SFCs with the Central Finance Commission and Five Year Plans
It is necessary to draw up a detailed calendar regarding various events and stages associated with
the SFC and this calendar should be followed meticulously to overcome problems of non-
synchronisation with CFCs and five year plans.

32
 th
In fact, by the end of year 2007 when 13 CFC is likely, to be constituted fourth SFC report of all the states should ideally
become available but that is not possible in any condition. What states can aspire is to make third SFC reports available to
CFC, even that will require highly coordinated and sincere efforts. States can follow following calendar to achieve this
target.
•
nd
Last date by which 2 SFCs of the State should submit their report – June 2005
•
nd
Last date by which State should submit ATR on 2 SFC Report – December 2005
•
rd
Last date by which State should constitute 3 SFC in their state – March 31, 2006
•
rd
Last date by which 3 SFCs should submit its report – December 31, 2007
•
rd
Time period for Submission of ATR by States on 3 SFC report – During the year 2008
•
th
Likely date of constitution of 13 Central Finance Commission – Start of2008
•
th
Likely submission of 13 CFC report to GOI – End of 2009

12th Finance Commission has discussed this issue of non-synchronisation of SFCs in detail (para
8.36? 12FC) and has urged states to take necessary steps to achieve it (par ? a 8.55 (ii)). An
illustrative calendar to achieve this could be as follows

Enhancing the Impact of SFC Recommendations on the Finances of Local Bodies

This is a very difficult general issue to address. It will essentially require addressing two issues first,
acceptance and implementation of SFC recommendations in their entirety and second, improvement
in the fiscal health of the state which will make enough resources available so that it can devolve
more resources to the local bodies.

Quantum of Revenue Sharing

The next issue is the extent of sharing of state resources that should be devolved to the local bodies.
There are primarily two methods. The first is based on estimating gross financial requirements of
local bodies based on past trends and thus calculating the percentage share in the divisible pool. The
second method is normative, involving identification of the core/ essential services, establishing
standards/ norms for the provision of services, calculating gaps between actual service provision and
needs (service gap) and then estimating the costs to fill service gaps to find out the fiscal gap. The
next policy decision is to decide the extent to which fiscal gap is to be financed through revenue
sharing. Most of the SFCs at present are following the first method as a result one finds wide
differences in absolute and percentage terms of revenue sharing by states with local bodies.
Karnataka first SFC tried to adopt the normative method, but it had to adopt the first method due to
lack of data. The Tamil Nadu SSFC has calculated the service and fiscal gap using the second
approach and has then structured its recommendations showing that the extent of revenue sharing
proposed will be sufficient to address gaps calculated using the normative approach.

It is necessary that in the future SFCs should increasingly adopt the normative approach to calculate
the service and fiscal gap while basing their recommendations on the quantum of revenue sharing.
Along with their recommendations, SFCs should provide fiscal accountability norms for local bodies,
that is, the extent of efforts that local bodies should take to address service and fiscal gaps. The
scheme should also provide some equalisation grants to address needs of certain local bodies
suffering from weak economic base or other constraints.

Recommendations that can be implemented in the medium-term

Following are some recommendations that can be implemented within a time-frame of 2 to 5 years.

Revenue / Tax Assignments

There is a clear trend in the recommendations of the SFCs favouring revenue sharing and grants-in-
aid rather than tax assignments. This is a soft approach and certainly not a healthy trend. Tax
assignments should be given adequate importance in the context of two realities one, deteriorating
fiscal health of state finances and tax assignments being a better instrument of decentralisation. The
theory of public finance does provide guidelines on the sources that can be assigned to local
governments. Keeping these principles in mind and their feasibility in the Indian context, SFCs and
states should go ahead to assign taxes to local bodies in the future.

33
Principles of Revenue Sharing
SFCs have utilised different approaches while laying down principles of revenue sharing, but it is
necessary that there is broad uniformity about the principles of revenue sharing. In the absence of
such uniformity, there is a like hood of variation in approaches, which will result in asymmetrical
decentralisation in different states.

The concept of global sharing along with creation of divisible pool is gaining ground in India. Among
the various approaches, the approach adopted by Karnataka SFC for revenue sharing that of Non
Loan Gross Own Revenue Receipts is most pragmatic, broad based and capable of bringing benefits
of economic growth (buoyancy) in the State to local bodies.

Cities contribute to national economy and to the revenues of central government; municipal
expenditure creates positive externalities for central government’s income. In the light of this Tamil
Nadu SSFC has recommended that a 5 % share of the central devolution to the state should be part
of the divisible pool for sharing of resources with local bodies.

It can be said that if future SFCs adopt the concept of global sharing to form the divisible pool on the
basis of NLGORR (Karnataka model) coupled with 5 to 10 percent share in central devolution to the
State then India can move towards a broadly uniform pattern of revenue sharing to avoid
asymmetrical decentralisation in different states.

System of performance based incentive grants

Keeping aside all policy and structural issues, the basic fact remains that the performance of both
urban and rural local bodies is deplorable and need to be improved. Giving more grants/funds to local
bodies without linking them to performance level will be like pouring more water in bottomless pot.
Barring basic sustenance nature general grant, rest of the grants should be performance based
incentive grants. Tamil Nadu SSFC has come out with comprehensive structure in this regard.

Equalisation concept to correct distortions in horizontal resource sharing

As discussed equalisation, grants can be one of the solutions to correct distortions in horizontal
resource sharing among local bodies. It is suggested that SFCs should work out judicious and
appropriate equalisation policy comprising medium term time span (five years) and states should
show political courage to implement it.

Resource sharing between urban-rural local bodies and between tiers of local bodies
Various SFCs have different methods for arriving at the share of urban and rural local bodies’ in the
divisible pool. Some SFCs have used only population as the basis for sharing resources while some
others have opted for the composite index made up of demographic, economic and social indicators.
Various indices utilised to formulate the composite index need a critical look. Population and area are
commonly used criteria. The second set of criteria widely used by SFCs is illiteracy and percentage
of SC/ST population. The third set involves a variety of criteria not used by more than one SFC and
these include people per hospital bed, road length per sq. kms., percentage of workers, financial
needs, revenue collection efforts, per capita receipts of own revenues and per capita expenditure on
core services. Surprisingly the SFCs under study have not opted for indicators like per capita income,
or people below poverty line or percentage of population living in slums. It is difficult to suggest policy
options or definite answers regarding the ideal set of indices. Specific research is required on the
merits and demerits associated with using these and other indicators for inter-se distribution of
resources.

Recommendation that can be implemented in Long-term

Creating statutory mechanisms for monitoring implementation

In order to overcome various implementation issues, states should create a statutory mechanism to
monitor implementation of various recommendations made by the SFCs and accepted by the State.

Capping non-formula based devolution by SFCs

The foregoing analysis of the recommendations of the state finance commissions and an analysis of
the actual budgets of state governments indicates that state governments have been increasingly
resorting to non-formula based grant funding to local bodies. Such a system of non-formula based

34
grants throws the local fiscal devolution system out of gear. Since it may not be possible to curb
completely non-formula based transfers in a democratic setup, it is suggested that the state finance
commissions consider capping the extent of non-formula based grants to local bodies

Fiscal responsibility norms and index of self reliance for local bodies
This is a global trend. In India, union government has adopted Fiscal Responsibility and Budgetary
Management Legislation upon itself, Twelfth Finance Commission has recommended that States will
have to adopt such kind of legislations in order to qualify for various debt relief and devolution
packages. There should similar structure in place for local bodies. Tamil Nadu SSFC has already
suggested fiscal responsibility norms and index of self reliance for local bodies. Other SFCs by
following Tamil Nadu SSFC example should evolve appropriate Fiscal Responsibility Structure and
States should implement them strictly.

Hard budgetary constraints on local bodies

Budgeting systems in local bodies are very weak, rudimentary and removed from reality. States
should carry out proper study and impose hard budgetary constraints on local bodies.

Improving own fiscal health by state governments

One of the fundamental reasons for impoverished state of local bodies and infrastructure at local level
is inadequate devolution of resources from state to local bodies. Though there exists huge vertical
imbalance in distribution of resource and therefore need for sizeable devolution of funds from state to
local, state governments are not in position to do it due to their bad fiscal health. States will have to
improve their own fiscal health if perceptible change has to happen to the state of local finance and
local infrastructure development.

Conclusion

State Finance Commission, a new mechanism to structure the fiscal devolution framework and state-
local fiscal relations has by and large turned out to be inadequate and ineffective due to various
reasons including policy, implementation and general administrative issues. Though we find flashes of
creativity and policy innovations, most of the SFC reports have turned out to be unsatisfactory and
have failed to live up to their constitutional role.

At the same time it can also be said that the reports of the Second SFCs show that the new system of
fiscal arrangement envisaged by Constitutional Amendments more than a decade ago is coming of
age in spite of a host of infancy blues and if the third generation SFCs of the other states which are
being set up or would be set up in the near future improve upon the pragmatism and professionalism
shown by the SSFCs while effectively dealing with policy weaknesses reviewed in this paper.

Figure 1 – Making SFC Mechanism Focal Point of Fiscal Decentralisation

35
 Centralised
Data base
Permanent Statutory
Administrative Mechanism
Set up for SFC to monitor
Implementation
Making SFC of SFCs
Mechanism
Focal Point of
Fiscal
Decentralisation
Synchronisation
Creating convention of SFCs with CFC
Of accepting SFC and five year plans
Recommendations,
Public opinion Professional,
building independent
approach by
SFCs

th th
The 11 and 12 Central Finance Commissions have elaborately noted the weaknesses in the
working of SFCs and their reports. Though SFC reports were short on policy aspects the real reason
for the failure of the SFC mechanism in terms of bringing about a paradigm shift in the state-local
fiscal relationship was a weakness in implementation. States were never ready for such a mechanism
(it was thrust upon them through constitutional amendments) to determine the sharing of resources
with local governments. As a result, states have shown gross apathy in setting up SFCs, accepting
their reports and in implementing their recommendations. It is now high time for all states to come
together, with the central government in the lead, to pay attention to the institution of SFC and to
evolve a national consensus regarding the role, working, composition of the SFC and regarding the
moral commitment of state governments to implement the recommendations of SFCs. If these
measures are not taken urgently, there is a danger of jeopardizing the entire fiscal devolution
mechanism.

36
References

1. Andhra Pradesh (2002) – Second State Finance Commission Report – State Government of Andhra Pradesh –
Hyderabad
2. Crisil Infrastructure Advisory – Mumbai (2003), ‘Roadmap for the Reforming the State-ULB Framework in Karnataka.
3. Datta Abhijit (December 2003), ‘The national Finance Commission and Fiscal Devolution to Local Bodies’, Paper
presented in National Seminar on Municipal Finance held at New Delhi sponsored by the 12th Finance Commission.
4. Eleventh Finance Commission Report (2000)
5. GHK Consultant India Private Ltd – Vijay Tandon – (March 2004), ‘Fiscal Decentralisation and Devolution: An Indian
Overview
6. GHK Consultants – Richard Slater – March 2004 – Comparative Study of Devolution Frameworks in South Asia
7. Gujarat (1998) Report on Urban Local Bodies in Gujarat State – First Finance Commission, State Government of
Gujarat – Gandhinagar
8. Jha Ramanath – Regional Advisor, UMP-SA, ‘ Decentralisation in India –
9. Jha, Gangadhar (December 2003) ‘Municipal Finance Resource Mobilisation; Status,
10. Karnataka (2002) Report of the Second Finance Commission, State Government of Karnataka, Bangalore
11. Mathur Om Prakash (June 2000) – Decentralisation In India: A Report Card – UMP Asia Occasional Paper No. 47 –
United Nations Urban Management Programme
12. Mathur, O.P. (2000) “Decentralization and Fiscal Decision-Making”, The World Bank Institute - South Asia Urban and
City Management Course.
13. National Institute of Public Finance and Policy (NIPFP) – New Delhi - 2004 – ‘Municipal Finance Studies’, prepared
th
for 12 Finance Commission
14. National Institute of Rural Development – Hyderabad – (March 2000) – ‘Functional and Financial Devolution on PRIs:
A Study Across Select States – Sponsored by the Eleventh Finance Commission – Govt. of India
15. Rahim A. (March 2004), ‘Devolution to Local Bodies in West Bengal
16. Rao, M.G.(2004) “Linking Central Transfers to Fiscal Performance of States” Economic and Political Weekly, May 1,
pp 1820-1825
17. Rao.G.M,(2002), “ Decentralization of Institutions”, Development, Poverty and Fiscal Policy
18. Tamil Nadu (2002), ‘Report of Second Finance Commission’, Government of Tamil Nadu
19. Tenth Finance Commission Report (1996)
20. Twelfth Finance Commission Report (2004)
21. World Bank – Rural Development Unit – South Asia Region (January 2004), ‘India – Fiscal Decentralisation to Rural
Governments.

37
 Decentralisation and Local Finance Issues –
The Workings of State Finance Commissions in India

Case Studies on Workings of State Finance Commission

Case Study 1 - Review of Karnataka State Finance Commissions

Introduction
Karnataka has been among the forerunners in the implementation of number of policy reforms for the decentralized
governance. Particularly in the past decade and half it has become known for the growth of knowledge based industries
including software industry, development of educational and urban infrastructure. This is supplemented by a pragmatic stance
in relation to governance and decentralisation, which has been reinforced by innovative policy recommendations on fiscal
devolution from two Finance Commissions. Whilst these recommendations have not been implemented fully, they nevertheless,
rd
represent the basis of sound fiscal framework for the promotion of further devolution. In tune with the 73 CAA, GOK has
passed the new Karnataka Panchayat Raj Act in 1993. Similarly, it also suitably amended Karnataka Municipalities Act 1994 to
th
give effect to provisions of the 74 CAA.
rd th
It is not surprising that Karnataka is among the forerunners in the implementation of 73 & 74 CAA. In the late 1980s, also it
experimented with functional, fiscal and administrative devolution. The experiment included a short-lived attempt to subordinate
the powerful district bureaucracy to a locally elected council at district level. Later on, the government was forced to concede to
powerful interests that reinstated the dominant role of deconcentrated administration.

The First State Finance Commission (FSFC) was set up in 1994, which submitted its report in 1996. The Second State Finance
Commission (SSFC) was set up in October 2000 and submitted its report in December 2002.

Karnataka is one of the first states in India to extend property tax reforms to all urban local governments through the
introduction of capital value method of property tax assessment and self-assessment procedures for property tax. Another
innovation in Karnataka has been the introduction of a new solid waste charge to offset the additional costs of compliance with
Hon’ble Supreme Court rulings on environmental standards.

The Fiscal Devolution Framework

Both the SFCs of Karnataka have recommended detailed fiscal devolution framework (see Table 1.1) covering both vertical and
horizontal aspects of devolution as follows
• 1st stage/level of devolution – Determining the share of the state government and the share of all the local
governments (PRIs & ULBs) out of the total revenue of the state
• 2nd stage of Devolution – Determining the share of all rural and all urban local governments out of the total share of
revenue available for local government as per first stage of devolution.
• 3rd stage of Devolution – Determining the share of all the three tiers of rural local governments. Similarly determining
the share the share of all the three tiers of urban local governments out of the respective share of rural & urban
governments as per second stage of devolution.
• 4th stage of Devolution – Determining the share of an individual body under each tier of rural and urban local
government. For e.g. – share of individual zilla, taluka panchayat or gram panchayat or of an individual municipal
corporation or municipal council.
Table 1.1 - Fiscal Devolution Framework for Local Governments in Karnataka
st nd
Level of Devolution 1 SFC Frame work 2 SFC Frame work
st
1 level Devolution 36 percent of Non-Loan Gross Own 40 percent of Non Loan Gross Own
Local Governments Share in State’s Revenue Receipts (NLGORA) Revenue Receipts (NLGORR)
Resources.
nd
2 Level Devolution Based on Five Indicators Based on Same Five Indicators
Division of Resources between Population 33.3 % Population 30 %
Urban & Rural Local Government. Area 33.3 % Area 30 %
Backwardness Indicators Backwardness Indicators
Illiteracy Rate 11.11 % Illiteracy rate 15 %
Population per SC & ST Population 15 %
Hospital Bed 11.11 % Persons per
Road Length Hospital Bed 10%
Per Sq. km. 11.12 %
Total weightage of backwardness Total weightage of Backwardness Index
Index 33.34 % 40 %
Total 100.00% Total 100%

Application of these indicators Application of these weightage indicators

resulted into 85% share to PRIs & 15 resulted into 80: 20 sharing between PRI
% to ULBs– that is & Municipal Bodies that is –
85 % of 36 = 30.60 % 80 % of 40 = 32 % of NLGORR
15 % of 36 = 5.40 % 20 % of 40 = 8 % of NLGORR
Thus PRIs Share came to be 30.60 Thus, PRI share came to be 32% of
% of NLGORR Municipal Bodies- NLGORR and ULBs to get 8 % of
5.40 % of NLGORR NLGORR.

38
 rd
3 Level Devolution/Sharing of 40 % Zilla Panchayat - The Committed expenditure to be
funds among different tiers of Rural 35 % Taluka Panchayat earmarked first out of the amount (32
& Urban Local Governments 25 % Gram Panchayat % of NLGORR) available to PRIs
- Block Grants to the Gram Panchayats
100 % (30.60 % of
Part A – Panchayats at the rate of Rs. 3.50 lacs per Gram
NLGORR)
Panchayats to be deducted next from
This formula was not accepted by the
the above amount –
State Government, as there was high
(Block Grant to increase every year
ratio of committed expenditure, that
by Rs. 25 thousand per village
is, salary. As a result, actual
- Rs. 100 million to be deducted next
allocation took place on basis of
from balance for giving Incentive
salary expenditure only.
Grant
- Remaining amount to be shared by
ZP & TP in the ration of 65:35

Part B – Municipal Bodies

th
4 Level Devolution/Sharing of Composite Index made up of Two weighted indicators for inter- se
funds among different Urban Local Five weighted indicators for Inter-re allocation among urban local
Governments Allocation among Urban Local governments –
Governments Population 67 %
Population 33.3 % Illiteracy 33 %
Area 33.3 % Total 100 %
nd
Backwardness 2 SFC dropped other indicators like
Indicators Area, SC & ST population and population
- Illiteracy 11.11 % per Hospital beds as 2001 data was not
- Population per available and it felt that 1991 data should
Bed 11.11 % not be applied.
- Road Length
Per Sq. km 11.12
Total 33.4 %
Source – Constructed the basis of information in FSFC and SSFC of Karnataka

Innovations / Positive Aspects of Karnataka SFCs:

Multi-level Fiscal Devolution Framework –

The SFCs of Karnataka have developed detailed multi-layered fiscal devolution framework. The fiscal devolution framework
envisaged by Karnataka SFCs comprises all the levels of devolution – vertical and horizontal.

The NLGORR Concept –

st
In order to address 1 stage devolution that is share of state local governments in total revenue of the state, Karnataka SFCs
adopted the concept of Non Loan Gross Own Revenue Receipts of the State. Under NLGORR, entire gross own revenue
receipts of the state Government other than loans and the state share of the central revenues forms the divisible pool. FSFC
recommended that all local governments should get 36% share of NLGORR, which Karnataka Government accepted. SSFC
has recommended 4% increase in the share that is 40% share of NLGORR for local government. Only Karnataka SFCs have
adopted such a broader and most progressive concept for sharing state revenue between State and Local governments. The
concept of NGORR is comprehensive, simple, highly transparent and progressive.

The Normative Approach –

The FSFC of Karnataka sought to use Normative Approach in place of gap filling approach for the assessment of the total
revenue requirements of local governments. This approach was based on the philosophy that any person living any where in
Karnataka should get a minimum of essential public/civic services calculated on the basis of certain normative standards
pertaining to each core services along with an estimated amount of priority capital investment over a 5 year period.

Balanced Financial Allocation Approach/Composite Index

For second stage devolution that is sharing between rural & local bodies, FSFC suggested composite index of five indicators
(see Table 1.1). SSFC has modified it slightly. The important or positive aspect is to have such an index for working out share
of rural and urban local bodies.

FSFC of Karnataka has applied this concept of index made up of indicators for determining the share of an individual local body
th
within the tier (4 level of devolution framework).
FSFC then identified certain normative standards pertaining to some core services and recommended that the existing physical
levels of the essential public services should be raised over a period of five years.

Norms for inter-se allocation of the Eleventh Finance Commission Grants

Second SFC of Karnataka has worked out norms for inter-se allocation of the EFC Grants (Table 1.2) as envisaged by the
EFC.

39
Table 1.2 - Framework for Distributing Eleventh Finance Commission Grants to local bodies
Particulars/Criteria/Norms for Distribution Total Amount
A. Panchayati Raj Institutions

Amount required for maintenance of accounts and audit to be

allocated at first instance Rs. 2.34 Crores
Amount required for development of Data Base Rs. 0.94 Crores

Each Gram Panchayat to be given Rs. 1.0 lacs for the purpose of
Maintenance of civic services Rs. 56.59 Crores
Remaining Amount to be distributed between Zilla Panchayats &
Taluk Panchayats in the ration of 40:60.
(Inter-se distribution among the zilla and taluk panchayats as per
weightages assigned by SFC)
Zilla Panchayats Rs. 11.37 Crores
Taluk Panchayats Rs. 7.58 Crores

Total Amount Rs. 78.82 Crores

B. Municipal Institutions

Amount required for development of data base to be deducted first Rs. 0.17 Crores
Remaining Amount to be distributed between municipal institutions
As per the weightages worked out by the SFC Rs. 24.79 Crores

Total Amount Rs. 24.79 Crores

Source – Second Finance Commission Report of Karnataka

Incentive Grants Scheme for Gram Panchayats and Urban Local Bodies
SSFC of Karnataka has recommended setting up incentive fund to encourage Gram Panchayats to maximize their revenue
mobilisation. An amount of Rs.100 million has been recommended to be earmarked every year as incentive fund and not to be
diverted for any other purpose. All Gram Panchayats whose Internal Resource Mobilisation (recovery against the demand-
current and past) is 60 percent and above in each year for three consecutive preceding financial years are eligible to be
considered for awarding cash incentive under this fund.
It also recommended that the state government formulate an incentive scheme on similar terms for municipal bodies after two
years of implementation of the capital value based property tax system.

Common Purpose Fund for Urban Local Bodies

In order to facilitate the development of a comprehensive database, computerization, development of software required for
Urban Local Bodies, training, preparation of draft documents pertaining to contracts, agreements, tenders, manuals, studies
and surveys etc., the Second State Finance Commission has recommended a ‘Common Purpose Fund’. For this fund SSFC
has recommended a sum of Rupees fifty million each year out of the total share of the Urban Local Bodies as per devolution
recommended by the Second State Finance Commission.

Besides these special innovations, SSFC has recommended following reforms:

• Introduction of the concept of user charges at the Gram Panchayats by amending KPR Act 1993.
• Fixing of minimum & maximum rate of property tax (8% & 12% respectively) in case of Gram Panchayats and regular
revision of property assessment roll once in four years by the designated authority.
• Assignment of 50 percent of the share out of revenue realised by lease/auction of sand beds & stone quarrying.
• In order to facilitate adequate and speedy implementation of the Hon’ble Supreme Court of India’s order regarding
development of Sanitary Land Fill Sites SSFC has recommended that the cost of acquisition of land should be borne
by the State Government. This should be outside the NLGORR.
• Consolidation of multi-sectoral schemes to avoid overlapping.
• Timely release of funds.

Weak Policy Aspects

SFCs of Karnataka as mentioned above have come out with a simple but comprehensive fiscal devolution framework. But in
actual practice, the framework has suffered on two broad counts – one, inherent weaknesses associated with the devolution
framework and recommendations of SFCs and two, inadequate implementation by the State Government as follows:

Doing Away with Normative Approach

Though the FSFC suggested the use of a normative approach, it was not adopted in actual implementation. Later on taking into
account the enormous financial needs and problems associated with estimation of normative needs SSFC, though agreeing
with its superiority dropped it and has gone ahead with devolution based on the composite index.

The Composite Index

nd
The idea of using a composite index for determining 2 stage devolution between urban & rural local government is quite
logical and appropriate; some of the constituent indicators of the index are not appropriate. SSFC itself felt this way and has
recorded its inability when it selected indicator persons per hospital bed in place of per capita income or population below
poverty line for lack of adequate data. As a result, the composite indicator has failed to capture real economic backwardness. It
is true that was not available specific data but SSFC should not have opted for inappropriate indicators, rather like Tamil Nadu

40
SSFC, it should have opted for appropriate indicators like per capital income or population below poverty line and should have
fixed responsibility on GOK to work out necessary data base during the course of SFC implementation.

Legitimizing Existing Pattern

rd
At the 3 stage of devolution, SSFC has given more preference to ZP & TP the first two tires of PRI because it observed that in
actual practice Gram Panchayats were getting less than 5 percent of the amount made available for rural local government in
rd
spite of recommended share of 25 percent share FSFC. In fact, the ultimate aim of democratic & fiscal decentralization (73 &
th
74 CAA) is to strengthen lowest level of local government that is Gram Panchayats. Gram Panchayats are the real rural local
governments while Zilla and Taluka Panchayats are intermediary local bodies. SSFC has done away with this allocation noting
inability of GOK to change present rigid non-plan (mostly salary) expenditure structure favouring ZP & TP. Thus, SSFC has
legitimized present devolution distortions, which is favouring ZP and TP at the expense of Gram Panchayat. SSFC should have
provided time bound programme to bring down non-plan cost of ZP & TP and to increase share of GP.

The Block Grant for GP

SSFC has recommended uniform Block Grant of Rs.0.35 million with an incremental increase of Rs. 25000 every year to Gram
Panchayats irrespective of their size or other indicators in the want of data. The concept of providing block grant is a welcome
innovation but it should have provided minimum block grant and additional grant on basis of indicators like population, size and
service level.

Shrinking of Composite Index

At the fourth stage of devolution that is pertaining to inter-se allocation between municipal bodies, SSFC has adopted only two
indicators, population and illiteracy rate against the five indicators used by FSFC again in the context of non-availability data. It
nd
should have adopted other suitable indicators the way it has done in case of 2 level devolution as referred above. In actual
practice this adoption of only two indicators has altered inter-se allocation among the municipal bodies to considerable extent in
a negative way that it will not be possible for the state government to adopt and implement it.

Incentive Fund
SSFC has set up incentive fund but it has suggested that the GP, which gets incentive for achieving more than 60 per cent
recovery ratio for three years in row, should not be considered for incentive fund for next three years. Such a provision is likely
to put an end to sustainability of good tax recovery performance by GP, as there is no incentive for it. Also, the amount
earmarked under the incentive fund has tended to be rather meagre and linked to only one sort of reform.

Non Measurements Devolutions out side the SFC Framework

There exists sizeable amount of devolution to local governments outside the SFC Framework; Karnataka SFCs have not made
any effort to estimate size of such devolution and their impact.

Borrowing Policy
Though there is ample scope to strengthen policy in the of debt financing drawing from the successful experience of
neighbouring Tamil Nadu and other parts of India, SFCs of Karnataka did not dwell upon borrowing policies for local
governments. In Karnataka Municipal Corporation have limited powers to borrow whilst municipalities and rural local
governments do not have significant borrowing powers. GOK manages loans on their behalf and transfers funds on a notional
basis, since the line departments or parastatals of GOK carry out capital works. The state government still undertakes a needs
assessments and fiscal capability analysis on a case-by-case basis. There have been several instances where the GOK
without assessing the debt absorption and repayment capability of a local authority, has allocated disproportionate loans to a
local government as a part of it’s (and not the local government’s) political agenda. The track record of funding agencies
(mostly multi-laterals) is very poor in this regard. Once the state has provided a guarantee of repayment, they have not looked
into the needs and capabilities of the recipient local government and have thus simply ended up serving the political agenda of
the State Government itself. Karnataka SFCs have not taken this present ‘totally top down practice associated with borrowing
by local government and has not provided any policy input regarding borrowing or debt financing policy for local governments.

Implementation Blues
Whilst the SFCs in Karnataka have recommended a simple but comprehensive fiscal allocation framework, in practice
implementation has been weak. The grants provided to local bodies do not fully corresponded to the recommended allocation
criteria. The inadequacies associated with the implementation of SFC recommendations are as follows

Devolution of SFC Grant to Local Bodies –

The actual grants provided to ULB’s (rural & urban) do no correspondence to the recommended devolution framework of both
the SFC’s. GOK has not adopted the formula based percentage share recommended by the first or the second SFC. Its primary
objective or concern is to ensure that the grant received by each ULB is sufficient to pay the salaries of their employees. As a
result, it can be observed from the table 4 that it has transferred more amount than the 36 percent of NLGORR. During 1997-
98-2001-02, GoK transferred on an average 38.98 per cent share of NLGORR to local bodies. But transferring of more amount
than the share recommended by the FSFC does not mean that each individual local body received its due or legitimate
devolution as per SFC formulae. Linking of fiscal transfer to salary commitment instead of prescribed devolution formulae is
iniquitous distortion and in actual practice is creating inequality among local bodies. This is because the strength of employees
of local bodies was sanctioned by GoK long ago (more than two decades) and today it does not have any co-relation with
population size, area, revenue or functions or level of service of local body. As a result, the local body, which have got higher
staff because of any reason in the past, get more inter-se allocation of grant at the cost of other local bodies and other
parameters.

Table No. 1.3 - Actual Devolution of Funds to PRIs & Urban Local Bodies in Karnataka Rs. In Crores
___________________________________________________________________________

41
Sr. Item 1997-98 1998-99 1999-00 2000-01 2001-02
No. Actual Actual Actual Actual RE
1. Projected NLGORR 7825.55 8764.62 9816.37 10994.33 N.A.
of the State by
FSFC

2. Actual NLGORR 7676.28 8412.96 9355.65 10702.66 11327.76

of the State

3. Devolution to 2685.00 3010.00 3278.00 3661.00 3724.00

Panchayat Raj (34.98)* (35.78) (35.04) (34.23) (32.87)
Institutions
4. Devolution to Urban 274.81 332.37 415.66 531.43 575.50
Local Bodies ((3.58) (3.95) (4.44) (4.97) (5.08)

5. Total Devolution 2959.81 3342.37 3693.66 4192.43 299.50

to PRIs and ULBs (38.56) (39.73) (39.48) (39.17) (37.96)
out of NLGORR
Source – Second SFC Report of Karnataka
*Figures in bracket indicate percentage to NLGORR

Second SFC has also noted this linking of actual devolution to salary and not to the SFC formulae (para 6.52 & 10.20) but in a
very lenient way. It should have strongly commented on this and should have calculated distortion / inequality caused by this
approach of GoK. Also as a remedy to correct present practice, it should have devised mechanism of equalization grant for a
certain period for the ULBs, which are likely to suffer reduction in quantum of grant do to implementation of formula based
devolution.

Table 1.4 and 1.5 reveal another facet of the same fact how in actual practice GOK has not adhered to the FSFC formulae, it
can be observed that not only distortion exists at the first or second stage of devolution but also it has existed in all levels.
Tables 1.4 and 1.5 clearly indicate that GOK has not followed in actual practice inter se or horizontal distribution framework
suggested by First SFC. These tables also indicate that there also exists big gap between the devolution amount proposed in
the budget estimates and actually transferred to the local bodies.

Table No. 1.4 - Devolution to PRI as per SFC recommendations, Budget Estimates and Actual Figures
(Rs. In Crores)
___________________________________________________________________________1. NLGORR 1997-98
1998-99 1999-00 2000-01 2001-02 2002-03
Actual Actual Actual Actual RE (BE)
2. Allocation 2348.94 2574.37 2862.83 3275.01 3466.29 4148.93
should have
been made
to PRIs as
per First
SFC recomm-
endation
(30.6% of
NLGORR)
3. Allocation made to PRIs by the Govt. in the Budget (Link Document).
(i) Plan 732.00 732.00 792.00 762.00 1083.21 673.08
(ii)Non-plan 2020.99 2357.01 2707.95 2892.47 2993.94 3286.47

Total 2752.99 3089.01 3499.95 3854.82 4077.15 3959.55

Percentage
to NLGORR 35.86 36.72 37.41 36.02 35.99 29.20

4. Actual releases made by the Govt.

(i) Plan 649.00 645.00 630.00 819.00 893.00
(ii)Non-plan 2036.00 2365.00 2648.00 2842.00 2831.00

Total 2685.00 3010.00 3278.00 3661.00 3724.00

Percentage 34.98 35.78 35.04 34.21 32.87

to NLGORR
----------------------------------------------------------------------------------------------------------------
Source – Second State Finance Commission of Karnataka

Thus, though the Karnataka SFC’s evolved a comprehensive devolution framework for fiscal devolution but in actual practice, it
has failed to take and cause any qualitative difference.

Central Finance Commission Grant –

SSFC has evolved devolution framework for inter-se allocation of Eleventh Finance Commission Grant but in actual practice,
this grant is counted as a part of the SFC grant by GOK. This is against the recommendation of SFCs.

42
Chief Minister’s Special Development Grant –
The actual overall devolution for ULB does also include, though not provided by SFCs Chief Minister’s Special Development
Grant. These amounts are distributed to local bodies on the sole discretion of the chief minister. In a democratic polity, it may
not be feasible to ensure that all inter-governmental transfers are governed by an objective formula, but such transfers should
be guided by clarity and limits.

Mechanism for making Deductions –

Deductions regarding the outstanding dues from the ULBs are made in lump sum manner from the overall sum (gross SFC
grant) available for ULBs, before dividing it among individual ULBs. Gross-level deductions made by the State are as follows:
• Electricity charges (paid to KPTCL)
• Repayment of loans (transferred to KUWSDB, which borrows on behalf of the ULBs)
• Interest and repayment on the securitised dues to KPTCL
• Pension contribution dues (paid to State Accounts Department)

Table No 1.5 - Allocation Proposed and Allocation Actually Taken Place

Rs. In Crores
2000-01 2001-02 2002-03
1 NLGORR of the State 10702.66 11327.76 13558.59
(Actual) (RE) (BE)
2. Allocation should have been 3275.01 3466.29 4148.59
made to PRIs as per First
SFC recommendation (30.6% of NLGORR)
(i) ZP (40% of 2) 1310.01 1386.52 1659.57
(ii) TP (35% of 2) 1146.25 1213.20 1452.12
(iii) GP (25% of 2) 818.75 866.57 1037.23
Total 3275.01 3466.29 4148.93
3 Allocation made to PRIs by the Govt. in the Budget (Link Document)
-------------------------------------------------------------------------------------------------------
(i) ZP 1442.55 1514.12 1451.88
(37.42%) (37.14%) (36.37%)
(ii) TP 2276.16 2342.96 2309.61
(59.05%) (57.47%) (58.33%)
(iii) GP 136.11 220.07 198.06
(3.53%) (5.40%) (5.00%)
--------- -------------------------------------------------------------------------------------------------------
Total 3854.82 4077.15 3959.55
--------- -------------------------------------------------------------------------------------------------------Source – Second SFC of Karnataka
Report

The practice of deducting the entire amount of dues (towards above items) pertaining to all Urban Local Bodies put together
from the total devolution amount is biased in favour of those local bodies who have higher amount payable. As a result of this
practice the local bodies, which have borrowed less, or consuming less water or electricity are paying for the local bodies,
which have higher amount of payables. The amount due from each local body should be deducted out of the allocation
available to that local body only. But GoK does not have such a system, as maintaining accounts of dues or receivable amount
from ULBs are not maintained individual local body-wise. Absence of such a system is resulting in to distortion or inequality.
SSFC has noted this practice also in its report (para 6.52) but again it has not worked out the actual distortion taking place due
to prevalence of such practice and has not pressed this point emphatically /forcefully. It is surprising that SSFC, which
recommended setting up of General Purpose Grant to carry out various reforms, has failed to notice lack of proper accounting
of dues and their recoveries at the State Government level.

Summing Up
The regular formation of SFCs and implementation of their various recommendations by GOK has certainly brought in
budgetary certainty and degree of predictability. The SFCs of Karnataka have developed a simple and transparent framework
for fiscal transfers. It certainly has allowed local governments to plan and budget their affairs with certainly but as the budgeting
practices in local bodies are highly defective and unaugmented, it is difficult to know how far they have benefited from well laid
out system of transfers. The institution of SFC has certainly brought in hard budgetary constraints in Karnataka but, as reported
by SSFC of Karnataka there are still sizeable amount of fiscal transfers, which are out side the SFC scheme and in actual
practice GOK has not delinked fiscal transfer from salary commitments of local bodies and finally it is carrying out various debt
related and other water and electricity consumption related deduction in a gross manner from the total amount of devolution.
These practices are creating distortions and inequality. Second SFC of the Karnataka has commented about it. But it has not
strongly criticized it or has not brought about clarity about such non-formulae based fiscal transfers or distortions taking place in
the actual share of devolution received by individual local body. In a democratic polity, it will not be feasible to bring each and
every transfer from state to local under devolution formulae (Chief Minister Special Development Grant Fund is testimony of it)
but clarity about it and an overall limit to such transfers will certainly serve the objective of hard budget constraints, predictability
and transparency. Similarly, a system of deducting dues of an individual local body from her own devolution share can certainly
be created and from the point of view of inter se equity must be created and adopted.

The SFCs of Karnataka have certainly addressed the issue of incentive structure, but the amount earmarked for this purpose is
far meagre and for singular reforms.
The degree of budgetary autonomy has not improved much because it depends on legal structure and degree of self-reliance.
Not much of the legal autonomy has been granted by carrying out legal amendments to the Acts and the dependency of local

43
bodies on State transfers still continues to be very high. The real budget autonomy will come through only when their degree of
self-reliance will improve through sustained internal system reforms by local bodies.

44
 2
Case Study 2 - Review of Tamil Nadu State Finance Commissions

Introduction
Tamil Nadu is another state, which has shown high pragmatism in the field of urban sector particularly in the post economic and
structural reforms period. It is the only state in which all municipal bodies (107 in number) have successfully adopted accrual
based double entry accounting system. Also, it has implemented several urban reforms under Tamil Nadu Urban Development
Project.
rd th
Government of Tamil Nadu consequent to the enactment of 73 and 74 Constitutional Amendment Acts enacted the Tamil
Nadu Panchayats Act 1994 and has made amendments to the District Municipalities Act 1920 and the Municipal Corporations
Act.

The First State Finance Commission was constituted in April 1994 wide G.O. 350 and it submitted its report in November 1996
covering the period April 1997 to March 2002. This Commission comprised of a retired senior civil servant as chair along with
the Director of Municipal Administration, director Rural Development and a respected non-official member, with a senior civil
st
servant as member secretary. The Second State Finance Commission was constituted on 1 December 1999, which submitted
its report to the GOTN in May 2001.

The Fiscal Devolution Framework

The fiscal devolution framework recommended by SFCs of the Tamil Nadu is as follows
Table 2.1 - Fiscal Devolution System / Framework for Local Governments in Tamil Nadu as per SFC Recommendations
st nd
Level of Devolution 1 SFC Frame work 2 SFC Frame work
st
1 level Devolution Concept of Global sharing Concept of Global Sharing
Local Governments Share in State’s Percentage of State Own Tax Part A - Percentage of State Own Tax
Resources. Revenue Revenue
1997-98 8% 2002-03 8%
1998-99 9% 2003-04 8%
1999-0 10% 2004-05 9%
2000-01 11% 2005-06 9%
2001-02 12% 2006-07 10%
GOTN accepted 8 % but did not Part B – 5% of Central Devolution to
increase it by 1 % per annum as State
recommended
nd
2 Level Devolution On the basis of population Based on Composite Index made up of
Division/Sharing of Resources following criteria
between Urban & Rural Local -Population 50%
Government (PRIs). -Needs
O&M 10%
Capital 10%
Debt 5%
-Resource Potential
Inverse of Per
Capita house /
Property Tax 15%
Inverse of assigned
Revenue 10%
Using these weighted criteria SFC has
fixed share of rural and urban local
bodies at 58:42

rd
3 Level Devolution Vertical sharing After allocating the proposed salary
of funds among different tiers of requirements of District Panchayats, the
Rural & Urban Local Governments balance funds to be distributed between
Part A – Sharing among the three village Panchayats and Panchayat
Tiers of Panchayats Unions in the ratio of 60:40 respectively.

85 % of Devolved funds under global 87 % of Devolved funds under global

sharing formula to be allocated to sharing formula to be allocated to local
local govt. govt.
15 % of Devolved Funds to be used 13 % of Devolved Funds to be used for
for Equalization and Incentive Funds Equalization Fund (5%) Incentive Funds
(5%) and Reserve Funds (3%)

Part B – Sharing among tiers of Composite Index made up of

Municipal Bodies -Population 50%
-Needs
O&M 10%
Capital 10%
Debt 10%

45
 -Resource Potential
Inverse of Per Capita 10%
House/property tax
Inverse of assigned 10%
Revenue
Using these criteria SFC has fixed share
as follows
Municipal Corporations 33%
Municipalities 32%
Town Panchayats 35%
th
4 Stage of Devolution – Among Village Panchayats
Horizontal or inter se distribution - Population 60%
On the basis of Population
among Panchayats and municipal - SC/ST Population 10%
bodies. - Area 10%
-Among Panchayats - Asset Maintenance 10%
---------
100%
Among Panchayat Unions
- Population 60%
- SC/ST Population 10%
- Area 10%
- Resource Gap on Inverse10%
- Per Capita land revenue 10%
---------
100%
- Among Municipal Bodies
Among Corporations
- Population 50%
- Slum Population 10%
- Per Capita Own Income 20%
- Asset Maintenance 10%
- Salary and pension expenditure
10%
---------
100%
Among Municipality

- Population 50%
Among Municipality - SC/ST Population 10%
Population 40 % - Per Capita Own Income 20%
- Asset Maintenance 10%
SC/ST Population 20 % - Salary and pension
Financial and Service indicator expenditure 10%
40 % ---------
100%
Among Town Panchayats

- Population 50%
- SC/ST Population 10%
- Per Capita Own Income 20%
- Asset Maintenance 20%
---------
100%

Source- Constructed on the basis of information from first and second state finance commission reports of Tamil Nadu

Innovative Aspects of Tamil Nadu FSFC

Global Sharing or Divisible Pool Concept –

The Tamil Nadu First State Finance Commission like the Karnataka FSFC adopted the progressive concept of common
th
divisible pool or global sharing. The concept of global sharing was for the first time adopted in India by the 10 Central Finance
Commission for sharing central revenues to States. It is really noteworthy that when the concept of global sharing was in the
process of take-off at the Central level, FSFC and GOTN positively responded to the concept of global sharing with the local
bodies. For this purpose SFC delineated 2 revenue pools – A and B. ‘A’ Pool comprises entertainment tax, surcharge on stamp
duty and local cess plus surcharge levied by the state but earmarked as ‘assigned revenue’ for local governments. Pool B
comprises the divisible pool made up of all other taxes and is then subdivided with 40 % of motor vehicle tax, 15% of sales tax
and 25 % of excised duty being allocated to local government. The local government share under this formula was equivalent
to 8 % of the State’s Own Tax Revenue (SOTR) for 1997-98. The FSFC of Tamil Nadu recommended a phased increase of 1
% per annum until 2002 (maximum up to 12 per cent) taking in to account fiscal constraints at the state level and capacity
constraints at the local government level for the absorption of additional funding.
The global-sharing of tax revenue enables aggregate buoyancy of the State economy to be shared with Local bodies, which
results in substantial step-up annually in flow of funds from Government to local bodies. This is evident from the following –

Table 2.2 - Devolution of funds prior to devolution by First SFC (1996-97)

46
 Rs. In Million
Grants Assigned Revenue Total
Rural Local Bodies 1058.7 669.9 1728.6
Urban Local Bodies 1795.1 2358.8 4153.9
Pension commitment (both local bodies together) 600.0
Total 2853.8 3028.7 6482.5
___________________________________________________________________________
Source – SSFC of Tamil Nadu

Table 2.3 Statement showing devolution of funds under Pool A (Assigned Revenue) and Pool B (Global Sharing)
Rs. In Million
Year Pool A Pool B Total % of SOTR
(Assigned revenue)
1997 – 98 2951.0 6125.6 9076.6 8 %
1998 – 99 3649.1 7929.4 11578.5 8 %
1999 – 00 3919.6 8051.9 11971.5 8 %
Source – SSFC of Tamil Nadu

Thus, it can be observed that after FSFC report and its acceptance by GOTN, local bodies of Tamil Nadu have received
increasing devolution even though GOTN kept sharing of revenue stagnant at 8 percent of SOTR and did not increase it by 1
per cent every year as recommended by FSFC.

Equalization Fund –
FSFC suggested this fund at the rate of 15 % of the devolution amount to make good the imbalance and inadequacies, if any,
to Panchayat Raj Institutions and urban local bodies consequent on the adoption of inter-se distribution criteria.

Incentive Fund –
The FSFC suggested continuance of the then existing incentive grants provided statutorily to rural local bodies. Further, it has
recommended extension of the grants to urban local Bodies to improve their own source of income.

Weak Policy Aspects of FSFC

The FSFC report was not characterised by much of weak policy aspects. The structure was sound and various
recommendations were of high order but not very refined one. This task was done later on by SSFC.

Implementation Blues
Though the First SFC of Tamil Nadu came out with a comprehensive and progressive fiscal devolution scheme in actual
implementation, it suffered from various constraints and inadequacies as follows –

Freezing of Local Body Share –

GOTN accepted the main recommendation of global sharing at the rate of 8 per cent but did not increase it (local government’s
share) every year by 1 per cent as recommended by FSFC. Some of the other important recommendation which have not been
accepted by the Tamil Nadu Government were –
• Calculation of Land Cess and Land Cess Surcharge based on average land revenue,
• Compensation for Local Bodies towards Land Cess and Land Cess Surcharge during the period of waiver/remission
of land revenue,
• House – Tax – moving over to plinth areas based tax,
• Water Tax

Utilization of SFC Devolution –

The first SFC recommended specifically that the devolution be meant to cover maintenance of the assets at the time of the
award as also the assets, which will get created during the award period and the salary and wages of the Local Bodies. But in
practice, the GOTN set apart sizeable sum for works with the view to improve basis amenities both in rural and urban areas.
Further, the Government deducted at source dues pertaining to the debt repayment payable by local bodies to other institutions
from the devolution amount.

Equalization Fund –
GOTN utilised this fund to help select local bodies on discretionary basis sometimes even for creation of capital infrastructure.
No norms have been evolved regarding this fund by GOTN.

Non-acceptance of Various Recommendations –

First SFC in all made 462 recommendations out of which 100 recommendations were not accepted. Though recommendation
acceptance ratio of GOTN is much higher, still more than 20 percent recommendation were not accepted. Some of the major
recommendations, which have not been accepted by GOTN, were
• Calculation of Land Cess and Land Cess Surcharge based on average land revenue,
• Compensation for Local Bodies towards LC/LCS during the period of waiver/remission of land revenue,
• House-Tax – moving over to plinth – area based tax,
• Water tax

47
Innovative Aspects of Tamil Nadu SSFC
SSFC of Tamil Nadu has continued tradition of pragmatism and progressiveness as evident from the following

Concept of Global Sharing –

Second SFC continued with the concept of global sharing adopted by the first SFC and refined it further. Taking into
consideration fiscal constraints faced by the GOTN, it recommended 8 percent share for local governments (under Pool B) in
the State’s own tax revenue in the first two years of award and then 9 percent for the third and fourth year and finally 10 percent
for the fifth year of the award.

The most noteworthy recommendation of second SFC is enlargement of divisible pool by recommending 5 per cent share for
local bodies in the central devolutions received by the state since SSFC felt that local governments provide a substantial part of
the infrastructure for the manufacturing and service sector and that these sectors, in turn, contributes considerable revenue to
the centre by way of corporate income tax, union excise duty and customs etc, which are all buoyant revenue sources and that
local government is justified in getting a share of such buoyant sources.

Comprehensive Devolution Framework –

As observed in the Karnataka SFCs case here also first and second SFC of Tamil Nadu have evolved comprehensive fiscal
devolution framework comprising both vertical and horizontal sharing of devolution by local bodies (Please see table 7). FSFC
provided for all the four stages of devolution (refer figure 1 & 2) but it had utilised population as the only criteria for vertical and
horizontal distribution of devolution among various local bodies. Improving upon that second SFC has developed six criteria
based composite index for second and fourth level devolution. (Refer table 7)

Relationship between Formula Based Devolution and Non-formula Based Transfers to Local Governments –
Taking note of the inevitability of non-formula based devolutions/transfers by state to local bodies under democratic polity,
second finance commission has come out with recommendation of 80:20 ratios between formulae and non-formula based
transfers. SSFC has precisely calculated all the non-formula based plan, non-plan and other discretionary grants, which are out
side SFC devolution, and has provided a clear picture about total funds flowing to local bodies from State. Having drawn a clear
picture it has recommended that all transfers outside devolution should be about 25 percent of formula based transfers.

Estimation of Fiscal Gap and its Correlation with the Devolution Recommended by SSFC
Second SFC has estimated the revenue gap of local bodies on a logical and objective norms basis. Having estimated the total
revenue gap it has correlated the revenue gap figures with the fiscal devolution figures, which it has recommended, and in this
way, it has clarified the sufficiency of devolution amount recommended by it against the estimated fiscal gap or requirements of
local government as follows

Table 2.4 - The requirement of all local bodies and quantum of transfer of funds (2002-07)
Rs. In Million
I 1) Revenue Gap of all Local Bodies 119528.00
2) Capital Requirements of all Local Bodies 50250.00
-------------
Total Fiscal Gap 169778.00

II Probable devolution as per Second SFC Recommendations

a) Global sharing including 5 % share of Central Devolution 109643.30
b) Assigned Revenue 21312.40
-------------
Total Probable Devolution 130955.70
III Difference between revenue gap and probable transfer of
Fund through SFC devolution formulae (+) 11427.70
Source – SSFC of Tamil Nadu

Allocation of SFC Devolution for Capital Works –

Having established fact that there will be positive difference of Rs. 11427.70 million between revenue gap and transfer of funds
through SFC devolution SSFC went on recommending reserving certain portion of devolution for capital works as follows –

• In case of municipalities and corporation 10 %

• In case of Town Panchayats 15 %

• In case of Village Panchayats 20 %

Reservation of certain portion of SFC Grant for capital works is a yet another innovative feature of the SSFC of Tamil Nadu.

Reserve, Equalization and Incentive Fund -

As noted earlier FSFC recommended in all 15 % of devolution amount for these three funds, SSFC has gone a step ahead and
has framed rational principles for creation and utilization of funds with reasonably defined scope. SSFC has recommended
setting aside 13 percent of the total SFC formula based devolution out of which 3 % are for reserve fund, 5 % for equalization
and the balance 5 percent for incentive purposes.

48
Equalization as a concept has been introduced to make up shortfalls that may arise in the implementation of the principle
distribution. It is difficult to ensure that an objective formula will at all times meet the needs of all local governments. The
equalization grant is thus intended to meet specific service needs that are not covered under the new revenue sharing system.

Self-reliance Index –
The second SFC analyzed the resource base of local bodies in detail and has made various recommendations to improve the
utilization of own resource by the local bodies. As a part of it, the second SFC has provided present self reliance index and as
an important recommendation it has recommended that self reliance is to be achieved by the middle of the award period and
has asked GOTN and local bodies to work together to achieve it. The recommended self-reliance index for award period (2002-
07 is as follows
1. the own income of Municipal Corporations shall be in the range of 65 to 70 %
2. the own income of Municipalities shall be in the range of 55 to 60 %
3. own income of Town Panchayats shall be about 45 %, and
4. in respect of Village Panchayats the own income shall be about 25 %.

Fiscal Responsibility Norms for local bodies –

Another highlight of the Second SFC is its recommendation regarding introduction of the concept of fiscal responsibility for the
local bodies by amending Panchayats Act and Urban Local Bodies Act. Commission suggested following norms of fiscal
responsibility to be made binding for the local bodies.
• All local bodies shall wipe out revenue deficit by 2004,
• Ensuring a 5 % cash reserve in each year’s income
• Statutory ceiling on debt level
• Quarterly review of the budgetary allocation and spending
• Limiting the salary and pension commitment to 49 % and local governments to deploy at least 51 % for O & M, assets
creation, debt servicing and investment.
• Fixing responsibility for time and cost overruns on line agencies and government departments.

Norms for Regrouping and Restructuring Local Governments

Tamil Nadu SSFC felt that administrative re-organisation is necessary to ensure their (LGI) development as viable institutions of
Self Government. Accordingly, in its report SSFC has discussed in details existing classification of different tiers of rural and
urban local governments and has come out with revised norms for regrouping or reclassifying local governments of Tamil Nadu.
Regrouping of local government institutions is always sensitive issue but SSFC has handled it with detailed analysis.

Setting up of State-Local Bodies Council –

Second SFC suggested setting up of such council on the lines of Inter – State Council to be chaired by Chief Minister and
having representatives from all types of local bodies and related government departments to make state-local relationship of
federal character from present unitary character.

Staffing Norms –
Second SFC has discussed entire range of issues associated with the human resources of local bodies. The most important
aspect is it has recommended staff ratio per thousand for different types of local bodies as follows and has asked state
government and local bodies to maintain it strictly for control of salary cost
• Chennai Corporation - 3.5 employees per thousand population
• Other Municipal Corporations - 3 employees per thousand population
• Municipalities - 2.5 to 3 employees per thousand people
• Town Panchayats - 1.75 to 1.90 employees per thousand

Commission further recommended that

Productivity norms may be prescribed for all categories of staff to achieve rightsizing of establishment keeping in view the
overall staff norms as recommended above.
Illustratively assessments per collection staff may be prescribed at 2400.

Time Bound Release of Devolution to Local Governments –

Timing of funds flow is an important component of any efficient system of fiscal devolution. Elected members and functionaries
of local government reported continuing delay in the release of funds. In response to this, the SSFC has recommended a
subdivision of the present quarterly releases so that payments are spread across 3 months of each quarter to prevent
bunching. At the same time, the SFC recommended the implementation of detailed adjustments to certain state tax regimes
and processes to ensure more streamlined inflows of revenue into the divisible pool.

Regulatory and Support Arrangements –

The SSFC has also made a number of recommendations on strengthening the regulatory and support arrangements for
devolution. A number of the more innovative recommendations relate to urban local government although these are in the
process of being extended to rural local governments. Some of the more innovative recommendations are:
• Establishment of an Incentive Fund for those local governments that have successfully launched public health
projects through public participatory approaches and with involvement of the private sector

• Involvement of professional agencies such as life insurance companies and banks to administer the contributory
pension scheme and commutation of pensions for all employees covered under the scheme.

The SSFC has also made a number of important recommendations on strengthening local government accounting and
auditing. The Director of Local Fund Audit verifies all transactions relating to urban local government. Municipal Corporations
st
are expected to compile and submit their accounts for audit before 1 July while other municipalities are expected to submit

49
 th
accounts by 15 May. The audit function should then be completed within a period of one year. In practice, however, the
auditing of accounts is often delayed due to delayed compilation. In order to improve the efficiency of the audit function the SFC
has recommended that:
• Steps to be taken to accord statutory status to Director of Local Fund Audit to improve the expertise of auditors and
25% of the posts of Assistant Directors Local Fund Audit may be earmarked for direct recruitment to induct
professionals auditors such as chartered accounts and cost and works accountants.

• Pre-audit may be introduced for work bills in Municipalities, Town Panchayats and Panchayat Unions in place of
concurrent audit

• Formation of district committees to help clear accumulated audit objections

At the same time, the SSFC recommended strengthening local government accounting systems by extending the accrual
accounting system introduced into all municipalities and corporations from 200-01 to Town Panchayats and Panchayat Unions
from 2003-04 after sufficient training and after completion of a pilot scheme in 10 municipalities and 2 corporations. GOTN has
implemented this reform with respect to municipal bodies and now is in the process of implementing it in Panchayat Unions.

Management Audit –
The State Planning Commission has evolved a scheme for management audit whereby all works taken up in different schemes
will be subjected to scrutiny at random. This process covers schemes under basic amenities, remunerative enterprises and
other development works. The SPC recommends that management audit team should comprise Additional Directors from office
of the Director of Rural Development/ Commissioner of Municipal Administration/ Director of Town Panchayats and an Officer
from State Planning Commission. The SSFC has recommended adoption of management audit system.

Budgeting Process –
The SSFC recommended that based on the experience of participatory budgeting in Brazil each local government should
develop a printed draft budget to be distributed free to relevant public stakeholder groups such as Gram Sabhas/ Urban Sabha/
and Ward Committees and after detailed debate any necessary modification should be reflected in the final budget document.
In addition copies of printed budgets may be displayed in the notice boards of Village Panchayats/ Panchayat Unions/ Town
Panchayats/ and Municipalities. Further, all the local governments, except Village Panchayats are to be encouraged to can
take advantage of the Internet and host websites providing salient features of their area including their budget. In the case of
Village Panchayats, relevant data such as works selected in the year, budget etc. can be made available through the
information kiosk at the Panchayat Union.

It further recommended step-by-step introduction of the Zero-base budgeting, at first instance in all municipal corporations and
special grade municipalities and in line agencies directly and intimately connected with local bodies viz. Tamil Nadu Water
Supply and Drainage Boards, TN Slum Clearance Board etc

Access to Loans and Grants (Debt Management Policy) –

As of now, the State Government issues guarantees on the loan liabilities of local governments. According to Section 66 of the
Tamil Nadu Urban Local Bodies Act, a municipal council with the prior sanction of Government may borrow by way of
debentures on security of taxes, duties etc covered under the Act. Hence, there is a mechanism for regulation of borrowings
from local bodies. The SSFC recommended that the Head of the Departments should continue to oversee the financial position
of local bodies effectively and to limit the borrowings at certain prudent level especially in Urban Local Bodies. For instance, it is
understood that Mumbai Corporation has a debt ceiling, which is 7 times of the ARV of the properties in that Corporation. The
SSFC in Tamil Nadu recommended a ceiling of four times of own resources. The SFC also recommended that the total debt-
servicing ratio to annual revenue receipts should not exceed 25% in order to ensure that local governments have sufficient
funds to meet routine expenditure requirements establishment (49%) and O&M expenses (25%).

Beside above specific landmark recommendations Second SFC of Tamil Nadu has also made the following important
recommendations
• Incentive funds for adoption of report card system for performance monitoring by local bodies.
• It recommended that a 25 per cent ceiling on deduction from gross state finance commission devolution towards
repayment of all loans and 20 per cent ceiling regarding non-debt deductions.
• The local body representatives to be declared as public servants to enable invoking the provision of Prevention of
Corruption Act, 1998 and Benami Act.
• Setting up of Ombudsman type of institution for local body representatives with six-month time frame to complete the
enquiry and give findings.

Weak Policy Aspects

Tamil Nadu SSFC report was again devoid of weak policy aspects. Keeping in tact framework of FSFC, it refined all the
concept and policy aspects put forward by the FSFC. Also, SSFC provided performance based orientation to fiscal devolution
mechanism through concepts and recommendations regarding self reliance index, fiscal accountability norms, staffing norm,
per unit O & M and Development cost norms for calculating fiscal responsibility and needs of local governments.

Implementation Blues
The same old story of inadequate implementation unfortunately got repeated with SSFC recommendation. Though government
has accepted principle and formulae of devolution and sharing of resources with the local government institutions, it has not
acted upon other recommendation especially about performance based devolution.

Summing Up
Substantial progress has been made in Tamil Nadu with regard to the local devolution and fiscal reforms. The SFCs of Tamil
Nadu has elaborated a progressive revenue sharing arrangement between state and local government based in line with the

50
Constitution Amendment Act. These recommendations, that have been largely but not wholly implemented, have resulted in the
emergence of a more efficient and transparent system of fiscal devolution with provision for an incentive fund to reward good
performance and an equalization fund to address unanticipated anomalies.

The Second SFC has made in all 132 main recommendations and 218 sub-recommendations touching all the aspects
rd th
envisaged by the 73 and 74 Constitutional Amendment Act. The overall quality, framework, layout, language, information,
data etc. of the SFC report is of very high standard. The report of the SSFC of the Tamil Nadu can be considered one of the
best SFC report and gives hope that the institution of SFC is coming to the age and will be able to serve objectives envisaged
by the Constitutional Amendment Acts.
st nd
Fiscal devolution in Tamil Nadu is an evolving process and derives from the recommendations of the 1 and 2 State Finance
Commissions. Overall, there has been little change in relation to tax assignments for local government other than attempt to
ensure more timely transfers of earmarked taxes from State to local level. The focus of innovation has, instead, been
concerned with revenue sharing and grants in aid. State-local revenue sharing arrangements are thus central to the evolving
fiscal devolution process in Tamil Nadu based on a revenue sharing concept from a tax pool made up of the net proceeds of all
state taxes, excluding entertainment tax.

The formation of SFC and implementation of their recommendation has certainly brought in budgetary certainty and degree of
predictability. The SFCs of Tamil Nadu have provided simple and transparent framework for fiscal transfers. It certainly has
allowed local governments to plan and budget their affairs with certainly but budgeting practices in local bodies are highly
defective and unaugmented, so it is difficult to know how far they have benefited from well laid of system of transfers. Institution
of SFC has certainly brought in hard budgetary constraints but as reported by Second SFC of Tamil Nadu still there are
sizeable amount of fiscal transfers, who are out side the SFC scheme. But Second SFC of Tamil Nadu has certainly brought
about clarity about such non-formulae based fiscal transfers and has even suggested limit to such transfers. In a democratic
polity, it will not be feasible to bring each and every transfer from state to local under devolution formulae but clarity about it and
an overall limit to such transfers will certainly serve the objective of hard budget constraints, predictability and transparency.

The SFCs of Tamil Nadu have certainly addressed the issue of incentive structure, Second SFC has recommended earmarking
of 13 per cent of devolution for various incentives or performance linked grants and has also provided norm for operation of
such funds.

The degree of budgetary autonomy has not improved much because it depends on legal structure and degree of self-reliance.
Not much of the legal autonomy has been granted by carrying out legal amendments to the Acts and the dependency of local
bodies on State transfers still continues to be very high. The real budget autonomy will come through only when their degree of
self-reliance will improve through sustained internal system reforms by local bodies.

It appears from its commitment to the devolution process that the GOTN has a rather pragmatic view of the benefits of reform.
Whilst the implementation of a more transparent and predictable formula for funding local government has undoubtedly
facilitated the states overall budget management and monitoring process it has also enabled local governments to develop a
greater measure of financial independence, and in turn, seek new ways to fund local infrastructure and services that place less
direct burden on state finances. There are numerous cases in Tamil Nadu of municipalities now leveraging development capital
from a variety of sources. It is interesting to note that the devolution reforms remain in place in spite of the fact that opposition
parties dominate many types of council.

Locally elected councils are strongly in favour of the current fiscal framework since it provides greater budgetary certainty than
the former ad hoc system of transfers that would commonly penalize opposition councils and allows for greater stability of cash
flows. It is also felt that the fiscal reforms have helped develop the role of politicians as responsible agents in the development
process as the new arrangements have contributed to improved service delivery.

51
 3
Case Study 3 - Review of Andhra Pradesh State Finance Commissions

Introduction
Andhra Pradesh is yet another state from southern part India, which has made long strides in the last decade and has received
lot of acclaim for its initiatives in the area of e-governance, educational infrastructure and development of software and
computer industry.

Andhra Pradesh has long been noted amongst Indian states for the explicit emphasis its charismatic Chief Minister, Chandra
Babu Naidu, has placed on public administration reform. This has been arguably driven by a desire to promote private sector
investment and economic development. The primary articulation of the reform agenda is the 1999 “Andhra Pradesh Vision
2020,” which defines a long term development agenda for the state. Governance and public administration reform is central to
this vision. Moreover, the change process in the state is underpinned by a number of “articles of faith” (Mooij (2003)). These
include an emphasis on delivery and performance, the associated introduction of performance targets and measures; and the
use of technology for introduction of e-governance in order to achieve accountability and transparency and to reduce corruption
in governance. The direct manifestation of the reform agenda in policy terms includes:
ƒ 1996 Policy paper on fiscal management;

ƒ Cabinet Sub-Committee on Administrative Reforms;

ƒ White paper on Governance and Public Management;

ƒ Task force on Good Governance.

The Andhra Pradesh case illustrates some innovative approaches to performance enhancement for local government, through
pilot programmes that aim to incentivise and reward improvement. One such programme is based upon a broad range of
performance criteria related to municipal reform and infrastructure service delivery, with donor support. Another approach,
running in parallel, focuses more exclusively on revenue improvements. Whilst the overall policy framework in the state is
based more on an economic reform agenda than on a strong orientation towards devolution, there is nevertheless a clear
recognition that effective local government underpins economic development.

In relation to decentralization, there has been a clear focus on improving the performance of local bodies, so that they can play
a more developmental role, promoting socio-economic development and service delivery. The GOAP has, however, arguably
sought to ensure such efficiency gains through a more regulatory approach rather than through directly empowering local
bodies. Certainly, the Telugu Desum Party (TDP) has sought to develop a rural power base, but generally the formulation and
implementation of policy remains highly centralized. At district level, an increasing number of powers are concentrated in the
hands of District Collectors (Indian Administrative Service Officers) rather than in control of local politicians or even district level
heads of departments. Mooij (2003) also notes that whilst the District Collectors have a direct line to the Chief Minister, which
helps to ensure implementation, this also serves to ensure central control.
nd
Andhra Pradesh Government constituted its First State Finance Commission 22 June 1994, which submitted its report in May
th th
1997. The Second State Finance Commission was constituted on 8 December 1999 and it submitted it report on 19 August
2002.

The Fiscal Devolution Framework

Andhra Pradesh SFCs have not gone for defining common divisible pool. Both SFCs of Andhra Pradesh have tried to
delineate/define state-local relationship or fiscal devolution system under each of the following heads:
I. Devolution.
II. Grant-in-aid.
III. Assignments.

While working out devolution amount AP SFCs have adopted gap filling or “need based” devolution approach. The
multi-layered framework recommended by the SFC is as follows:

Table 3.1 - The Fiscal Devolution Recommended by SFC of Andhra Pradesh

___________________________________________________________________________
I. Devolutions:
A) Devolutions for Panchayats:
i) Civil Amenities Requirements of Panchayats.
i) Finding out of average per capita expenditure for providing core Services in best GP
ii) Average per capita expenditure X Total G.P. population = total amount required for
civic amenities by all GPs.
iii) Total amount required – total Income of G.P. from all sources of own income = net
amount required by GPs.
iv) Net amount – EFC Grant = Amount to be devolved by GOAP. Devolution amounts
thus worked out to be distributed amongst GPs on Population basis as follows:
• Tribal Panchayats - 35%
• Panchayats with a population up to 500 30%
• Panchayats with a population up to 500 to 1000 20%
• Panchayats with a population above 1000 15%

B) Devolutions for Municipal bodies.

i) Civic amenities requirements of Municipalities
i) Working out Average per capita expenditure of core functions.
ii) Average per capita expenditure X population of Municipalities = Total amount required.

52
 iii) Total amount required – Income from own sources of municipalities = net amount
required to be devolved.
iv) Net amount – EFC grant amount for municipalities = amount to be devolved by GOAP.
v) Inter-se allocation as per following criteria:

The inter se distribution may be made on the following basis keeping in view the varying per capita income of the Municipalities
and their expenditure needs. The Commission recommends that the amount earmarked for civic amenities may be distributed
on the following criteria:
a) Total population of the Municipal Council 60 per cent.
b) Area excluding slum 10 per cent
c) Slum population 10 per cent.
d) Municipalities where the tax demand is
less than the amount required for salaries
of the non-teaching staff. The amount
may be distributed in proportion to the
gap between the two, i.e. expenditure
on salaries of non-teaching staff minus
tax demand. 10 per cent
d) Revenue mobilization. 10 per cent
---------------
Total 100 per cent
----------------

ii) Civil Amenities Requirements of Municipal Corporations:

i) Average per capita expenditure of core functions.
ii) Average per capita expenditure X population of Municipalities = Total amount required.
iii) Total amount required – Income from own sources of municipalities = net amount required to be
devolved by GOAP.
iv) Net amount – EFC grant amount for municipalities = amount to be devolved by GOAP.
v) Inter-se allocation criteria -
a) Population 60%
b) Area excluding slums 10%
c) Slum population 10%
d) Revenue Mobilization. 20%
------
100%
II. Grant – in-Aid: As shown in the table below 7
III. Assigned Revenue As Shown in the table below 7

The total devolution by way of assignments and grants recommended by the Commission for both the Rural and Urban Local
Governments is Rs.1, 7939.40 million (i.e. 1, 1673.30 million for Rural Bodies and Rs.6266.10 million for Urban Bodies). It
works out to 10.385 percent (i.e. 6.76 per cent to Rural Local Bodies and 3.63 percent to Urban Local Bodies) in the total Tax
and Non-Tax Revenues of the State Government including the share of Central Taxes, for the year 2000-2001. The details of
additional devolutions recommended by SSFC are shown below in table 7
___________________________________________________________________________
Source – First and Second SFC Reports of Andhra Pradesh

Table 3.2 - Additional Devolution As Recommended by SSFC for Rural (PRI) and Urban Local Governments
Rs. In Crores
For Rural Local Governments (PRI)
I Formulae Based Devolution
Requirement for civic amenities of Panchayats 367.94
(as explained in the Table 3.1 above)
II Assigned Revenue
Abolition of Land Cess Compensation 33.88
Excise Cess 42.08
III Grant-in-Aid
Construction of Office Buildings 31.00
Strengthening of small Panchayats 68.24
Special Repairs to Sub Centres 10.00
Office cum Residential buildings to ANMs 80.00
Rural Water Supply 168.60
Rural Sanitation 25.40
Minor Irrigation 19.40
Rural Roads 80.00
Construction of Mandal Panchayat Buildings 12.00
Toilet facilities in the schools 2.41
Drinking Water facilities in schools 0.41
Construction of new schools in place of old buildings 1.50
Special repairs to school buildings 6.50
Maintenance of Rural roads (Grant to Zilla Panchayats) 130.00
Maintenance of school buildings (Zilla Panchayat Grant) 26.00
Maintenance of Minor Irrigation (Z.P. Grant) 11.30
Maintenance of MP, ZP and other office buildings 4.88
Maintenance of Rural Water Supply (Z.P. Grant) 26.00

53
 For payment of pension, etc 19.79
-------------
Total of I + II + III for Rural Local Governments (PRI) 1167.33
-------------
For Urban Local Bodies
I Formulae Based Devolution
For providing civic amenities to Municipalities (Table 6) 130.00
For providing civic amenities to Corporations (Table 6) 165.00
II Assigned Revenue
M.V. Tax Compensation 74.00
Excise Cess. 11.92
III Grant-in-Aid
Salary Grant where tax demand is less than Establishment charges 39.22
Incentive Grant for Solid Waste Management to Municipal Corporations 5.00
Urban Water Supply and Drainage 177.50
Maintenance Grant for Municipal buildings 3.35
Revised scales of pay and increase in D.A. 19.70
Salaries to Medical Officers, Staff and purchase of Medicines 0.92
---------
Total of I + II + III for Urban Local Governments 626.61
----------
Total Additional Devolution to local bodies (rural + urban) 1793.94
Source – Second SFC Report of Andhra Pradesh

Table 3.3 - Framework for Distributing Eleventh Finance Commission Grants to local bodies as worked by Second SFC of
Andhra Pradesh
Eleventh Finance Commission allocated grant of Rs. 152.05 crores per annum for rural local bodies and Rs. 32.93 crores per
annum for urban local bodies. Second SFC of Andhra Pradesh has worked out its inter se distribution among local bodies as
follows
For Panchayats
1(a) CIVIC AMENITIES TO GRAM RS. IN CRORES
PANCHAYATS (As fixed by Eleventh Finance Commission)
Criteria – Population:
i) For Tribal Panchayats 35% 43.60
ii) Panchayats with a population 30% 37.37

iii) Panchayats with a population 20% 24.91

iv) Panchayats with a population 15% 18.68

124.56
1. (b) CIVIC AMENITIES IN BEST
GRAM PANCHAYATS 0.07
(As fixed by Eleventh Finance Commission) ----------
124.63
2. DATA BANK
Creation of SFC Cell 0.30
Data Bank at Mandal, District 17.97
Level and State Level
(As fixed by Eleventh Finance Commission)

3. MAINTENANCE OF ACCOUNTS - 18.27

GRAM PANCHAYATS AND MANDALS
Junior Assistant for Mandal 9.15
Parishads and Clerical Assistance
to Gram Panchayats
(As fixed by Eleventh Finance Commission.)
Grand Total 152.05
MATCHING CONTRIBUTION:
As regards matching contribution, the following rates are suggested:
Tribal Gram Panchayats Nil
Gram Panchayats with an income up to Rs.2 Lac 15 percent
Gram Panchayats with an income of more than Rs.1 Lac per annum 25 percent

The Gram Panchayats shall prepare five-year plans and annual plans for utilization of the grants by prioritizing their needs.

For Municipal Bodies

The Eleventh Finance Commission allotted a grant of Rs. 329.3 million per annum for the municipal bodies of Andhra Pradesh
as follows
Rs. In Million
For creation of data base relating to finance of municipal bodies 0.925
For maintenance of civic amenities 329.300

Keeping in view, the varying per-capita incomes of the Municipal bodies and their expenditure needs, the Second State
Finance Commission recommends that the amount earmarked for civic amenities may be distributed on the following criteria.

54
 • To Municipal Councils/ 60 percent based on population
Corporations
• To Slum areas. 20 percent based on population.
• To Municipalities in which the tax 20 percent based on population.
demand is less than the amount
required for salaries of the non-
teaching staff. The amount may be
distributed in proportion to the gap
between the two i.e. expenditure
on salaries of non-teaching staff
minus tax demand.

The Commission considers that the Municipal Corporation of Hyderabad, Vijaywada and Vishakhapatnam have good resources
and are in a better position to raise resources. Therefore, they need not be given any grant out of this. The other Municipal
Corporations may be treated on par with the 110 municipalities and be made eligible for the grant with reference to the
principles enunciated above.

The grant shall be utilized for providing civic amenities as prescribed in the Eleventh Finance Commission. The Municipal
bodies shall prioritise their needs, prepare a plan of action for 5 years, and utilize the amounts accordingly.

The grant of Rs.9.25 lacs for Data Base is meagre. The State Government may provide matching amount from the State
Budget and utilize the amount for providing Computers in Municipalities, which have not installed computers. If there is any
balance, the amount may be kept at the disposal of the Commissioner and Director of Municipal Administration for creating an
Urban Data Bank in his office.

MATCHING CONTRIBUTION:
As regards matching contribution, 20 percent may be fixed in respect of Municipalities where the tax demand is less than the
salaries of the non-teaching staff, 30 percent matching contribution may be prescribed in respect of other Municipalities and
corporations.

Innovative Policy Aspects of SSFC of AP

Appropriate base to address the issue of very small Gram Panchayats

SSFC of AP has adopted base of population slabs in place of per capita base for providing special grant to Gram Panchayats
having very small population base.

Focus on Gram Panchayats in Devolution Framework

SSFC has given significant importance to the institute of Gram Panchayat. It can be observed that out of additional devolution
of Rs.11673.30 million p.a. for Panchayats, 80 per cent amount has been allocated to GPs and only 20% per cent has been
allocated to Zilla and Mandal (Taluka) Panchayats.

Salary Grant Where Tax Demand is less than Establishment Costs

SSFC noted that there are 81 municipalities in AP state whose total tax demand is sufficient to meet the salary bill of the non-
teaching municipal employees considering the fact that some municipal bodies may in reality have inadequate economic base,
the Second SFC has recommended special grant in aid of Rs.392.20 million to Municipalities.

Incentive Grants for better Solid Waste Management

SSFC recommended one time incentive grant of Rs.10 million per Municipal Corporation, if they come forward to establish
Solid Waste Management Plants.

Weak Policy Aspects

Overall, the framework for inter-governmental fiscal relations evolved by SFCs of AP is quite limited in comparison with other
states. There are no clear allocation mechanisms for the sharing and transfer of funds between different levels of government.
Transfers are entirely based upon the state government’s own discretion.

Absence of Devolution Model

The biggest weakness of fiscal devolution framework suggested by SFC of AP is the absence of devolution model consisting of
sharing of resources. The AP Framework is overwhelmingly grant-in-aid model. It is just equal to grant-in-aid code system
which existed prior to constitutional Amendments and when SFCs were not in existence. Even the SSFC has shown civil
amenities requirements funds under devolution mode, it is again a grant-in-aid calculated in an elaborative way. Thus, first
stage of fiscal devolution is missing completely.

Though GOAP’s annual devolution to local bodies in 2000-2001 was Rs.52757.90 Million, that is 30.53 percent of the tax and
non-tax revenues of the State including the share of Central Taxes and will go up to 40.92 percent, if GOAP accepts additional
devolution of Rs.17939.40 million recommended by the Second SFC, no where GOAP is required to share specific percentage
of its resources compulsorily. The second SFC should have recommended/codified such a percentage sharing of resources of
State and from total share of those local bodies should have worked out different grant-in-aid or inter-se devolution packages.

55
Absence of Efficiency Based Criteria
It can be observed that entire devolution mechanism is based on gap filling approach and wherever composite index of different
criteria is used, there is complete absence of efficiency-based criteria. Only in one place, in the case of inter-se allocation
between Municipal Corporation, 20% weightage has been given to resource mobilization.

Simultaneously, except one incentive grant head of Rs.50 Million (one time) and that too for municipal corporations for
improving solid waste management, the entire existing devolution package of Rs.52757.90 million and additional devolution
package of Rs.17939.40 million does not contain any incentive grant.

While ending its report, the Second SFC has recommended linking of release of grants to the performance of the local bodies
in the matter of collection of taxes and non-taxes, but it has not provided any framework for it.

Absence of vital basic information

The report of the second SFC does not contain certain basic information. For example, it has mentioned on page No.198 total
figure on total annual devolution to the local bodies, but there is no information about its constituent parts and its trend
movement in past year. In entire report, there is no information about the total devolution to local bodies in the past five or ten
years. Also, the second SFC report has discussed only additional devolution, which it has recommended, but at any place, it
has not analyzed the existing devolution and its efficacy.

Similarly, there is a passing mention about the additional amount of devolution of Rs.9791.60 million per annum recommended
by the first SFC, but there is no further information about its bifurcation, main items, its actual implementation and attainment of
desired objectives, etc.

Implementation Blues

Inadequate implementation
SSFC has dwelt upon this aspect considerably. As noted by Second SFC, out of 84 recommendations made by first SFC, 24
recommendations were not accepted while 5 recommendations were accepted with modifications. Thus, almost one-third
recommendations were not accepted by GOAP without recording reasons for non-acceptance.

• It further points out that several recommendations accepted by GOAP were not implemented.

• Out of additional devolution of Rs.9791.60 million recommended by the first SFC, only 44.37 per cent that is devolution of
Rs.4344.20 million was accepted by GOAP.

In case of several Grants-in-aid, adequate amount is not released or the norms for allocation were not followed.

Inordinate delay in setting up SFCs review and accepting of their report

SSFC has elaborately listed various simple but problematic administrative failures while setting up SFC. For example, non-
availability of office staff and other resources to start functioning of SFC, lack of data, inordinate delay in getting replies and
records of earlier SFC etc.

Summing Up
As discussed above workings of SFCs of Andhra Pradesh has suffered from both count one, inherent weakness in SFC’s
approach and inadequate implementation. Compare to pre SFC situation budgetary certainty and predictability of funding has
certainly improved but it has not introduced concept of hard budgetary constraints and formulae based fiscal devolution. It can
be observed from the table 9 that out of total additional devolution package of Rs. 17939.40 million recommended by Second
SFC of Andhra Pradesh only Rs. 6629.40 million (36.95) have been suggested under formulae based devolution while rest of
the funds have been suggested under grant-in-aid transfers. Further Andhra Pradesh SFCs have not calculated total fiscal
transfers taking place to local bodies beyond SFC devolution.

There is lack of incentive structure or performance-linked devolution of funds to local bodies. All Andhra Pradesh local bodies
suffer from the problem of high dependency on the fiscal transfers and not many legal amendments have been carried out to
suggest increase in budget autonomy in Andhra Pradesh Local Bodies. Thus barring some innovations SFCs of Andhra
Pradesh have not charted new way and has thus failed to provide new dimension to existing state-local relationship.

56
 4
Case Study 4 -Review of Gujarat First State Finance Commission

Introduction
th
Government of Gujarat constituted First State Finance Commission on 15 September 1994 and the commission submitted its
th th
interim report on the recommendations of 10 Central Finance Commission on 8 September 1997. It handed over final report
on rural local government bodies on 13-7-98 and report on urban local bodies in October 1998.

As GOG has only recently constituted second state finance commission as a result its report is not available for review.

The FSFC being first generation SFC its report is of very preliminary nature. Gujarat State has the legacy of highly developed
rd th
local government system and fairly well developed Grant-in-code even prior to 73 & 74 CAA or formation of State Finance
Commission. Report of FSFC of Gujarat is more of documentary nature and in its fiscal devolution framework it has mainly
focused on listing of information regarding existing taxes, non-tax sources and grant-in-aid and possible ways for efficient use
of existing tax sources.

In the report of the FSFC one, find very good documentation about existing tax sources applied by local bodies and the grants
released to them. Also, there is a good data about local bodies but it does not contain data about finances of State and total
grant-in-aid over the years to local bodies – budgeted and actually disbursed.

However, SFC has provided estimation of devolution package recommended by it and its projection over five years, which is
provided in the table 4.1 and 4.2.

Table 4.1 - Size of Fiscal Transfer to Urban Local Bodies in Gujarat – 1995-96
Grant sanctioned to the urban local bodies: year 1995-96 (Rupees in lacs)
1. Decentralised district planning, 449.33*

2. Grant of education department, 11059.97

3. Grant of entertainment tax (municipal finance board) 1514.12

4. Health department :
- Health department, 316.59
- Gujarat Water supply department. 123.16
5. Urban development department :
1. Grant for pay and allowances 920.00
2. Per capita basic grant 87.72
3. Road improvement grant. 99.00
4. Incentive Grant 160.00
5. Land revenue grant 130.00
6. Grant of local cess 99.00
7. Grant of motor vehicles tax 1.03

1491.75
14954.92
* 9.17% of the District Decentralised planning grant
Source – First State Finance Commission Report of Gujarat

Table 4.2
Statement showing details of Additional Income to be given in the first year to urban local Bodies and new Additional burden on the State
Government as per the Recommendation of the First State Finance Commission of Gujarat
(Rs. In Lacs)

Sr. Para Particulars Additional Additional Burden on Remarks

No. Income to State People/

Urban Local Govt. Tax Payer/

Bodies Service

Taker

1 2.2 Motor Vehicle 325.32 325.32

2 2.4 Professional Tax 2499.00 24999.0

3 2.5 Entertainment Tax 1409.00 1409.00

57
 4 2.6 Education Cess. 1400.00 1400.00

5 2.7 Conversion Tax on N.A. 8.83 8.83 14 Land Revenue on N.A. it distributed a rate of
85% instead of 75%. After increase of 20%
59.50 59.50 in the income of Rs. 70, lacs and considering
at the rate of 85% Rs. 71.40 lacs will be
11.90 -2.1
available.

6 2.8 Land Revenue 204.00 204.00 Additional Rs. 204 Lacs will be available for
land revenue after increasing the Recovery
347.00 -61.00 408.00 amount at 85% (Rs. 347 lacs) instead of
35% (Rs. 143 lacs)After Doubling the Rate of
land revenue.

7. 2.9 Local Cess. 110.00 110.00 Due to Doubling the Rate of local cess.

220.00 220.00

8 3.1 Surcharge on 2300.00 2300.00 Amount Recovered from 1988-89 to 1997-98

will have to be given through Muni. Fin.
Stamp Duty 2440.00 2440.00 Board in five annual instalments.

9 3.2 Cable TV/Dish 200.00 200.00

Antenna Tax

10 4.2 Grant-in-aid for 237.00 237.00

Establishment

11 4.8 Per head Basis Grant 88.00 88.00

12 4.9 Incentive Grant-in-aid 1335.00 1335.00 As this is additional recovery burden will not
fall on anyone
Additional Recovery 9022.00

13 5.1 District Planning Board 7644.00 No increase is proposed in annual

development plan outlay but an increased
share is recommended for decentralized
planning from the approved plan and hence
additional burden is not there.

14 7.1 Grant as per 1687.00

recommendation as
Central Finance
Commission

15 8.1 Fee/ License Fee 32.00 332.00

16 8.7 Tax on Open land 435.00 435.00

17 8.9 Tax on Advertisement 232.00 232.00

18 8.14 Theatre Tax 200.00 200.00

19 13.1 Election Expenditure 81.00 81.00

20 13.4 Exemption from Sales Tax 1100.00 1100.00

Total 33927.55 13623.55 1951.00

Source – First State Finance Commission Report of Gujarat

Table – 4.3
Estimates of Income for the next five years according to Recommendation of First State Finance Commission - Gujarat

Para Particular 1998-99 1999-00 2000-01 2001-02 2002-03 REMARKS

No.

2.2 Motor Vehicle Tax 341.59 358.66 376.6 395.43 It is estimated that Grant-in-
aid will be available from
Grant-in-aid for repairing
1999-2000 Growth Rate of
of Road
5% is taken due to price
rise.
2.4 Professional Tax 2499 2499 2499 2499 2499 No change in AGR.
2.5 Entertainment Tax 1409 1409 14.9 1409 1409 No change is made in
Annual Growth Rate.
2.6 Education Cess. 1400 1633.52 1905.99 2223.91 2594.86 Growth Rate of 116.68% is
considered for property tax.

58
2.7 Conversion tax on N.R. 80.23 88.25 97.08 106.79 117.46 AGR of 10% is considered.
2.8 Land Revenue 551 551 551 551 551 No change in Annual
grouching or in AGR.
2.9 Local Cess. 330 330 330 330 330 No change in annual growth
or in AGR.
3.1 Surcharge on (A) 2300 2530 2783 3061.3 3367.43 AGR10% Recovered
amount of surcharge in
Stamp Duty (B) 2440 2440 2440 2440
1988-89 to 1997-98 to be
distributed in five
instalments to GMFB.
3.2 Cable TV/Dish Antenna 200 220 242 266.2 292.82 Annual Growth Rate of 10%
Tax
4.2 Establishment 237 248.85 261.29 374.36 288.07 Annual Growth Rate of 5%
Expenditure
4.8 Per Head Basic Grant- 88 88 88 88 88 No change is made in
in-aid Annual Rate.
4.9 (A) Incentive Grant for 1334.95 2669.62 3900.82 5846.74 Particular of calculation are
enhanced recovery given in para 4.9
Total At the Rate At the Rate of At the Rate
Recovery of of 5% 6% of 8%
3%
4.9 (B) Additional Recovery 9022.23 12760.44 18416.47 19598.99 Particular of calculation are
due to incentive given in para 4.9
5.1 Decentralised Planning 8408.4 9249.24 10174.16 11191.58 Annual Growth Rate of 10%
7.1 Central Finance 1687 1687 1687 1687 1687 Calculation is made as per
Commission present annual instalment.
8.2 Fee/License Fee 333 333 333 333 No change in AGR
8.77 Property tax on open 435 526.35 526.35 578.98 AGR taken at 10%
land
8.9 Tax on advertisement 232 280.72 280.72 308.79 AGR taken at 10%
8.14 Theatre tax 200 200 200 200 No change in annual growth
rate
13.4 Facility of P form for 1100 1212.75 1212.775 1273.39 Annual growth rate of 5%
sales tax

Total 13221.23 35131.79 50357.43 50357.43 55391.54

Source – First State Finance Commission Report of Gujarat

Recommendations of FSFC of Gujarat

There were no innovative aspects associated with First SFC report. It essential discussed various reform measures to improve
working of local bodies while some of them got implemented many of the important recommendation were not implemented by
GOG. The summarized information about important recommendations is as follow.

Setting up Tax and Tariff Commission

For fixing the minimum and maximum rate – not implemented by GOG

Adoption of Area based (hybrid of capital value method) property tax system
In place of existing Annual Rental Value was recommended by the SFC. It provided two alternative models of area based
assessment system. With some modification in year 1999 GOG introduced Area Based Property Tax Assessment System and
Ahmedabad and Vadodara Municipal Corporations have successful adopted it.

Compulsory Taxation
First SFC observed that no taxes are compulsory for Municipalities at present. It recommended that property tax, water tax and
scavenging tax should be made compulsory but GOG has not acted upon this recommendation. Even today, there are few
municipalities, which are not levying tax.

Property Tax on Open Lands

It recommended levy of property tax on the open lands, this feature is also incorporated in the act in 1999 along with area
based property tax assessment system.

Advertisement Tax
It recommended that local bodies should be authorized to collect tax on the advertisements and this feature has got introduced
through General Development Control Regulation of Town Planning.

59
Privatisation of Services
It recommended privatisation of the services wherever possible but not much has happened on this front.

Incentive Grants
It suggested that the present system of incentive grant being not effective should be discontinued and suggests various norms
and rules for restructuring of existing incentive grants. Not much has happened regarding this recommendation.

Perspective Planning
It made very good recommendation about adoption of concept of perspective planning by all local bodies. It recommended that
every local body should study and plan for development of their area for coming 20 years, which should be review every five
years, and a rolling plan should be prepared. Nothing has happened on this front.

Increasing Tenure of Chairmen/Mayor

It recommended tenure of the office of the Chairmen / Mayor of the local bodies should be increased up to 2 ½ years from
existing practice of 1 year. In 1999 –2000, GOG implemented this recommendation by suitable amendment to the Act.

Exemption from Sales Tax

First SFC recommended exemption from Sales Tax for the material purchases by local bodies but this recommendation has not
been accepted and implemented.

Exemption from Industrial Disputes Act

It recommended that local bodies should be excluded from the Industrial Disputes Act. This was a good recommendation but it
was also not accepted or implemented.

Weak Policy Aspects

As Second State Finance Commission has recently got constituted and it has just started it work. Consequently, its review
report about implementation of recommendations of First SFC is not available as a result; no information or analysis about
actual implementation of various recommendation of First Finance Commission is possible. Still one can observe following
weaknesses associated with First Finance Commission of Gujarat.

Absence of formulae based devolution framework

First SFC has not attempted to work out formulae to share resources between state & local government. Similarly, it has not
recommended any new assignment of resources to the local bodies.

Poor Data Base

SFC report is quite poor on relevant data, it has individual local body level data but macro level data or in-depth analysis of the
data, past trends, present financial position, future requirements, revenue gap etc is missing in the report.

Implementation Blues

Lacklustre Attitude/Response by GOG

Where in other states third SFC are getting constituted or on verge of constitution, in Gujarat just recently second SFC has got
constituted. Even first SFC took four years to submit its report and using that delay GOG did not constitute second SFC for
another five years. GOG has shown great apathy in implementation of First SFC recommendation. Large part of
recommendations have not been implemented while some have been implemented but after considerable lapse of time.

Summing up FSFC of Gujarat

Gujarat State traditionally had very well developed grant-in-aid account code, thus there was quite a good degree of
predictability about the fiscal transfer from state to local body. First SFC has simply refined earlier grant-in-aid code without any
paradigm change in its composition or structure. Accordingly, SFC report has neither increased degree of budgetary certainty
nor it has introduced hard budgetary constraints in the state-local fiscal relationship in Gujarat. Similarly, there is no increase in
the transparency of the framework, in fact as mentioned earlier there is no formulae based framework for fiscal transfer.

Also, there is absence of incentive structure. SFC did try to rationalize norm and operational guidelines of incentive fund but
has not come out with fiscal aspect of it.

Degree of budgetary autonomy is surprisingly high, as traditional municipal and panchayat acts provided for greater budget
autonomy. Also, local bodies of Gujarat are again traditionally more self-reliant. But SFC report or recommendations have not
resulted into greater budgetary autonomy or increased fiscal devolution. As observed by the First SFC itself that in the year
1995-96 the total grants sanctioned for the urban local bodies was Rs. 1495.49 million which amounted less than 1.5 per cent
of the annual budget estimate of the GOG and it constituted less than 10 per cent of the total income of urban local bodies.
(Refer Table 13).

60
 5
Case Study 5 -Devolution in West Bengal

Introduction
West Bengal illustrates a continuing strong commitment to devolution based upon a high degree of political certainty resulting
from over twenty five years of control by the CPI (M) party with a well embedded political structure at the local level
accompanied by little effective opposition in local government. Consequently, the state government has enacted a range of
innovative legislation designed to strengthen local political power bases. This includes the Chairperson in Council (Cabinet
style) system, coordinated local planning mechanisms, and the basis of a systematic fiscal framework.

The Government of West Bengal has consistently supported the empowerment of local government. The state’s urban and
rural local government system has been successfully functioning with regular elections and devolution of powers for almost
three decades. The state has led other states in India in developing a legislative framework for decentralised local government,
with separate Municipal Corporation Acts for large urban local authorities, a progressive West Bengal Municipal Act, 1993
governing the municipalities and the West Bengal Panchayats Act, 1973 for the various levels of rural local bodies in the state.
This strong commitment to empowered local government is closely linked to the nature of politics within the state. Since 1977,
West Bengal has been ruled by a Left Front coalition led by the Communist Party of India (Marxist). This has demonstrated a
strong ideological commitment to promoting decentralisation and rural reform especially. Decentralisation has also arguably
also served to strengthen local party power bases, and the CPI-M has evolved highly organised party cadre machinery.
rd th
In the light of the passing of the 73 and 74 CAA, the West Bengal government was quick to amend the laws relating to local
bodies providing them the functional authority for the responsibilities in the CAA. It was also pro-active in setting up State
Finance Commissions, as well as a Municipal Administrative Reforms Committee later in 2001. The state continues to show a
clear political commitment to the promotion of all forms of decentralization. Examples of this include:

Promoting the effective operation of the District Planning Committees. Such committees are central to the annual development
planning hierarchy, and whilst operational in other states in India have been more actively implemented within West Bengal

The establishment of the Kolkata Metropolitan Planning Committee. Although legally mandated within the 74th CAA, this is the
first such metropolitan planning body in India allowing municipal representation in this level of planning (Municipal councillors
comprise two thirds of the committee).

At a local level, the GOWB has supported the establishment of ward committees in all urban local authorities and an associated
ward level planning process. This is serving to promote a localised expression of need.

Local government finances need to be considered in the context of the serious fiscal crisis affecting the state government, with
a broadening revenue expenditure gap. This context has undoubtedly reduced the scope for more radical changes in the nature
of the fiscal framework.

Pre-SFC Scenario
Urban local authorities derive revenue from government grants, property tax and other assigned taxes such as entertainment
tax, motor vehicle tax etc. Despite having the delegated power to raise revenues, urban local authorities in the West Bengal are
largely dependent on government grants to meet their establishment costs. The entire salary payments and 80% of the
dearness subvention are provided by the state government together with a significant portion of pension dues. These have led
to a situation in which urban local authorities have become complacent about their own resource mobilization and
consequently, civic services are often poor. In relation to expenditure, the single largest expenditure head is salary and wages,
which generally accounts for more than 70% of expenditure.

Urban local authorities thus rely heavily on government grants, plan funds and development schemes to fund the necessary
infrastructure works. Studies have repeatedly shown that urban local authorities are capable of significantly increasing their
own revenues and easing the pressure on the state for funds.

Rural local authorities have three major sources of revenue: schematic funds, untied funds from the centre and funds from the
state. Although PRIs are empowered to collect certain local taxes and levy user charges, they are essentially grant-dependent
and experience poor local revenue collection.

In this context, the degree of fiscal autonomy enjoyed by local government is limited. Central schemes such as the Jawahar
Rozgar Yojana are routed through the panchayat system and are heavily specified in terms of details with perhaps the only
freedom being in terms of location or detailed choice of beneficiary. This highlights the fact that rural local authorities are almost
fully dependent on centre / state funding and hence the fiscal devolution policy is very important for these urban local
authorities. It is clear that there is a significant dependence upon vertical transfers. The State Finance Commissions have thus
been important in defining the nature of such transfers.

Administrative Mechanisms
An interesting administrative decentralization mechanism that reflects the extent to which urban decentralization is politically
underpinned in West Bengal is the cabinet style Mayor/ Chairman in Council structure. Under this arrangement, a number of
local councillors form a cabinet, each with executive responsibilities for separate service delivery functions. This is in marked
contrast to local government in other states in which councillors are generally subordinate to Municipal Commissioners (often
state appointed Indian Administrative Service officers). In West Bengal, the top official is generally a superannuated state
government officer appointed on a two year contract. As a result, his/ her knowledge of municipal governance is more limited
and these officials are generally considerably less powerful than the councillors are. Within rural local government, there are
standing committees at various levels that are the interaction points with district officials, opposition members and line
ministries.

61
In relation, the staffing, state government has significant control. It determines and controls the levels of staffing, recruitment
and transfers. As a result, individual local authorities can be unaware of their approved staffing patterns and these are also not
generally revised in line with changing needs.

62
Regulation and Support Mechanisms
In relation to regulation and support, the primary innovations of the GOWB relate to the “institutional architecture” established to
support urban local government. For its urban administration, GOWB has established a number of state level enabling
institutions under the Municipal Affairs Department. These include the following:

• The Directorate of Local Bodies (DLB), which is charged with monitoring urban local government operations and
legislative compliance. Created in 1980 the DLB serves to oversee the performance of the local bodies and to coordinate
their activities. This includes both an auditing role and final sanction of staffing levels. Under a new government programme,
with bilateral support, the roll of the DLB will be enhanced to guide and support local governments in the implementation of
financial, managerial and technical reforms.

• The Municipal Engineering Directorate (MED), which provides engineering support. MED was created in 1981 to function
as the engineering cell of the DLB for planning and implementation of water supply, drainage, sewerage and other
engineering works for urban local government.

• The Institute of Local Government and Urban Studies provides training. Established in 1982, its primary purpose was to
undertake research, training and consultancy services for urban local government. The institute will be strengthened through
a new capacity development programme that aims to introduce the concept of decentralised support to training and local
government.

• The West Bengal Valuation Board was set up in 1979 for centralised assessment and valuation of properties for tax
purposes. Such a body is unusual within Indian public administration, and represents an attempt to ensure economies of
scale, and objective standardised professional assessment.

• The State Urban Development Agency (SUDA) was set up in 1991 as a registered society to work as the state level body
for monitoring implementation of poverty-alleviation programmes in the urban areas in the state.

First State Finance Commission

The First State Finance Commission (FSFC) reported in 1995. The FSFC established, for the first time, clear and transparent
‘entitlements’ for local authorities based on a range of indicators. Major recommendations included:

• Streamlining of certain shared taxes for local authorities and levying of a surcharge to compensate for earlier entry tax;

• Staff costs including full dearness allowance to be met by the state government;

• Greater allocation of untied funds as ‘entitlements’ to local authorities. For this the commission decided to earmark 16
percent of the net proceeds of all tax collected by the state in a year for transfer to local bodies. These will be untied
funds at the disposal of the local bodies and to be released to the districts in suitable instalments.

• Local authorities should be encouraged to step up their internal resource mobilization especially from property tax

• An Incentive scheme has been suggested to encourage Panchayats and Municipalities to raise their income. 2 percent
of the entitlement due to a district will be set aside to act as an incentive fund.

• Suitable adjustments in district organization should be made for ensuring effective use of the entitlement funds at local
level

• Improved financial systems such as audit, accounts and budgeting systems should be established in local governments.

The FSFC brought out clear percentage ‘entitlements’ at each level of local government and emphasized the importance of
untied funds as a vital tool for establishing the autonomy and responsiveness of local governments.

Although the Government accepted the FSFC recommendations in principle, these have yet to be fully implemented. Instead of
the entitlement fund, the state government is now allotting a part of the plan fund as lump sum ‘Grants in aid to Local
authorities, mainly to the Zilla Parishads. The department requests the ZPs to utilize these grants for schemes and programmes
already identified with some flexibility to prioritise them at the local level. Although funds thus released approximated 16 percent
of the tax revenues, this system hardly reflects the spirit behind the FSFC recommendation.

West Bengal Second State Finance Commission

The Second State Finance Commission (SSFC) submitted its recommendations in 2002. The SSFC built upon the framework
of the FSFC and made the following significant recommendations:

• The level of entitlement grant should be maintained at 16 percent of tax revenues. However, since the exact amount of
revenues cannot be determined until the audit by the Comptroller and Auditor General of India (CAG), a minimum
amount of Rs.7.0 billion should be provided for untied entitlement during the year, balance being issued after the
revenue is confirmed in next year.

• 2 percent of the entitlement should be retained as incentive at the state level instead of the district level.

• Legislation should be passed for local government to collect taxes on urban areas and multi-storied buildings

• User charges, service charges and level of fees should be enhanced

• Better capacity should be built locally for planning, implementation & monitoring.

63
• The administrative and institutional arrangements should be established in local government for participatory
democratic process and co-ordination with District Planning Committees.

Fiscal Devolution Framework

At first level of devolution, FSFC recommended 16 % to total taxes collected by the state in a financial year to the local
governments as ‘untied entitlement’.

At second level of devolution, the SFCs have used a number of basic criteria to calculate the entitlement for each district. These
are shown in the table 5.1 next page .

At the third level after completing the above procedure, and allowing for the 2 per cent incentive fund at each district level, the
FSFC recommended that the funds be split into three parts, namely
i) District Municipal Fund,
ii) District Panchayat Fund and
iii) District Special Area Fund.

Table 5.1 - State Finance Commission Criteria for district wise fund allocations
Criteria FSFC % Criteria SSFC
weight %
weight
Population of the district 50% Population 50%
Illiteracy level of the district 10% Non Literate Population 7%
Backward population of the district 10% ST Population 8%
Area of the district 10% SC and minority population 7%
Rural population 10% Density of Population 7%
Inverse ratio of per capita Bank Deposit 10% Rural population 7%
(including PAC working capital)
Infant Mortality Rate 7%
Per capita Net District Domestic Product 7%
(NDDP) at constant price
TOTAL 100% TOTAL 100%
Source – First and Second SFC Reports of West Bengal

The allocation to these three components is to be made in line with the population under each of the divisions. The special area
fund is expected to cover specific areas that do not fall under either Panchayats or Municipalities. The SSFC marginally revised
the procedure, suggesting that the 2 percent retention is made at the state level rather than the district level. It also suggested a
further 0.4 percent separate fund for hilly areas. The SSFC also suggested that the district fund should be split into only two
components namely a District Municipal Fund and District Panchayat Fund on the basis of the rural and urban population of the
district.

At the fourth level, the amount available for intra-district allocation in the urban sector is to be divided on the basis of a further
set of weighted population and socio-economic measures (population, literacy, scheduled caste/ tribe, population density,
length of kutcha drains etc).
At the fourth level amount available for rural bodies the SFCs specified a percentage allocation for the vertical allocation
formula as shown below:

Vertical Level FSFC SSFC

Zilla Parishads 30% 20%
All Panchayat Samitis together 20% 20%
All Gram Panchayats together 50% 60%

At the fifth level of devolution that is inter-se distribution the sharing of entitlement funds amongst Panchayat Samitis to be
based on weighted criteria (population, SC/ST population, non literates, villages without power, and villages without pucca
approach roads). In Gram Panchayats the criteria used is based on population, SC/ST population, and non literates alone.

Table 5.2 - Fiscal Devolution Framework recommended by SFC for Local Governments in West Bengal
st nd
Level of Devolution 1 SFC Frame work 2 SFC Frame work
st
1 level Devolution 16 percent of total taxes collected by 16 percent of total taxes collected by the
Local Governments Share in State’s the state in a financial year to the state in a financial year to the local
Resources. local governments as ‘untied governments as ‘untied entitlement’.
entitlement’. Subject to minimum amount of Rs. 7000
million.
nd
2 Level Devolution Based on six Indicators Based on Eight Indicators
Division of Resources between Population 50.0 % Population 50.0 %
districts. Area 10.0 % Density of Population 7.0 %
Illiteracy Rate 10.0 % Illiterate Population 7.0 %
Backward Population 10.0 % SC Population and 8.0 %
Rural Population 10.0 % Minority Population
ST Population 7.0 %

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 Inverse ratio of per 10.0 % Rural Population 7.0 %
capita Bank Deposit (including PAC Infant Mortality 7.0 %
working capital) Per Capita Net District 7.0 %
Total 100.00% Domestic Product (NDDP)
At constant price
Total 100.00%
rd
3 Level Devolution/Sharing of On the basis of population under On the basis of proportion of rural and
funds among Rural & Urban Local three categories urban population in the district
Governments
District Municipal Fund District Municipal Fund
District Panchayat Fund District Panchayat Fund
District Special Area Fund (for the after setting aside 0.4 % amount from
areas not falling under municipal or district’s allocation for Hilly Areas
panchayat category)
th
4 Level Devolution/Sharing of On the basis of a further set of Based on five Indicators
funds among different tiers of Local weighted population and socio- Population 50.0%
Governments economic measures (population, Density of Population 12.5%
A – Among Urban Local literacy, scheduled caste/ tribe, SC & ST Population
Governments (intra-ULG Allocation population density, length of kutcha as per 1991 Census 12.5%
of District Municipal Fund) drains etc). Non Literates 12.5%
Length of Kutcha
Drains in Munici 12.5%
th
4 Level Devolution/Sharing of Zilla Parishads 30.0% Zilla Parishads 20.0%
funds among different tiers of Local Panchayat Samitis 20.0% Panchayat Samitis 20.0%
Governments Gram Panchayats 50.0% Gram Panchayats 60.0%
B – Among Rural Local Government
th
5 Level Devolution Inter se Amongst Panchayat Samitis to be Amongst Panchayat Samitis
distribution among local based on weighted criteria Based on five Indicators
governments of one tier (population, SC/ST population, and Population 50.0%
non literates) Density of Population 12.5%
a) inter-se sharing between SC & ST Population
panchayat samitis as per 1991 Census 12.5%
Non Literates 12.5%
In Gram Panchayats the criteria used Length of Kutcha
is based on population, SC/ST Drains in Munici 12.5%
population, and non literates alone Amongst Gram Panchayats
b) inter-se sharing between Based on two indicators
Gram Panchayats Population 50.0%
Non Literates 50.0%
Source – First and Second SFC Reports of West Bengal

Beside above formulae based fiscal devolution SSFC has recommended following to strengthen finances of local governments
–
• Entertainment tax may continue to be collected by the State and retaining 10 % collection charges rest of 90 per cent
amount to be transferred to local governments over and above fiscal devolution at 16 % of total tax collection as
explained above.
• Legislation enabling the LSGs to collect taxes on urban land and multi-storied buildings.
• Powers to collect land revenue and cesses may be devolved to the LSCs.
• Responsibility for collection of irrigation charges may be given to the Panchayats and the revenue devolved to them.
• Different rates and fees levied by the ULBs should be revised.
• Government should consider reconciliation of overlapping responsibilities for planning and allocation of fund between
DPC and regional development boards in the rural and urban areas.

Innovative Aspects of SFCs of West Bengal

Concept of Untied Entitlement for Devolution of Funds

As noted above the FSFC recommended 16 per cent of total tax collected as devolution to local governments in state as an
‘untied entitlement’. SSFC has retained this principle.

Both SFCs recommended concept of untied fund for strengthening grass-root level democracy and will lead to participative
democracy. They felt that untied fund only would provide local government to carry out development schemes drawn by them to
meet their felt need. SFCs felt that the centrally sponsored projects have cut and dried framework, which did not permit
modifications to suit the local needs. (Para 2.04 West Bengal SSFC)

While justifying concept of untied entitlement SSFC observed, “Although the local self governments received only a small
amount as untied entitlements following the FSFC’s recommendations, they made good use of it. There was a general
appreciation of such fund by the people because it was possible for them to take up schemes, which helped to meet part of
their felt needs. During our discussions with representatives of LSGs in the districts, we were requested to enlarge the amount
of untied grants.” (Para 2.09 West Bengal SSFC)

Both SFCs rejected a needs based approach for determining the untied entitlement allocation for local government since it felt
there was insufficient reliable data to fulfil this purpose.

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Both SFCs felt that local government should be allowed to devise their own approaches for managing their budgets based on
their estimation of the feasibility of rendering services within budgetary constraints. The state’s contribution (entitlement) should
be based more on broad principles of equity rather than on any assumed cost of services to be rendered.

District as the First level of Distribution of Funds

SFCs of West Bengal adopted district as the primary unit for inter-se distribution of funds in place of distribution of funds
between rural and urban local bodies at the first level of fiscal devolution framework.

Criteria (formulae) Based Allocations for Inter-district Fund Entitlements

The SFCs of West Bengal have drawn elaborate formulae for each level (vertical and horizontal) of fiscal devolution. The first
and most important criterion is population with a weightage of 50 percent. A range of other socio-economic indicators are also
used which allow for the varying levels of development in the districts. It can be seen that additional criteria were introduced in
the SSFC.

Three Way Intra-District Allocations

The FSFC of West Bengal came out with unique three way intra-district allocations at the third level of fiscal devolution. Instead
of sharing funds in two set categories rural and urban, FSFC recommended sharing of funds in three categories rural, urban
and special areas or transitional or peri-urban areas.
The SSFC retained this structure but has changed focus of special area fund from areas not following under rural or urban to
hilly areas. The SSFC should have retained areas not following rural or urban in the special area category along with hilly
areas.

Incentive funds
As described above both the First and Second SFCs recommended the establishment of an Incentive Fund to encourage the
mobilization of own resources by local government. The special feature is both SFCs recommended setting aside of 2 per cent
allocation at first place from the amount to be devolved as untied incentive funds to local government. FSFC suggested its
deduction from the district level allocation that is after first level of devolution while SSFC has recommended creation of
incentive fund by deducting 2 per cent amount from devolution at the state level that is before first level devolution.

Weak Policy Aspects

Implementation Blues

Inadequate Implementation of FSFC Recommendation

While reviewing the actions taken by West Bengal government on the recommendations of the FSFC and its impact on the
local government’s functioning in general and their financial state in particular SSFC observed following –

“The State Government following the recommendations of the FSFC, decided to divide the state plan schemes into state and
district level schemes, but this was not reflected in the state budget.

Instead of devolving funds as recommended by the FSFC a part of the plan fund was allotted as lump sum grants-in-aid to local
bodies from different departmental budgets directly to the local governments mainly to Zilla Parishads. The departments
requested the ZPs to utilize grants-in-budget funds schemes and programmes already identified and proposed at the
departmental level giving ZP only the option to select and prioritize schemes to be executed. The objectives of the
recommendations of the FSFC were hardly met by this kind of transfer of fund by the departments even when the total
allotment approximated 16 per cent of the tax resources as recommended by the FSFC. Only a small amount of fund was
released as untied entitlement to the local bodies.” (Para 1.07 West Bengal SSFC)

The observations made by SSFC aptly summarize how entire scheme recommended by FSFC was made null and vide in
implementation.

Lack of Knowledge about FSFC Recommendations

There exists lack of knowledge about FSFC recommendation among the local government functionaries across the country, but
other SSFC report have not come out clearly on this issue. SSFC of West Bengal has placed this truth in absolutely
unambiguous terms as follows
“Lack of knowledge about the recommendations of the FSFC amongst the people proved a handicap for the SSFC. It could not
benefit from reactions from the representatives of the local governments whose experiences counted. The Commission,
therefore, had to formulate their recommendations largely on their own understanding of the relevant issues’.

These words of SSFC clearly reflect the impact of FSFC on the institutions and people managing and working in these
institutions.

Non Implementation of Incentive Fund Scheme

The government is yet to develop the criteria for the release of these funds but the concept of ‘incentive based’ release of funds
has now been accepted at the state level. The Directorate of Local Bodies (DLB) has developed a monitoring mechanism and
funds are sanctioned to progressive local authorities that have demonstrated significant improvements in revenue collection,
expenditure management and accounting improvements. This parallels other central government schemes such as the Urban
Reforms Initiative Fund and City Challenge Fund (described elsewhere in this report). Similarly, donor interventions in the West
Bengal local government sector are also promoting incentive based financial reform and fiscal independence.

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 Decentralisation and Local Finance Issues –
The Workings of State Finance Commissions in India

Annexures and Figures

67
Annexure I A – Decentralisation Initiatives in Developing Countries

Brazil - The Constitution of Brazil, 1988

Philippines - The Local Government Code of 1991

India - The Constitution (seventy-fourth) Amendment Act on Municipalities, 1992

Japan - Decentralization Promotion Law of 1995 and Decentralization Promotion Plan, 2000

Korea - Local Autonomy Law, 1995

South Africa - New Constitution 1996

Thailand - 16th Constitution, 1997; Decentralization Plan and Process Act, 1999

Tanzania - Act No. 6 of 1999

Indonesia - Law No.22 of 1999 regarding regional governments and Law No.25 of 1999 concerning the fiscal
balance between the Central Government and the Regions

Pakistan - Local Government Ordinance, 2001

Cambodia - Law on the Administration and Management of Commune/Sangkat, January 12, 2001
and Sub-Decree on Decentralization of Powers, Roles and Duties to Commune
Sangkat Councils, February 21, 2002.

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ANNEXURE – I B - THE STRUCTURE OF SUBNATIONAL GOVERNMENTS IN LARGE DEMOCRACIES

Country Intermediate Local

Industrial Countries
Canada 10 provinces, 2 territories 4,507 municipalities
France 22 regions, 96 departments 36,772 communes
Germany 13 states, 3 city-states 329 counties, 115 county-free cities, 14,915
municipalities
Italy 22 regions, 93 provinces 8,100 municipalities
Japan 47 prefectures 655 cities, 2,586 towns
Spain 17 autonomous communities 50 provinces, 8,907 municipalities
United Kingdom Counties 540 rural districts, metropolitan districts, and London
boroughs
United States 50 States, F.D. 39,000 counties and municipalities, 44,000 special-
purpose local authorities

Other Countries
Argentina 23 provinces 1,617 municipios
Bangladesh - 4 city corporations, 129 pourashavas (smaller
municipalities), 4500 union parishads (which group
85,500 villages)
Brazil 27 states, F.D. 4,974 municipios
Colombia 32 departments, F.D. 1,068 municipalities
Ethiopia 9 regions, plus 2 special city administration, 66 550 woredas
zones
India 25, states, 7 union territories 3,586 urban local bodies (95 municipal corporations,
1,436 municipal councils, 2,055 nagar panchayats),
234,078 rural local bodies
Iran 25 provinces 720 districts and municipalities

Kenya 39 county councils 52 municipal, town and urban councils

Korea, 6 special cities, 9 provinces 67 cities, 137 counties

Malaysia 13 states 143 city, municipal, and district councils

Mexico 31 states, F.D. 2,412 municipios
Mozambique 10 provinces 33 municipalities
Nepal 75 districts and town panchayats 4,022 village panchayats
Pakistan 4 provinces 15 municipal corporations, 457 municipal and town
committees, 40 cantonment boards, 4,683 union and
district councils.
Philippines 76 provinces 64 cities, 1,541 municipalities, 41,924 barangays
Poland 16 provinces, 307 poviats 2,489 gminas
Russian Federation 21 republics, 17 territories or autonomous 1,868 raions, 650 first-tier cities, 26,766 secondary
areas, 49 provinces (oblasts), 2 cities of federal cities, townships, and villages
status
South Africa 9 provinces 850 local authorities
Thailand 75 changwats, Bangkok 6,397 districts, 148 municipalities and cities
Turkey 74 provinces 2,074 municipalities
Uganda 45 districts, 13 municipalities 950 sub counties, 39 municipal divisions, 51 town
councils
Ukraine 24 regions (oblasts), 1 autonomous republic, 2 619 districts
municipalities
Venezuela 23 states, F.D. 282 municipalities
- not applicable
F.D. Federal district
Source : World Development Report 1999/2000

69
 rd
Annexure II - Constitution (73 Amendment) Act, 1992
Part IX
The Panchayats
243 In this Part, unless the context otherwise requires
(a) “District” means a district in State;
(b) “Gram Sabha” means a body consisting of persons registered in the electoral rolls relating to a village
comprised within the area of Panchayat at the village level;
(c) “Intermediate level” means a level between the village ad district levels specified by the Governor of a Sate
by public notification to be the intermediate level for the purposes of this Part;
(d) “Panchayat” means an institution (by whatever name called) of Self Government constituted under article
243B, for the rural areas;
(e) “Panchayat area” means the territorial area of a Panchayat.
(f) “Population” means the population as ascertained at the last preceding census of which the relevant
figures have been published.
(g) “Village” means a village specified by the Governor by public notification to be a village for the purposes of
this Part ad includes a group of villages so specified.

243A A Gram Sabha may exercise such powers ad perform such functions at the village level as Legislature of State may
be by law, provide.

243B (1) There shall be constituted in every State, Panchayats at the village, intermediate and district levels in
accordance with the provisions of this Part.
(2) Notwithstanding anything in clause (1), Panchayats at the intermediate level may not be constituted in a
State having a population not exceeding twenty lakhs.

243C (1) Subject to the provisions of this Part, the Legislature of a State may, by law, make provisions with respect
to the composition of Panchayats;

Provided that the ratio between the population of the territorial area of a Panchayat at any level and the number of
seats in such Panchayat to be filled by election shall, so far as practicable, be the same throughout the State.

(2) All the seats in a Panchayat shall be filled by persons chosen by direct election from territorial
constituencies in the Panchayat area and; for this purpose, each Panchayat area shall be divided into
territorial constituencies in such manner that the ratio between the population of each constituency and the
number of seats allotted to it shall, so far as practicable, be the same throughout the Panchayat area.
(3) The Legislature of a State may, by law, provide for the representation-
(a) of the Chairpersons of the Panchayats at the village level in the Panchayats at the intermediate level
or, in the case of a State not having Panchayats at the intermediate level, in the Panchayats at the
district level;
(b) of the Chairpersons of the Panchayats at the intermediate level, in the Panchayats at the district level;
(c) of the Members of the House of the People and the Members of the Legislative Assembly of the State
representing constituencies which comprise wholly or partly a Panchayat area at a level other than the
village level, in such Panchayat;
(d) of the Members of the Council of States and the Members of the Legislative Council of the State,
where they are registered as electors within-
(i) a Panchayat area at the intermediate level, in Panchayat at the intermediate level
(ii) a Panchayat area at the district level, in Panchayat at the district level.
(4) The Chairperson of a Panchayat and other members of a Panchayat whether or not chosen by direct
election from territorial constituencies in the Panchayat area shall have the right to vote in the meetings of
the Panchayats.
(5) The Chairperson of-
(a) a Panchayat at the village level shall be elected in such manner as the Legislature of a State may by
law, provide; and
(b) a Panchayat at the intermediate level or district level shall be elected by, and from amongst, the
elected members thereof.

243D (1) Seats shall be reserved for-

(a) the Scheduled Castes; and
(b) the Scheduled Tribes.

In every Panchayat ad the number the seats so reserved shall bear, as nearly as may be, the same proportion to the
total number of seats to be filled by direct election in that Panchayat as the population of the Scheduled Castes in
that Panchayat area or of the Scheduled Tribes in that Panchayat area bears to the total population of that areas and
such seats may be allotted by rotation to different constituencies in a Panchayat;

(2) Not less than one-third of the total number of seats reserved under clause (1) shall be reserved for women
belonging to the Scheduled Castes or, as the case ay be, the Scheduled Tribes.
(3) Not less than one-third (including the number of seats reserved for women belonging to the Scheduled
Castes and the Scheduled Tribes) of the total number of seats to be filled by direct election in every
Panchayat shall be reserved for women and such seats may be allotted by rotation to different
constituencies in a Panchayat.

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 (4) The offices of the Chairpersons in the Panchayats at the village or any other level shall be reserved for the
Scheduled Castes, the Scheduled Tribes and women in such manner as the Legislature of a State may, by
law, provide:

Provided that the number of offices of Chairpersons reserved for the Scheduled Castes and the Scheduled Tribes in
the Panchayats at each level in any State shall bear, as nearly as may be, the same proportion to the total number of
such offices in the Panchayats at each level as the population of the Scheduled Castes in the State or of the
Scheduled Tribes in the State bears to the total population of the State.

Provided further that not less than one-third of the total number of offices of Chairpersons in the Panchayats at each
level shall be reserved for women:

Provided also that the number of offices reserved under this clause shall be allotted by rotation to different
Panchayats at each level.

(5) The reservation of seats under clauses (1) and (2) and the reservation of offices of Chairpersons (other
than the reservation for women) under clause (4) shall cease to have effect on the expiration of the period
specified in article 334.
(6) Nothing in this Part shall prevent the Legislature of a State from making any provision for reservation of
seas in any Panchayat or offices of Chairpersons in the Panchayats at any level in favour of backward
class of citizens.

243E (1) Every Panchayat unless sooner dissolved under any law of the time being in
force, shall continue for five years from the date appointed for its first meeting and no longer.
(2) No amendment of any law for the time being in force shall have the effect of causing dissolution of a
Panchayat at any level, which is functioning immediately before such amendment, till the expiration of its
duration specified in clause (1)
(3) An election to constitute a Panchayat shall be completed-
(a) before the expiry of its duration specified in clause (1)
(b) before the expiration of a period of six months from the date of its dissolution:

Provided that where the remainder of the period for which the dissolved Panchayat would have continued is less than
six months, it shall not be necessary to hold any election under this clause for constituting the Panchayat for such
period.
(4) Panchayat constituted upon the dissolution of a Panchayat before the expiration of its duration shall
continue only for the remainder of the period for which the dissolved Panchayat would have continued
under clause (1) had it not been so dissolved.

243F (1) A person shall be disqualified for being chosen as, and for being, a member of
a Panchayat-

(a) he is so disqualified by or under any law for the time being in force for the purposes of elections to the
Legislature of the State concerned.

Provided that no person shall be disqualified on the ground that he is less than twenty-five years of age, if
he has attained the age of twenty-one years;
(b) if he is so disqualified by or under any law made by the Legislature of the State.
(2) If any question arises as to whether a member of a Panchayat has become subject to any of the
disqualifications mentioned in clause (1), the question shall be referred for the decision of such authority
and in such manner as the Legislature of a State may, by law, provided.

243G Subject to the provisions of this Constitution, the Legislature of a State may, by law, endow the Panchayats with such
powers and authority as may be necessary to enable them to function as institutions of Self-Government ad such law
may contain provisions for the devolution of powers and responsibilities upon Panchayats at the appropriate level.
Subject to such conditions as may be specified therein, with respect to-

(a) the preparation of plans for economic development and social justice;
(b) the implementation of schemes for economic development and social justice as may be entrusted to them
including those in relation to the matters listed in the Eleventh Schedule.

243H The Legislature of a State may, by law,-

(a) authorize a Panchayat to levy, collect and appropriate such taxes, duties, tolls and fees in accordance with such
procedure ad subject to such limits;
(b) Assign to Panchayat such taxes, duties, tolls and fees levied and collected by the State Government for such
purposes and subject to such conditions and limits.
(c) Provide for making such grants-in-aid to the Panchayats from the Consolidated Fund of the State; and
(d) Provide for constitution of such Funds for crediting all moneys received, respectively, by or on behalf of the
Panchayats ad also for the withdrawal of such moneys there from, as may be specified in the law.

243(I) (1) The Governor of a State shall, as soon as may be within one year from the
commencement of the Constitution (Seventy-third Amendment) Act 1992, and thereafter at the expiration
of every fifth year, constitute a Finance Commission to review the financial position of the Panchayats and
to make recommendations to the Governor as to-

71
 (a) the principles which should govern-
(I) the distribution between the State and the Panchayats of the net proceeds of the taxes, duties
tolls and fees leviable by the State, which may be divided between them under this Part and the
allocation between the Panchayats at all levels of their respective shares of such proceeds;
(II) the determination of the taxes, duties, tolls and fees, which may be assigned to, or appropriated
by, the Panchayats;
(III) the grants-in-aid to the Panchayats from the Consolidated Fund of the State;
(j) the measures needed to improve the financial position of the Panchayats;
(k) any other matter referred to the Finance Commission by the Governor in the interests of
sound finance of the Panchayats.

(2) The Legislature of a State may, by law, provided for the composition, of the Commission, the qualifications,
which shall be requisite for appointment as members thereof and the manner in which they shall be
selected.
(3) The Commission shall determine their procedure and shall have such powers in the performance of their
functions as the Legislature of the State may, by law, confer on them.
(4) The Governor shall cause every recommendations 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.

243J The Legislature of a State may, by law, make provisions with respect to the maintenance of accounts by the Panchayats
and the auditing of such accounts.

243K (1) The superintendence, direction and control of the preparation of electoral rolls for, and the conduct of, all
elections to the Panchayats shall be vested in a State Election Commission consisting of a State Election
Commissioner to be appointed by the Governor.
(2) Subject to the provisions of any law made by the Legislature of a Sate, the conditions of service and tenure
of office of the State Election Commissioner shall be such as the Governor may by rule determine

Provided that the State Election Commissioner shall not be removed from his office, except in like manner and on like
grounds as a Judge of a High Court ad the conditions of service of the State Election Commissioner shall not be
varied to his disadvantage after his appointment.

(3) The Governor of a State shall, when so requested by the State Election Commission, make available to the
State Election Commission such staff as may be necessary for the discharge of the functions conferred on
the State Election Commission by clause (1).
(4) Subject to the provisions of this Constitution, the Legislature of a State may, by law, make provision with
respect to all matters relating to, or in connection with, elections to the Panchayats.

243L The Provisions of this Part shall apply to the Union territories and shall, in their application to a Union territory, have effect
as if the references to the Governor of a State were references to the Administrator of the Union territory appointed
under article 239 and references to the Legislature or the Legislature Assembly of a State were references, in relation
to a Union territory having a Legislative Assembly, to that Legislative Assembly.

Provided that the President may, by public notification, direct that the provisions of this Part shall apply to any Union
territory or part thereof subject to such exceptions and modifications as he may specify in the notification.

243M (1) Nothing in this Part shall apply to the Scheduled Areas referred to in clause (1), and the tribal areas
referred to in clause (2) of article 244.
(2) Nothing in this Part, shall apply to-
(a) the States of Nagaland, Meghalaya and Mizoram;
(b) the hill areas in the State of Manipur for which District Councils exist under any law for the time being
in force.
(3) Nothing in this part-
(a) relating to Panchayats at the District level shall apply to the hill areas of the District of Darjeeling,
Gorkha hill council exist under any law for the time being in force;
(b) Shall be construed to affect the functions and powers of the Darjeeling Gorkha hill council constituted
under such law.
(4) Notwithstanding anything in this constitution,-
(a) The legislature of a State referred to in sub-clause (a) of clause (2) may, by law, extend this Part, to
that State, except the areas, if any, referred to in Clause (1), if the legislative assembly of that State
passes a resolution to that effect by a majority of the total membership of that house and by a
majority of not less than two-thirds of the members of that House present and voting;
(b) Parliament may, by law, extend the provisions of this part to the Scheduled Areas and the tribal
areas referred to in clause (1) subject to such exceptions and modifications as may be specified in
such law, and no such law be deemed to be an amendment of this Constitution for the purpose of
article 368.

243N Notwithstanding anything in this Part, any provision of any law relating to Panchayats in force in a State
immediately before the commencement of the Constitution (Seventy-third Amendment) Act, 1992 which is
inconsistent with the Provisions of this part, shall continue to be in force until amended or repealed by a competent
Legislature or other competent authority or until the expiration of one year from such commencement, whichever is
earlier;

72
Provided that all the Panchayats existing immediately before such commencement shall continue till the expiration of their
duration unless sooner dissolved by a resolution passed to that effect by the Legislative Assembly of that State or, in the case
of a State having a Legislative Council, by each House of the Legislature of that State.

243O Notwithstanding anything in this Constitution,-

(a) The validity of any law relating to the delimitation of Constituencies or the allotment of seats to such
constituencies made or purporting to be made under Article 243K, shall not be called in question in any Court;
(c) No election to any Panchayat shall be called in question except in an election petition presented to such
authority and in such manner as is provided for by or under any law made by the Legislature of a State.

73
 th
Annexure III - Constitution (74 Amendment) Act, 1992
Part IX A
The Municipalities
243P In this part, unless the context otherwise requires,-
(a) “Committee” means a Committee constituted under Article 243S;
(b) “district” means a district in a State;
(c) “Metropolitan Area” means an area having a population of ten lakhs or more, comprised in one or more districts
and consisting of two or more Municipalities or Panchayats or other contiguous areas, specified by the Governor
by Public notification to be a metropolitan area for the purposes of this Part;
(d) “Municipal area” means the territorial area of a Municipality as is notified by the Governor;
(e) ‘Municipality” means an institution of Self-Government constituted under Article 243Q;
(f) “Panchayat” means a Panchayat constituted under Article 243B;
(g) “Population” means the Population as ascertained at the last preceding census of which the relevant figures
have been published.

243Q (1) There shall be constituted in every State,-

(a) a Nagar Panchayat (by whatever name called) for a transitional area, that is to say, an area in
transition from a rural area to an urban area;
(b) a Municipal Council for a smaller urban area; and
(c) a Municipal Corporation for a larger urban area, in accordance with the provisions of this Part;

Provided that a Municipality under this clause may not be constituted in such urban area or part thereof as the
Governor may, having regard to the size of the area and the Municipal services being provided or proposed to be
provided by an industrial establishment in that area ad such other factors as he may deemed fit, by public notification,
specify to be an industrial township.

(2) In this article, ‘a transitional area’, ‘a smaller urban area’ or ‘a larger urban area’ means such area as the
Governor may, having regard to the population of the area, the density of the population therein, the
revenue generated for local administration, the percentage of employment in non-agricultural activities, the
economic importance or such other factors as he may deem fit, specify by public notification for the
purposes of this Part.

243R (1) Save as provided in clause (2)

all the seats in a Municipality shall be filled by persons chosen by direct election from the territorial
constituencies in the Municipal area and for this purpose; each Municipal area shall be divided into
territorial constituencies to be known as wards.

(2) The legislature of a State, may, by law, provide-

(a) for the representation in a Municipality of-
(i) persons having special knowledge or experience in local administration;
(ii) the Members of the House of the People and the Members of the Legislative Assembly of the
State representing constituencies which comprise wholly r partly the Municipal area;
(iii) the Members of the Council of States and the Members of the Legislative Council of the State
registered as electors within the Municipal area;
(iv) the Chairpersons of the Committees constituted under clause (5) of article 243(S)
Provided that the persons referred to paragraph, (i) shall not have the right to vote in the
meetings of the Municipality;
(b) the manner of election of the chairperson of a Municipality.

243S (1) There shall be constituted Wards Committees, consisting or one or more
wards, within the territorial area of a Municipality having a population of three lakhs or more.
(2) The legislature of a State, may, by law, make provision with respect to-
(a) The composition and the territorial area of a Wards Committee
(b) The manner in which the seats in a wards committee shall be filled.
(3) A member of a Municipality representing a ward within the territorial area of the wards committees shall be
a member of that committee.
(4) Where a wards committee consists of-
(a) one ward, the member representing that ward in the Municipality; or
(b) two or more wards, one of the members representing such wards in the Municipality elected by the
members of the wards committee, shall be the chairperson of that Committee.
(6) Nothing in this article shall be deemed to prevent the Legislature of a State from making any provision for
the constitution of Committees in addition to the Wards Committees.

243T (1) Seats shall be reserved for the Scheduled Casts and the Scheduled Tribes in
every Municipality and the number of seats so reserved shall bear, as nearly as may be, the same
proportion to the total number of sets to be filled by direct election in that Municipality as the population of
the Schedule Castes in the Municipal area or of the Scheduled Tribes in the Municipal area bears to the
total population of that area and such seats may be allotted by rotation to different constituencies in a
Municipality.
(2) Not less than one-third of the total number of seats reserved under clause (1) shall be reserved for women
belonging to the Schedule Caste or, as the case may be, the Scheduled Tribes.

74
 (3) Not less than one-third (including the number of seats) reserved for women belonging to the Scheduled
Castes and the Scheduled Tribes) of the total number of seats to be filled by direct election in every
Municipality shall be reserved for women and such seats may be allotted by rotation to different
constituencies in a Municipality.
(4) The officers of chairpersons in the Municipalities shall be reserved for the Scheduled Castes, the
Scheduled Tribes and women in such manner as the legislature of a State, may by law, provide.
(5) The reservation of seats under clauses (1) and (2) and the reservation of officers of chairpersons (other
than the reservation for women) under clause (4) shall cease to have effect on the expiration of the period
specified in article 334.
(6) Nothing in this Part, shall prevent the Legislature of a State from making any provision for reservation of
seats in any Municipality or offices of Chairpersons in the Municipalities in favour of backward class of
citizens.

243U (1) Every Municipality unless sooner dissolved under any law for the time being
in force, shall continue for five years form the date appointed for its first meeting and no longer;

Provided that a Municipality shall be given a reasonable opportunity of being heard before its dissolution.

(2) No amendment of any law for the time being in force shall have the effect of causing dissolution of a
Municipality at any level, which is functioning immediately before such amendment, till the expiration of its
duration specified in clause (1).

(3) An election to constitute a Municipality shall be completed-

(a) Before the expiry of its duration specified in Clause (1);
(b) Before the expiration of a period of six months from the date of its dissolution;

Provided that where the reminder of the period for which the dissolved Municipality would have continued is less than
six months, it shall not be necessary to hold any election under this clause for constituting the Municipality for such
period.

(4) A Municipality constituted upon the dissolution of a Municipality before the

expiration of its duration shall continue only for the reminder of the period for which the dissolved
Municipality would have continued under clause (1) had it not been so dissolved.

243V (1) A person shall be disqualified for being chosen as, and for being, a member of
a Municipality-
(b) if he is so disqualified by or under any law for the time being in force for the purposes of elections to
the Legislature of the State concerned;
Provided that no person shall be disqualified on the ground that he is less than twenty-five years of
age, if he has attained the age of twenty-one years;
(c) if he so disqualified by or under any law made by the Legislature of the State. (2) If any question
arises as to whether a member of a Municipality has become subject to any of the disqualifications
mentioned in clause (1), the question shall be referred for the decision of such authority and in such
manner as the Legislature of a State may, by law, provide.

243W (1) Subject to the provisions of this Constitution, the Legislature of the State may,
by law, endow-
(a) The Municipalities with such powers and authority as may be necessary to enable them to function as
institutions of Self-Government and such law may contain provisions for the devolution of powers and
responsibilities of Municipalities, subject to such conditions as may be specified therein, with respect
to-
(i) the preparation of plans for economic development and social justice;
(ii) the performance of functions and the implementation of schemes as may be entrusted to them
including those in relation to the matters listed in the Twelfth Schedule.
(b) the Committees with such power and authority as may be necessary to enable them to carry out the
responsibilities conferred upon them including those in relation to the matters listed in the Twelfth
Schedule.

243X The Legislature of a State may, by law-

(a) authorize a Municipality to levy, collect and appropriate such taxes, duties, tolls and fees in accordance
with such procedure and subject to such limits;
(b) assign to a Municipality such taxes, duties, tolls and fees levied and collected by the State Government for
such purposes and subject to such conditions and limits;
(c) provide for making such grants in aid to the Municipalities from the Consolidated Fund of the State; and
(d) provide for constitution of such funds for crediting all moneys received, respectively, by or on behalf of the
Municipalities and also for the withdrawal of such money there from, as may be specified in the law.

243Y (1) The Finance Commission constituted under article 243-I shall also review the
financial position of the Municipalities and make recommendations to the Governor as to-
(a) the principles, which should govern-
(i) The distribution between the State and the Municipalities of the net proceeds of the taxes, duties,
tolls and fees leviable by the State; which may be divided between them under this Part and the
allocation between the Municipalities at all levels of their respective shares of such proceeds;

75
 (ii) The determination of the taxes, duties, tolls and fees, which may be assigned to or appropriated by
the Municipalities;
(iii) The grants in aid to the Municipalities from the consolidated fund of the State;
the measures needed to improve the financial position of the Municipalities;
any other matter referred to the Finance Commission by the Governor in the interests of sound
finance of the Municipalities.
(2) The Governor shall pass 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.

243Z The Legislature of a State may, by law, make provisions with respect to the maintenance of accounts by the
Municipalities and the auditing of such accounts.

243ZA (1) electoral rolls for and the conduct of all election to the Municipalities shall be
vested in the State Election Commission referred to in article) The Superintendence, direction and control
of the preparation of 243K.
(2) Subject to the provisions of this Constitution the Legislature of a State may, by law, make provision with
respect to all matters relating to, or in connection with, elections to the Municipalities.

243ZB The provisions of this Part shall apply to the Union Territories and shall, in their application to a Union
Territory, have effect as if the references to the
Governor of a State were references to the Administrator of the Union Territory appointed under Article 239
and references to the Legislature or the Legislative Assembly of a State were references in relation to a
Union Territory having Legislative Assembly, to that Legislative Assembly;

Provided that the President may, by public notification, direct that the provisions of this Part, shall apply to any Union
Territory or part thereof subject to such exceptions and modifications as he may specify in the Notification.

243ZC (1) Nothing in this Part shall apply to the Scheduled Areas referred to in clause
(1), and the tribal areas referred to in clause (2), of Article 244.

(2) Nothing in this Part shall be construed to affect the functions and the powers of the Darjeeling Gorkha hill
Council constituted under any law for the time being in force for the Hill areas of the District of Darjeeling in
the State of West Bengal.
(3) Notwithstanding anything in this Constitution, Parliament may, by law, extend the provisions of this part to
the scheduled areas and the tribal areas referred to in Clause (1) subject to such exceptions and
modifications as may be specified in such law, and no such law shall be deemed to be an amendment of
this Constitution for the purposes of Article 368.

243ZD (1) There shall be constituted in every State at the District level a District
Planning Committee to consolidate the plans prepared by the Panchayats and the Municipalities in the
District and to prepare a draft development plan for the District as a whole.

(2) The Legislature of a State may, by law, make provision with respect to-
(a) the composition of the District Planning Committees;
(b) the manner in which the seats in such Committee shall be filled;

Provided that not less than four-fifths of the total number of members of such Committee shall be elected by, and
from amongst, the elected members of the Panchayats at the District level and of the Municipalities in the District in
proportion to the ratio between the population of the rural areas and of the urban areas in the District;
(c) the functions relating to District Planning which may be assigned to such Committees;
(d) the manner in which the chairpersons of such committees shall be chosen.

(3) every District Planning committee shall, in preparing the draft development plan-
(a) have regard to-
(i) matters of common interest between the Panchayats and the Municipalities including spatial planning,
sharing of water and other physical and natural resources, the integrated development of infrastructure and
environmental conservation;
(ii) the extent and type of available resources whether financial or otherwise;
(b) consult such institutions and organizations as the Governor may, by order, specify.
(4) The chairperson of every District Planning Committee shall forward the development plan, as
recommended by such Committee to the Government of the State.
243ZE (1) there shall be constituted in every Metropolitan area a Metropolitan Planning
Committee to prepare a draft development plan for the Metropolitan area as a whole.
(2) The Legislature of a State may, by law, make provisions with respect to-
(a) the composition of the Metropolitan Planning Committees;
(b) the manner in which the seats in such Committees shall be filled;
Provided that not less than two-thirds of the members of such committee shall be elected by, and from
amongst the elected members of the Municipalities and chairpersons of the Panchayats in the
Metropolitan area in proportion to the ratio between the population of the Municipalities and of the
Panchayats in that area;

76
 (c) the representations in such Committees of the Government of India and the Government of the State
and of such organizations and institutions as may be deemed necessary for carrying out the functions
assigned to such committees;
(d) the functions relating to planning and co-ordination for the Metropolitan area which may be assigned
to such Committee;
(e) the manner in which the chairpersons of such committees shall be chosen.
(3) Every Metropolitan Planning Committee shall, in preparing the draft development plan,-
(a) have regard to-
(iii) the plans prepared by the Municipalities and the Panchayats in the Metropolitan Area;
(iv) matters of common interest between the Municipalities and the Panchayats, including coordinated
spatial planning of the area, sharing of water and other physical and natural resources, the
integrated development of infrastructure and environmental conservation;
(v) the overall objectives and priorities set by the Government of India and the Government of the
State;
(vi) the extent and nature of investments likely to be made in the Metropolitan area by agencies of the
Government of India and of the Government of the State and other available resources whether
financial or otherwise;
(b) consult such institutions and organizations as the Governor may, by order, specify
(4) The Chairperson of every Metropolitan Planning Committee shall forward the development plan, as
recommended by such committee, to the Government of the State.

243ZF Notwithstanding anything in this Part, any provision of any law relating to Municipalities in force in a State
immediately before the commencement of the Constitution (Seventy-fourth Amendment) Act, 1992, which
is inconsistent with the provisions of this Part, shall continued to be in force until amended or repealed by a
competent Legislature or other competent authority or until the expiration of one year from such
commencement, whichever is earlier;

Provided that all the Municipalities existing immediately before such commencement shall continue till the
expiration of their duration, unless sooner dissolved by a resolution passed to that effect by the Legislative
Assembly of that State, or, in case of a State having a Legislative Council, by each House of the
Legislature of that State.

243ZG Notwithstanding anything in this Constitution

(a) the validity of any law relating to the delimitation of constituencies or the allotment of seats to such
constituencies, made or purporting to be made under article 243ZA shall not be called I question in
any Court;
(b) no election to any Municipality shall be called I question except by an election petition presented to
such authority and in such manner as is provided for by or under any law made by the Legislature of
A State.

77
Annexure IV - Eleventh Schedule - (Article 243G)
rd
[Added by Constitution (73 Amendment) Act, 1992]
1. Agriculture, including agricultural extension.
2. Land improvement, implementation of land reforms, land consolidation and soil
conservation.
3. Minor Irrigation, water management and watershed development.
4. Animal husbandry, dairying and poultry.
5. Fisheries.
6. Social forestry and farm forestry.
7. Minor forest produce.
8. Small scale industries, including food processing industries.
9. Khadi, village and cottage industries.
10. Rural housing.
11. Drinking water
12. Fuel and fodder.
13. Roads, culverts, bridges, ferries, waterways and other means of communication.
14. Rural electrification, including distribution of electricity.
15. Non-conventional energy sources.
16. Poverty alleviation programme.
17. Education, including primary and secondary schools.
18. Technical training and vocational education.
19. Adult and non-formal education.
20. Libraries.
21. Cultural activities
22. Markets and fairs.
23. Health and sanitation, including hospitals, primary health centers and dispensaries.
24. Family welfare.
25. Women and child development.
26. Social Welfare, including welfare of the handicapped and mentally retarded.
27. Welfare of the weaker sections, and in particular, of the Scheduled Castes and the
Scheduled Tribes.
28. Public Distribution system.
29. Maintenance of community assets.

78
Annexure V - Twelfth Schedule - (Article 243W)
th
(Inserted by Constitution (74 Amendment) Act, 1992)
1. Urban planning, including town planning.
2. Regulation of land-use and construction of buildings.
3. Planning for economic and social development
4. Roads and bridges.
5. Water supply for domestic, industrial and commercial purposes.
6. Public health, sanitation, conservancy and solid waste management.
7. Fire services.
8. Urban forestry, protection of the environment and promotion of ecological aspects.
9. Safeguarding the interests of weaker sections of society, including the handicapped and
mentally retarded.
10. Slum improvement and upgradation.
11. Urban poverty alleviation.
12. Provision of urban amenities and facilities such as parks, gardens, playgrounds.
13. Promotion of cultural, educational and aesthetic aspect.
14. Burials and burial grounds; cremations, cremation grounds and electric crematoriums.
15. Cattle ponds; prevention of cruelty to animals.
16. Vital statistics, including registration of births and deaths.
17. Public amenities, including street lighting, parking lots, bus stops and public conveniences.
18. Regulation of slaughterhouses and tanneries.

79
Annexure VI – Amended Article 280 of Constitution of India
280. (1) The President shall, within two years from the commencement of this Constitution and thereafter at the expiration
of every fifth year or at such earlier time a the President necessary by order constitute a Finance Commission which
shall consist of a Chairman and four other members to be appointed by the President.

(2) Parliament may by law determine the qualifications, which shall be requisite for appointment as members of the
Commission and the manner in which they shall be selected.

(3) It shall be the duty of the Commission to make recommendations to the president as to –

(a) the distribution between Union and the States of the net proceeds of taxes which are to be, or may be,
divided between them under this Chapter and the allocation between the States of the respective shares of such
proceeds;

(b) the principles, which should govern the grants-in-aid of the revenues of the States out of Consolidated Fund
of India.

(bb) the measures needed to augment the Consolidated Fund of State to supplement the resources of the
Panchayats in the State on the basis of the recommendations made by the Finance Commission of the State.
rd
[Inserted by the Constitution (73 Amendment) Act, 1992]

© the measures needed to augment the Consolidated Fund of a State to supplement the resources of the
Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State.
th
[Inserted by the Constitution (74 Amendment) Act, 1992]

(d) any other matter referred to the Commission by the President in the interest of sound finance.

(4) The Commission shall determine their procedure and shall have such powers in the performance of their functions
as Parliament may, by law, confer to them.

80
ANNEXURE – VII - Comparative Statement on Revenue Income and Expenditure by Local Bodies of Tamil Nadu for 1997-98 to
2001-02
Table VII.1 – Statement showing revenue and expenditure of all Tamil Nadu Local Bodies 1997-98 to 2001-02
(Rs. in lakhs)
Sl. Local Revenue Income Utilisation % of % of
No. Body salary & SFC
O &M in devolutio
n in
Own Assigned SFC Total Salary O&M Total
Revenue Revenue devolution
1 VPs 45269 47700 131788 224757 32315 118205 150520 67 87
2 Pus 48224 2602 99699 150525 57425 38120 95545 63 96
3 Dt. Pts - - 17658 17658 1871 17 1888 11 100
4 TPs 61581 33675 49860 145116 40765 60005 10771 69 49
5 Mpts. 129849 44147 36367 209863 93472 81985 175457 84 21
6 Corpns 206655 68835 54445 329935 117766 112764 230530 70 24
Total 490578 196959 390317 1077851 343614 411097 754711 61 63
(average (average
) )
Source – Second SFC Report of Tamil Nadu

Table VII.2 - Statement showing revenue gap of all Tamil Nadu Local Bodies for 2002-07
(Rs. in lakhs)
Local Own Expenditure for 2002-07
Body Revenue
income
Salary Pension O & M Addl. Debt Non- Total Revenue Total Fiscal
O&M servicing Debt Gap Gap
liabilities
V.Ps 100465 54422 - 369707 - - - 424129 -323664 5988.63
P.Us 40000 74395 29724 112086 - - - 216205 -176205 2373.23
Dt. Pts. - 2786 - - - - - 2786 -2786 27.86
T. Pts. 102621 83304 14404 101516 19940 29303 4815 250282 -147661 3461.13
Mpts. 208373 183592 48772 157026 10755 42264 13516 455925 -247552 0.65
Corpns. 338988 231257 74032 222592 12273 82548 13698 636400 -297412
Total 790447 626756 166932 962927 42968 154115 32029 19857.27 -1195280 24882.27
Source – Second SFC Report of Tamil Nadu

Table VII.3 - Capital Requirements to fill in Gaps in Services Based on Norms for 2002-2007
Components Village Panchayat Town Municipalities Corporations Total
Panchayats Unions Panchayats
(Rupees in Crores)
Water Supply 500.00 - 454.61 266.02 137.81 1358.44
Sewerage - - 13.52 70.94 124.71 209.17
Roads 1150.58 211.18 131.10 190.02 375.28 2058.16
SWD - - 220.79 91.20 224.51 36.50
Street Lighting 96.76 - 40.99 49.41 26.39 213.00
Solid Waste - - 6.62 32.93 87.55 127.10
Management
Others - - 91.23 122.88 154.40 368.51
Additional Cost - - - 0 154.12 154.12
Factors
Total 1747.34 211.18 958.31 823.4 1284.77 5025.00
Source – Second SFC Report of Tamil Nadu
Table VII.4 – Class-wise total fiscal gap
Local Body Revenue Exp. Requirement Capital Expenditure Requirement Total Fiscal Gap
V.Ps 4241.29 1747.34 5988.63
P.Us 2162.05 211.18 2373.23
Dt. Pts. 27.86 - 27.86
T. Pts. 2502.82 958.31 3461.13
Mpts. 4559.25 823.40 5382.65
Corpns. 6364.00 1284.77 8648.77
Total 19857.27 5025.00 24882.27
Source – Second SFC Report of Tamil Nadu

Table VII.5 - Fiscal Responsibility Norms for Urban Local Bodies

In the context of the introduction of the draft bill on Fiscal Responsibility and Budget Management in the Parliament it is only a
matter of time the states will also bring in similar enactment. Hence, in the next phase the Urban Local Bodies which consider
themselves as units of local self-government need to follow suit.

Accordingly, the Commission has identified major areas and parameters of fiscal responsibility as applicable to Urban Local
Bodies.

81
 1) Prepare budget based on the need and performance covering a 3 year rolling plan of expenditure and revenue
projections.
2) Fix pre-determined target for achieving revenue surplus of 5%
3) Strictly adopt right size of staff strength based on norms.
4) Widen Tax Base
5) Eliminate Fiscal deficit
6) Fix limit on Debt.
7) Cut the time, and cost over run of capital expenditure on projects on internal rate of return basis.
8) Levy right level of User Charges (“)
9) Target for Collection :
(a) Current Demand 95 %
(b) Arrear Demand 75%
10) Assess returns and recovery for new projects.

After getting this vetted by Law department, suitable provisions may be made in the common Urban Local Bodies
Act.
(“) The end users who reap the benefits from the services should be made to pay for the services on the principle of service
provider – service receiver relationship (Examples: water supply and solid waste management).

82
ANNEXURE VIII - Total Receipts and Dependency of A.P. Local Bodies for the years 1996-97 TO 1999-2000

Table VIII.1 - Statement showing total receipts of A.P. Municipalities for the years 1996-97 to 1999-00
Rs. in lakhs
Sl.
Sources of Revenue Receipts during
No.
1996-97 1997-98 1998-99 1999-2000

1 2 3 4 5 6

1. Taxes 6659.00 6992.83 7877.58 7837.22

2. Non-taxes 5723.90 6471.07 8353.56 8044.96

3. Assigned Revenues 8562.12 9626.14 12097.18 12827.22

4. Grants 9641.04 11015.80 16272.34 19129.19

5. Deposits 2185.01 2129.23 2369.79 2597.62

6. Advances 487.67 459.79 708.16 706.25

Total Income 33258.74 36694.86 47678.61 51142.46

(Source: Second SFC Report of Andhra Pradesh)

Table VIII.2 - Statement showing the percentage own revenues of municipalities to the total receipts during 1996-97 TO 1999-
2000
Rs. in lakhs

Year Total Receipts Own Sources Percentage

1 2 3 4

1996-97 33258.74 12382.90 37.23

1997-98 36694.86 13463.90 36.69

1998-99 47678.61 16231.14 34.04

1999-2000 51142.46 15882.19 31.06

(Source – Second SFC Report of Andhra Pradesh)

Table VIII.3 – Statement showing the income of Municipal Corporations in the State from various sources during the period
from 1996-97 TO 2000-2001
Rs. in lakhs
Sl.
Sources of Revenue Receipts during
No.
1996-97 1997-98 1998-99 1999-2000

1 2 3 4 5 6

1. Taxes 8398.15 9712.57 11042.53 14405.35

2. Non-taxes 6247.35 8841.70 12376.05 9792.42

83
 3. Assigned Revenues 8339.07 9580.84 11530.55 12125.30

4. Grants 3163.43 3624.52 4870.83 8365.46

5. Deposits 3655.29 3807.33 4262.09 5401.71

6. Advances 624.87 660.68 781.44 1488.69

Total Receipts 30428.16 36227.84 44863.49 51578.93

(Source: Second SFC Report of Andhra Pradesh)

Table VIII.4 - Statement showing overall dependence of local bodies of Andhra Pradesh
Rs. in lakhs
Income from own sources
Year Total Receipts Income from Own Sources
as %

1 2 3 4

1996-97 30428.16 14645.50 48.13

1997-98 36227.84 18554.27 51.21

1998-99 44863.49 23418.58 52.19

1999-2000 51578.93 24197.77 46.91

Average 49.61 %
(Source: Second SFC Report of Andhra Pradesh)

84
Annexure IX – Tenth, Eleventh and Twelfth Central Finance Commission’s Framework for the Allocation of Grant to States for
Local Governments

Tenth Central Finance Commission –

For the Panchayats Rs. 100 per capita of rural population as per the 1971 census population.
Allocated grant amount for the urban local bodies to be allocated on the basis of the 1971 ratio of the inter-state slum to urban
population.

Eleventh Central Finance Commission –

Criteria for Inter Se Allocation of grant in aid amount among the states
Criteria Weight

Urban Population 1991 40 %

Urban Geographical area 1991 10 %
Revenue Effort of Municipalities 10 %
Distance from the highest average per capital non-
Agricultural gross state domestic product (GSDP) 20 %
Index of Decentralisation 20 %

Index of Decentralisation

1. Enactment/amendment of the State panchayats/municipality legislations,

2. Intervention/restriction in functioning of local bodies,
3. De-jure assignment of functions to municipalities vis-à-vis the twelfth schedule of the Constitution of India,
4. De-facto assignment of function to municipalities by way of rules, notification, and orders of state government,
5. De-jure assignment of taxation powers to municipalities,
6. Exercise of taxation powers by municipalities,
7. Constitution of the finance commission of states and submission of action taken reports,
8. Action taken on the major recommendations of the finance commission of states,
9. Election to the municipalities,
10. Constitution of district planning committees as per the letter and spirit of Article 243ZD.
Source – Report of the Eleventh Finance Commission – June 2000

Twelfth Central Finance Commission

Criteria for Inter Se Allocation of grant in aid amount among the states
Criteria Weight

Urban Population 2001 40 %

Urban Geographical area 2001 10 %
Revenue Efforts 20 %
Of which (a) with respect to own revenue of states 10%
(b) with respect to GSDP 10%
Distance from the highest average per capital non- 20 %
Index of Deprivation 10 %
th
12 Finance commission has retained three criteria with same weightage used by EFC. It has increased weightage of one
criteria namely ‘Revenue Efforts’ and has dropped on criteria of decentralisation and has introduced criteria of deprivation with
reduced weightage compare to EFC.
th
12 Finance Commission has recommended doing away with index of decentralisation as most of the states have carried out
necessary changes in the panchayat/municipal legislations and have taken necessary steps to transfer function and other
powers to local bodies.
th
The index of deprivation has been recommended by 12 Finance Commission to take into account intra-state disparities on the
basis of data relating to certain minimum needs of the population.

It has used 2001 census data regarding availability of drinking water and sanitation in rural and urban areas to construct the
index of deprivation. The formula used is D.I = 0.5x + 0.25(y=z) where D.I is deprivation index; x is the percentage of
households fetching water from distance, y is the percentage of households without latrines and z is the percentage of
households without drainage. A standard deviation of 0.5 is allowed so as to enable the least deprived state also to get a share.

85
Annexure X – Eleventh Central Finance Commission Report - Summary of Recommendations Relating to State Local Bodies
(Ref: Para 2.1)
14.31 Article 2431 should be amended to enable the States to set up the Stale Finance Commissions (SFC) at the
expiration of every fifth year or earlier, akin to the provision that already exists under article 280 for constituting the
Finance Commission. The synchronization of availability of the Slate Finance Commission reports may also be
ensured through either a Central legislation or an appropriate provision in the Constitution. (Para 8.11a).
14.32 State Finance Commission reports may contain specific chapters, as indicated in Para (8.11 b) so as to make them
more useful lo the Finance Commission. (Para 8.11 b).
14.33 Stale Governments should take their decision on the recommendations of the State Finance Commission, especially
in regard to matters relating to resource transfer, and place the ATRs on the floor of the State Legislature within six
months. Amendments to the laws, if necessary, should be made to ensure this at the earliest. (Para 8.11 c)
14.34 The words ‘on the basis of the recommendations made by the Finance Commission of the Slate’, appearing in sub-
clauses (bb) & © of article 280(3) of the Constitution, may be deleted. (Para 8.11.d).
14.35 States should, by legislation, ensure that the chairpersons and members of the SFCs might be drawn from amongst
experts in specific disciplines such as economics, law, public administration and public finance. (Para 8.12).
14.36 Taxes on land / farm income may be levied in suitable form to strengthen the resource base of the local bodies. The
amounts so collected may be passed on to these bodies for improving and strengthening the civic services. Local
Bodies may also be involved in collection of these taxes. (Para 8.15a).
14.37 Cess on land based taxes and other State taxes / duties may be levied and devolved to the local bodies for
augmenting specific civic services. (Para 8.15 b)
14.38 States should levy profession tax with a view to supplementing the resources of local bodies, or they should empower
the local bodies to levy it. The rates should be suitably revised from time to time. (Para 8.15c)
14.39 Property tax or house lax has not been exploited to its full potential. The relevant tax legislation should be suitably
modified to delink this tax from the rent control laws. Where a property has been let out, the property tax should be
made recoverable from the occupier. (Para 8.16a)
14.40 Abolition of octroi should invariably be accompanied with its replacement by a suitable tax that is buoyant and can be
collected by the local bodies. (Para 8.16b)
14.41 The rate structure of user charges levied by the local bodies should be revised regularly to keep pace with inflation
and to recover at least; as far as possible, the full-operations and maintenance cost. Local bodies should have the
power to fix the rates of taxes and user charges. (Para 8.16c)
14.42 The grants recommended for local bodies in this report should be given to those local bodies, which have the primary
responsibility for maintenance of civic services. The grant should be untied, but should not be used for payment of
salaries and wages. (Para 8.19a)
14.43 States should review the existing accounting heads under which funds are being transferred to the local bodies. For
each major head / sub major head, six minor heads should be created - three for the consultation with the
Comptroller and Auditor General of India (C&AG) and the Controller General of Accounts, to ensure uniformity
among the States. (Para 8.19a)
14.44 The C&AG should be entrusted with the responsibility of exercising control and supervision over the maintenance of
accounts and their audit for all the tiers / levels of panchayats and urban local bodies. (Para 8.19b)
14.45 The Director, Local Fund Audit, or any other agency made responsible for the audit of accounts of the local bodies,
should work under the technical and administrative supervision of the C&AG. In no case, should be the Director of
Panchayats or for Urban Local Bodies be entrusted with this work. The prescribed authority entrusted with the audit
and accounts of the local bodies should not have any functional responsibility in regard to these bodies, so as to
ensure his independence and accountability. (Para 8.19c)
14.46 The C&AG should prescribe the format for the preparation of budgets and for keeping accounts by the local bodies,
which should be amenable to computerization. (Para 8.19d).
14.47 Local bodies, which do not have trained accounts staff, may contract out the upkeep of accounts to outside agencies
/ persons. The C&AG may lay down the qualification and experience required for this purpose. The Director, Local
Fund Audit, or his equivalent authority, may do the registration of such agencies / persons. (Para 8.19 e)
14.48 Audit of accounts of the local bodies may be entrusted to the C&AG, who may get it done through his won staff, or by
engaging outside agencies on payment of remuneration fixed by him. An amount of half percent of the total
expenditure incurred by the local bodies should be placed with the C&AG for this purpose. (Para 8.19f)
14.49 The report of the C&AG, relating lo audit of accounts of the Panchayats and the municipalities, should be placed
before a committee of the State Legislature constituted on the same lines as the Public Accounts Committee. (Para
8.19g)
14.50 An amount of Rs. 4,000 per Panchayat per annum, on an average, should be adequate to meet the expenditure on
maintenance of accounts on contract basis, if the staff / facilities are not available within the Panchayat. The amount
may be paid from the grants that are recommended for the rural local bodies. Any additional fund required for this
purpose should be met from the grants given to the Stales for the Panchayats. Where a Panchayat has got staff
available for upkeep of accounts, these funds need not be so earmarked. If any municipality does not have a regular
staff for this purpose, the grants provided to it may also be so earmarked. (Para 8.20).
14.51 A database on finances of the Panchayats and municipalities should be developed at the district. Stale and Central
Government levels and be easily accessible by computerizing it and linking it through V-SAT. The Director, Local
Fund Audit, or the authority prescribed for conducting the audit of accounts of the local bodies, may be made
responsible for this task. The Chief Secretary of the State may do the State level coordination and monitoring. The
C&AG should be involved at all stages. (Para 8.21).
14.52 A total grant of Rs 1,600 crores for Panchayats and Rs.400 crores for the municipalities is recommended to be given
to States for each of the five years starting from the financial year 2000-01. The amounts indicated for maintenance
of accounts, audit of accounts and for the development of database, would be the first charge on these grants and
would be released by the concerned Ministries of the Government of India, after the arrangement suggested become
operational. Shares in respect of the scheduled, tribal and other excluded areas should be made available to the
rd th
respective States only after the relevant legislative measures are taken extending the provisions of the 73 and 74
amendments to such areas. (Para 8.22).
14.53 Inter-se share of States in the grants provided for the Panchayats and the municipalities is based on the rural / urban
population of the State (40 per cent), index of decentralization (20 per cent), distance from the highest per capita

86
 income (20 per cent). Revenue effort of the local bodies (10 per cent) and geographical area (10 per cent). (Paras
8.23, 8.24, 8.25 & 8.26).
14.54 While all the States barring Arunachal Pradesh have either enacted a new Panchayat / Municipal Act or have
rd th
amended the existing legislation in conformity with the 73 and 74 amendments, the schemes relating to the
subjects included in the Eleventh and Twelfth Schedules have not yet been transferred to these bodies in most of the
States as contemplated in articles 243G and 243W. Transfer of functions and schemes to the local bodes should be
specifically provided by legislation. (Para 8.28a)
14.55 The roles of the three tiers of the Panchayats have generally not been delineated in the State legislations and the
matter has usually been left to be decided by way of executive instructions. Legislative arrangements should be
made to indicate clearly the role that these bodies have to play in the system of governance in the rural areas of a
district. (Para 8.28b)
14.56 The two Union Ministries - the Ministry of Rural Development and the Ministry of Urban Development - have to
ensure that the local bodies function as institutions of self-Government and all impediments to the realization of this
ideal are removed. These Ministries should take the initiative for transferring the schemes related to their subjects
included in the Eleventh and Twelfth Schedules, to the local bodies. (Para 8.28c)
14.57 The three-tier Panchayat Raj System is very rigid arrangement. States may be provided flexibility to decide whether a
two-tier system would operate with greater efficiency and economy or a three-tier structure would be essential. (Para
8.28d).
th
14.58 For extending the provisions of the 74 amendment to the Fifth Schedule areas, Parliament is yet to enact the
enabling legislation. This may be speeded up. (Para 8.28c)
14.59 The Legislatures in the States of Meghalaya, Mizoram and Nagaland should take suitable action for extending the
provisions of the 73rd amendment to the non-Sixth Schedule areas. Alternatively, the existing village level institutions
rd
in these areas may be recognised as Panchayats for the purposes of the 73 amendment, by appropriate legislative
charges. (Para 8.28f)
14.60 Suitable enabling provisions in the Constitution may be introduced so that the hill areas in the State of Manipur and in
rd
the district of Darjeeling in West Bengal could get the benefit of the 73 amendment. (Para 8.28g)
14.61 Administrative reorganization of Panchayats is necessary to ensure their development as viable institutions of self-
Government (Para 8.28h)
14.62 The District Planning Committees and the Metropolitan Planning Committees should be constituted and made
functional. (Para 8.28i)
14.63 All Government properties of the Centre as well as the States should be subject to the levy of user charges. It should
be regulated by suitable legislation. (Para 8.32).

87
Annexure XI- Twelfth Central Finance Commission Report - Summary of Recommendations Relating to Workings State
Finance Commissions

Para 8.55
ii) The states should avoid delays in the constitution of the SFCs, their constitution in phases, frequent reconstitution,
submission of reports and tabling of the ATR in the legislature. It is desirable that SFCs are constituted at least two
years before the required date of submission of their recommendations, and the deadline should be so decided as to
allow the state government at least three months’ time for tabling the ATR, preferably along with the budget for the
ensuing financial year.
iii) The SFC reports should be readily available to the central finance commission, when the latter is constituted so that
an assessment of the state’s need could be made by the central finance commission on the basis of uniform
principles. This requires that these reports should not be too dated. As the periodicity of constitution of the central
finance commission is predictable, the states should time the constitution of their SFCs suitably.
iv) SFCs must be constituted with people of eminence and competence with qualification and experience in the relevant
fields.
v) The convention established at the national level of accepting the principal recommendations of the finance
commission without modification, should be followed at the state level in respect of SFC reports.
vi) The SFCs must clearly identify the issues which require action on the part of the central government to augment the
consolidated fund of the state and list them out in a separate chapter for the consideration of the central finance
commission.
vii) The suggestion made by SFCs regarding raising the ceiling on professional tax is endorsed for action by central
government.
viii) It is desirable that the SFCs follow the procedure adopted by the central finance commission for transfer of resources
from the centre to the states in respect of resource transfers from state governments to local bodies. The SFC reports
should contain an estimation and analysis of the finances of the state government as well as the local bodies at the
pre and post transfer stages along with a quantification of the revenues that could be generated additionally by the
local bodies by adopting the measures recommended therein. The gaps that may still remain would then constitute
the basis for the measures to be recommended by the central finance commission.
ix) While estimating the resources of the local bodies, the SFCs should follow a normative approach in the assessment
of revenues and expenditure rather than make forecasts based on historical trends.
x) A permanent SFC cell may be created in the finance department of state governments as the collection and collation
of data would need to be done constantly and data would need to be made available to the SFC.

88
 th
Annexure XII - Status of State Finance Commissions in Various States as on November 22, 2004 (as reported in 12 Finance Commission)

Sl. States / First State Finance Commission Second Finance Commission

Report submitted on --- & ATR Submitted on ---

No. Union Territories Constituted on Report submitted on & ATR Submitted on Constituted on
---------

1. Andhra Pradesh June 22,1994 May 31,1997; ATR on Nove 29, 1997 December 8, 1998 August 19, 2002; ATR on March 31, 2003

2. Arunachal Pradesh May 21, 2003 June 6, 2003; ATR on July 3, 2003 Not Constituted -----------------

3. Assam June 23, 1995 Febru 29, 1996; ATR on March 18, 1996 April 18, 2001 August 18, 2003; ATR Not Submitted

September 2001 RLB

4. Bihar April 23, 1994 SFC report Not Submitted, No ATR submitted June 1999
January 2003 ULB; ATR Not Submitted

5. Chhatisgarh* Not Constituted ----------------------------------- Not Constituted ------------------------

6. Goa April 22, 1994 June 5, 1999; ATR on Nove 12, 2001 Not Constituted ----------------------------

July 13, 1998 RLB

7. Gujarat September 15, 1994 November 19, 2003 Not Submitted
October 13, 1998 ULB ATR Submitted

8. Hariyana May 31,1994 March 31, 1997; ATR on Sept 1, 2000 September 6, 2000 Not Submitted

9. Himachal Pradesh April 23, 1994 November 30, 1996; ATR on February 5, 1997 May 25, 1998 October 24, 2002; ATR on June 24, 2003

10. Jammu & Kashmir April 24, 2001 May 2003, ATR Not Submitted Not Constituted -------------

11. Jharkhand* Not Constituted ------------------------------------------ January 28, 2004 SFC Report Not Submitted

August 8, 1996 RLB

12. Karnataka June 10, 1994 June 23, 1999 December 2002 ATR not submitted
January 31, 1996 ULB , ATR on March 31, 1997

13. Kerala April 23, 1994 February 29, 1996; ATR on March 13, 1997 June 23, 1999 June, 2002 ATR Not Submitted

14. Madhya Pradesh August 17, 1994 July 20, 1996; ATR on the Same day June 17, 1999 July 2003; ATR Not Submitted

15. Maharashtra April 23, 1994 January 31, 1997; ATR on March 5, 1999 June 22, 1999 March 2002; ATR Not Submitted

89
 April 22, 1994
16. Manipur December 20, 1996; ATR on July 20, 1996 January 3, 2003 Submitted; ATR Not Submitted
May 31, 1996

17. Meghalaya Not Applicable Not Applicable Not Applicable Not Applicable

18. Mizoram Not Applicable Not Applicable Not Applicable Not Applicable

19. Nagaland Not Applicable Not Applicable Not Applicable Not Applicable

November 21, 1996

20. Orissa December 30, 1998; ATR on July 9, 1999 June 5, 2003 October 25, 2003; ATR Not Submitted
August 24, 1998

February 15, 2002; ATR Submitted on June 8,

21. Punjab April 22, 1994 December 31, 1995; ATR on September 13, 1996 Sept. 21, 2000
2002

August 30, 2001, ATR Submitted on March 26,

22. Rajasthan April 23, 1994 December 31, 1995; ATR on March 16, 1996 May 7, 1999
2002

April 23, 1997

23. Sikkim August 16, 1999; ATR in June 1996 July 2003 Not Submitted
July 22, 1998

Submitted May 21, 2001; ATR submitted May

24. Tamil Nadu April 23, 1994 November 29, 1996; ATR on April 28, 1997 December 1, 1999
8, 2002

April 23,1994 RLB January 12, 1996 RLB/ April 1, 1997

25. Tripura October 29, 1999 April 10, 2003; ATR Not Submitted
August19, 1996 ULB September 197, 1999 ULB/ Nov 27, 2000

26. Uttar Pradesh October 22, 1994 December 26, 1996 ATR on January 20, 1996 February 25, 2000 June 2002, ATR Submitted on April 2004

27. Uttaranchal* January 31, 2001 Submitted 2002; ATR in 2002 Not Constituted ---------------------------

28. West Bengal May 30, 1994 November 27, 1995; ATR on November 27, 1995 14 July, 2000 6 February, 2002; ATR Not Submitted

29. Pondicherry March 12, 1997 March, 2000

30. Chandiarh April, 1995 December 31, 1997 January 9, 2001 Submitted

31. Delhi April, 1985 December 31, 1997

August 28, 1998

32. A & N Islands September 8, 1995

90
33. D & N Haveli September 8, 1995 August 28, 1998 NA NA

34. Daman & Diu September 8, 1995 August 28, 1998

35. Lakshadweep September 8, 1995 August 28, 1998

st
* - Chattisgadh, Uttaranchal and Jharkhand being newly carved states; their local bodies were covered by 1 SFC of their mother States.
th
Source - Nagarpalika Update – September-October 2003 – Vol.1 No. and 12 Finance Commission – Annexure 8.10

91
 Annexure XIII - Share of Municipalities in State’s Resources as Recommended by the Finance Commissions of States

State Recommended shares Recommended shares

(first state finance commission) (second state finance commission)

Andhra Pradesh 39.24% of state tax and non-tax revenue to all local 40.92%of state tax and non-tax revenue to all bodies,
bodies. both rural and urban bodies, 9.67% is allocated to
municipalities.
Assam 2% of state tax for local bodies, both rural and
urban. (The share of urban local bodies has not
been specified).

Himachal Pradesh An amount equal to Rs.12.2 crore as grants in lieu An amount equal to Rs.19.66 crore as development
of octroi for 1996/97, to raise to Rs.17.9 crore in grants for the year 2002/03, with a 10 per cent mark-
2000/01 and CSS grants to accrue to municipalities. up to neutralize inflation, rising to Rs.28.79 crore by
2006/07, and CSS grants to accrue to municipalities.

Karnataka 5.4% of the total non-loan gross own revenue 8% of non-loan gross own revenue receipts for
receipts for meeting the plan and non-plan municipalities.
requirements.

Kerala 1% of state revenues (excluding from certain

sources) be transferred to local bodies as non-
statutory non-plan grants distributed between the
rural and urban local bodies in proportion to their
population.

Madhya Pradesh 8.67% of the tax and non-tax revenues of state 1.07% of divisible pool of state own tax revenue.
government.

Maharashtra 25% to 100% of entertainment taxes collected from

municipalities of different grades, 25% of vehicle tax
and 10% of profession tax are recommended
shares for local bodies.

State Recommended shares Recommended shares

(first state finance commission) (second state finance commission)

Orissa Rs.179.5 crores is the projected transfer (grant) to

urban local bodies between 1998/99 and 2004/05.
(The deficit of Rs.1, 378 crores between the
estimated income and expenditure and an
additional requirement of Rs.381.48 crore for
improvement of core civic services should be met
by the Eleventh Finance Commission.

Punjab 20% of the net proceed for five taxes namely, stamp 4 per cent of net tax proceeds of all state taxes to be
duty, motor vehicle tax, electricity duty, devolved to all local bodies.
entertainment tax, cinematograph shows should be
transferred to municipalities, and the projected gap
of Rs.322 crore should be met by the Central
Finance Commission.

Rajasthan 2.18% the net proceeds of state taxes should be Total devolution of Rs.794.43 crore consisting of
devolved on the local bodies; the division of these 2.25% share in states net own tax revenue (excluding
proceeds between rural and urban should be in the entertainment tax); 15% share in entertainment tax for
ratio of 3.4:1. ULBs for the award period 2000-05 and 1% share in
royalty receipts from minerals to Gram Panchayats.

Tamil Nadu 8% of the state’s net tax revenue should be 8% of state’s own tax revenue, after excluding
devolved on the local bodies in 1997/98; this entertainment tax to local bodies for each year from
percentage should gradually increase in successive 2002/03 to 2006/07; shares of PRIs and ULBs in the
years to 9%, 10%, 11% and reaching 12% in recommended devolution will be in the ratio 58:42.
2001/02. The division of this amount between rural
and urban should be on the basis of population as
in the last Census.

State Recommended shares Recommended shares

(first state finance commission) (second state finance commission)

93
Uttar Pradesh 7% of the net proceeds of state’s total tax revenue
should be transferred to urban local bodies.

West Bengal 16% of the net proceeds of all taxes collected by the (a) Nearly, 72 percent tax proceeds from
state should be transferred to local bodies. Such entertainment tax.
funds should be released to the Districts. These (b) 16 percent allocated from states revenue as
proceeds should be divided between urban and untied entitlement fund, the proceeds of which are to
rural based on population. be distributed between ULB and Panchayats.

Source – O. P. Mathur (June 2000) – Decentralisation In India: A Report Card – UMP Asia Occasional Paper No. 47 – United
Nations Urban Management Programme
Source - India’s Municipal Sector – A Study for Twelfth Finance Commission (TFC) – O.P. Mathur with Sandeep Thakur –
(September 2004 ) – National Institute of Public Finance and Policy – New Delhi
Source – State Finance Commission Reports

94
Annexure IXV – Review of Role Expected of SFCs

Role/Functions Expected of SFCs Tamil Nadu Karnataka Andhra Pradesh West Bengal Gujarat

A. Review the macro-economic environment

within which the municipalities in India operate
1. Functions, powers, and authority; Y Y Y Y Y
2. Limits and constraints within which the Y Y Y/N Y/N Y/N
municipalities are permitted to function
3. Degree of autonomy granted to municipalities. Y Y Y/N Y/N Y/N

B. Undertake an appraisal of the finances

of municipalities
1. Changes and shifts in the fiscal health of municipalities, Y Y Y N N
referring to revenue and expenditure growth and performance
2. Trends in the volume and nature of transfers; and Y Y Y/N N N
3. Key issues in making fuller use of revenue resources
and reordering expenditure priorities Y Y Y/N Y/N Y/N

C. Estimate the revenue gap of municipalities

1. Trends in gap between revenue-raising capacity and Y N Y/N N N
expenditure needs; and
2. Assessment of the level of municipal under spending. N N N N N

D. Project the expenditure needs into the future

1. Assumptions in respect of the expenditure responsibilities; Y Y/N N N N
2. Norms and standards for services and activities; Y Y/N N N N
3. Accounting for revenue gaps and level of under spending Y N N N N
4. Needs arising out of the fiscal disabilities of municipalities. Y N N N N

E. Determine a fiscal package for financing

future expenditure needs
1. Principles for assignment of taxes, duties, tolls and fees; N N N N N
2. Principles for revenue sharing and grants-in-aid; Y Y Y Y Y
3. Degree of access of municipalities to the divisible Y Y Y Y N
pool of state resources;
4. Supplementing the revenue resources with grants-in-aid; and Y Y Y Y Y
5. Pre-conditions for making the fiscal package productive. Y N N N N
6. Relationship between formulae and non-formulae devolution Y N N N N

F. Other Aspects Relevant to Fiscal Devolution

1. Concept of Equalisation Grants Y N N N N
2. Incentive Grants to enhance performance Y Y Y Y Y
3. Reserve Fund and General Purpose Fund Y Y N N N
4. Norms for Inter-se Distribution of EFC Grants Y Y Y N N.A.

95
G. Other Aspects Relevant to Improving Local Bodies
1. Self Reliance and Fiscal Responsibility Norms Y N N N N
2. Debt Management (Borrowing) Policy Y Y N N YN
3. HRM / Staffing Review and Norms Y Y N N N
4. Budgeting Process Y N N N N
5. Administrative and Procedural Streamlining/Reforms Y Y N N YN
6. Accounting and Auditing Reforms Y Y N N N

96
Annexure XV – Views, suggestions of State Governments, Concerned Central Ministries regarding addressing local finance
35
issues and Role Expected of SFCs

Views of the States

8.6 Some of the major suggestions made by the states are as follows:
(i) a formula based approach, need to be followed for grants from the central finance commission; which may include a
minimum level of own revenue generation by the local bodies as one of the conditions;
(ii) the inter se distribution should take into account the rural capital assets rather than the population;
(iii) frequent occurrence of natural calamities should be taken into account; (iv) grants-in-aid should be provided to support an
incentive fund for the panchayat samitis and zilla parishads;
(v) the system of grants should be linked to the level of reforms undertaken by the states; (vi) the central grants should be
conditional upon the implementation of the SFC recommendations by the state government;
(vii) funds should be made available to meet the revenue account gap, as estimated by the SFC, as also for upgradation of
services;
(viii) the divisible pool of central taxes should be expanded by 10 per cent for devolution to local bodies;
(ix) central support is required to bridge the resource gap of local bodies for upgrading the infrastructure to provide services as
per norms;
(x) the Twelfth Finance Commission should follow the approach of the EFC and make an independent assessment of the
resources required by the local bodies;
(xi) an allocation of 5 per cent of the funds may be made for the newly created states; (xii) states, which have truly discharged
their constitutional mandate in letter and spirit of the 73rd/74th amendment, should be rewarded;
(xiii) 50 per cent of the transfers from the state government to the local bodies should be funded by the centre;
(xiv) the transfers recommended by the SFC should be treated as committed expenditure of the state government while
reassessing the expenditure forecasts.

8.7 Some states have sought compensation for the loss of revenue on account of abolition of octroi. Grants have been sought
for improving the training infrastructure and for continuing the efforts to streamline the data base and maintenance of accounts.
Several states have suggested the withdrawal of the condition, which requires either the state government or the local bodies to
provide matching contribution.

8.8 We have taken due note of these suggestions and kept them in view while arriving at the quantum of central grants that
could be set apart for the purpose of supplementing the resources of the local bodies.

Views of the Ministry of Rural Development

8.9 The Ministry of Rural Development (MRD) has raised the following issues related to panchayati raj institutions (PRIs) in its
memorandum:
i) poor revenue efforts by the PRIs; their internal revenue mobilization (IRM) of the PRIs constituted only 4.17 per
cent of their total revenue as per a study done on behalf of the EFC;
ii) inefficiencies arising because of reluctance to charge fees, low rates thereof even when imposed and non revision
for long periods;
iii) state governments prescribing minimum and maximum rates of tax thereby encroaching into the financial
autonomy of the PRIs;
iv) lack of administrative machinery for collection of taxes;
v) limited capacity of the people to pay taxes in the villages, especially in those affected by drought and other
disasters;
vi) inability of the central government to intervene in a substantial manner, local bodies being a state subject;
vii) lack of synchronization in the award periods of the central finance commission and the SFCs;
viii) part acceptance/implementation of SFC recommendations by state governments;
ix) release of funds meant for panchayats to line departments which operate independent of panchayats;
x) inability of the system to regularly collect, compile and monitor the status of panchayat finances;
xi) lack of information on the initiatives that were taken by panchayats towards data base building for which funds
were earmarked by EFC;
xii) poor quality of the SFC reports;
xiii) the casual manner in which SFCs are constituted.

8.10 MRD expressed the view that if a decentralization index is to be used, it should comprise parameters which are simple,
transparent and objective. It may include (i) constitution and functioning of district planning canters as required under article
243ZD; (ii) assignment of all the 29 functions given in eleventh schedule along with funds and all functionaries (iii)
implementation of the SFC recommendations.

Views of the Ministry of Urban Development and Poverty Alleviation

8.14 MUD&PA has suggested the following to improve the functioning of the urban local bodies:—
i) it should be made obligatory for the state governments to take a final decision on the recommendations of the
finance commission within a specified period preferably within 6 months;
ii) urban local bodies should be assigned a separate list of taxes and any exemption from levy of property tax should
be avoided. They should be adequately compensated if any exemptions are given by the state government;
iii) unproductive and non-viable taxes should be abolished and new sources of revenue should be explored;
iv) urban local bodies should explore the possibility of issue of municipal bonds;
v) the accounting procedure should be modernized and use of computer should be facilitated;
vi) performance budgeting and social auditing should be introduced;
vii) the cost of public utility services should be recovered by charging appropriate fees from the user of the services;

35
As reported in the Report of Twelfth Finance Commission – (Chapter – 8 Local Bodies) September 2004

97
 viii) municipalities must progressively recover full costs covering operation and maintenance, billing and collection
and capital;
ix) inter-governmental transfers including share in state taxes and grants-in-aid should be formula based and not
amenable to negotiation;
Abbreviations

12FC – Twelfth Finance Commission

CFC – Central Finance Commission
EFC – Eleventh Finance Commission
FSFC – First State Finance Commission
GOAP – Government of Andhra Pradesh
GOG – Government of Gujarat
GOK – Government of Karnataka
GOTN – Government of Tamil Nadu
GOWB – Government of West Bengal
GP – Gram Panchayat (Village Level Local Government)
IRM – Internal Resource Mobilisation
LB – Local Body
LGI – Local Government Institutes
LSG – local self governments
NIPFP – National Institute of Public Finance and Policy
NIRD – National Institute of Rural Development
PRIs – Panchayat Raj Institutions (Rural Local Governments)
SSFC – Second State Finance Commission
ULBs – Urban Local Bodies
TFC – Tenth Finance Commission
TP – Taluka Panchayat (Block Level Local Government)

ZP – Zilla Panchayat (District Level Local Government)

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Figure 2 - Overall (Macro) Fiscal Devolution Framework in India

Total National Resources

As per Central list provided As per State list provided in

in Constitution Constitution

Union Level
Resources State Level
Resources

Sharing of Union Resources

as per Recommendations of Sharing of State Resource
Central Finance Commission as per new institution of
State Finance Commission

Total State Govt.

Resources

Union’s State’s Share State’s Local Govt.’s Share in

Share In Union’s Resources Share State’s Resources

State to devolve total

amount received as per
Central Finance
Commission to Local
bodies. SFC to design
sharing formula/
frameworks

Rural Local Government’s Rural Local Urban Local Government’s Urban Local Government’s
Own tax / non-tax Government’s Share Share of State & Own tax & non-tax
Control Resources Resources

99
Figure 3 - Schematic Model of Devolution of State’s Resource to LBs

State’s Resources

State’s Local
Share
Ist Level
Government’s Share
Devolution

Rural Local Governments Urban Local Governments IInd Level

(Panchayat Raj Institutions) (Municipal Institutions) Devolution

IIIrd Level
Zilla Panchayats Taluka Panchayats Gram Panchayats Municipal Corporations Municipal Council for Nagar Panchayat for
(District Boards) (Taluka Boards) (Village Boards) for Larger Urban Area Smaller Urban Area a transitional area

MC 1 MC 1 NP 1

MC 2 MC 2 NP 2

ZP 1 ZP 2 ZP 3 GP 1 GP 2 GP 3 MC 3 MC 3 NP 3

MC 4 MC 4 NP 4
IVth Level Inter 101
se Allocation
TP 1 TP 2 TP 3
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Figure 4 - Fiscal Devolution/Transfers – Formulae Based and Discretionary

Local Local Local State’s State’s State’s Centre’s Centre’s Centre’s Centre’s
Tax Capital Tax Non-tax Capital Other
Non Capital Tax Non-tax Resource Resource
Resource Tax Resourc Resourc Resourc Resourc Resourc s Resourc

As per State Finance As per Central Finance

Commission Formulae Commission Formulae

Share of Share of a
Local Bodies State Govt. Share of Share of
State Govt Central Govt

Total Resources of a Local Body

Total Resource of a State Government Total Resource of Central Government

Non Plan grants to ULBs as per State Finance Commission

Non-Plan grants to State as per Finance Commission

Non-formula
Discretionary Grants for State Plan Schemes as
Grants to ULB per Planning Commission
from State

Non-Plan Plan Expenditure Grants for Central Plan Schemes

Expenditure of of Local Body Non-Plan Plan
Local Body
Expenditure Expenditure

Grants for Centrally Sponsored Schemes 103