Deconstructing A New Era in Fiscal Devolution in India
By Yamini Aiyar, Avani Kapur, Padmapriya Janakiraman, 06 Jun 2016

The Accountability Initiative (AI) at CPR has conducted extensive research on fiscal devolution in two separate studies—one that focuses on the effects of the Fourteenth Finance Commission recommendations on state finances, with a particular focus on effects on social sector investments. And a second study that focuses on understanding the fiscal devolution to rural local governments through a case study of fund flows to Gram Panchayats in one district in Karnataka.

Findings from the studies will be shared at a seminar on 3rd June with several stakeholders, including from the government of India. In the run-up, Yamini Aiyar, Avani Kapur, and Padmapriya Janakiraman from AI share their insights (below) on the importance and relevance of these studies, providing a glimpse into critical findings.

Is fiscal devolution a brave new move by the current government?

Yamini: As you know fiscal devolution means devolution of power and responsibilities from national government to sub-national governments. Constitutionally, the government is mandated to set up a Finance Commission (FC) every five years to determine the share of financial resources between the union and the state governments. 

In 2013, the government constituted the Fourteenth Finance Commission (FFC). The FFC recommendations, accepted by the Government of India in February 2015, are an attempt to re-align the constitutionally mandated responsibilities of state governments’ with adequate financial resources. To do this, the FFC recommended enhancing tax devolution (of the pool of resources shared between the centre and the states) to state governments from 32 per cent (Thirteenth Finance Commission) to 42 per cent from the years running 2015 through 2020.

There is a long standing precedent that the government of the day whole-heartedly accepts the recommendations of the Finance Commission. However, it must be said that there was a dissenting note that suggested a slower approach for devolution in the FFC report submitted in February, 2015, but the government chose to overlook that.

So while in its implementation the fiscal devolution being undertaken by the current government is new, it is to be noted that this was not a move made by the government, but was recommended by the FFC. 

Can you tell us more about the research undertaken by the Accountability Initiative (AI) on fiscal devolution?

Yamini: In 2015 after accepting the recommendations of the FFC, the Government of India presented its budget. In its budget presentation, in order to create the fiscal space to enhance tax devolution to state governments, it significantly cut down funds provided to states through Centrally Sponsored Schemes (CSS).

Let me explain how this works—there are different modes through which money is transferred from the Government of India to the states: i) taxes (determined by FC); ii) grants and aid (determined by FC); iii) central assistance to states (determined by the erstwhile Planning Commission, and now coordinated by the line ministries). Central assistance is essentially money tied to priorities identified by the centre, with mechanisms for implementation also largely identified by the centre. Over time, these became a critical source of financing social policy in India.

So what the government has done in the budget is to reduce the funds provided through central assistance (primarily CSS) to enhance tax devolution. While the cuts makes sense constitutionally, since the constitutional responsibility to provide services funded through CSS lies with the states, in practice over the last decade, a large number of these functions were re-appropriated by the centre. So in cutting back the CSS, the centre, in theory, gave the states the choice to prioritise funds the way they would like to in line with their constitutionally aligned responsibilities.

Yet, the move raised an important question. Key social sector services in India, are in many ways, a national responsibility, includingeducationhealth, social protection etc.  And it is the Government of India, which has signed up to the global Sustainable Development Goals to ensure these are nationally realised. So the question raised was how does one ensure that these national priorities are fulfilled if the centre is not financing these key activities (through CSS)? In addition, many state governments too began worrying if the cuts in the CSS would have a significant impact on the fiscal space available to them to invest in the social sector programmes? 

In order to answer these questions, we decided to examine state budgets so as to understand what is actually happening at the state level. It is important to say that given the vagaries of how budgeting takes place in India, the true picture of the investment pattern in this changed scenario will only come to light a few years down the line, because the Government of India and the state governments report on actual expenditure at a two-year lag . Moreover, it is important to take a long term view on such foundational changes to the country’s fiscal architecture.

Therefore the results of our study must be seen as indicative rather than definitive, and it is also important to note that the process of transition will always have teething problems. In that sense the findings are a sign of how states are beginning to adjust to the changed devolution. They also provide us a benchmark with which to track state expenditure over the remaining period of the FFC implementation, so that we have evidence with which to debate the effects of devolution four years from now.

Can you share key findings from the examination of these state budgets in light of the questions raised?

Avani: We studied state budgets from 19 states, and interestingly, despite initial reservations, here is what we found:

  • All 19 states saw an increase in funds transfer, which means that the cuts in CSS were offset by the increase in tax devolution. 
  • Further, even as the centre cut back on funds through the CSS, throughout the year, the Government of India passed a number of supplementary budgets. Consequently, in effect there was no significant reduction in the amount of funds traditionally transferred through CSS; in fact most states saw an increase compared with the previous financial year. 
  • At the all India level, union government transfers to states saw an increase of less than 1% of GDP between 2014-15, and the 2015-16 revised estimates. When we studied it state-wise, all states received at least 20 percent more from the union. 
  • Importantly, we have not seen any drop in expenditure on social sector schemes in these states.

You also conducted a study on fiscal devolution to local governments, especially Panchayats. Can you tell us more about this?

Yamini: The devolution story in India began with the path-breaking 73rd and 74th constitutional amendments (in 1992), when the Parliament committed India to devolving significant powers and responsibilities to a third tier of the elected local government. Over the years, anyone who is familiar with the evolution of the local government system in India will be aware of the fact that the actual devolution of key powers and resources, commonly referred to as the funds, functions, and functionaries, has been limited at best, leaving Panchayats and local municipalities with very little authority and financial resources to fulfill their constitutional mandate.

Despite this, there is very little empirical data that can actually tell us what is happening at the Panchayat level as well as at the local municipality level. More importantly, the key stakeholders (the elected representatives) themselves have very little idea of what powers and resources should be devolved to them, and what actually does get devolved to them.

To address this problem, we began in 2014 a micro-level analysis of trends in fiscal decentralisation to rural local governments (Panchayats) in the state of Karnataka.

Can you share key findings of this micro-level analysis in Karnataka?

Padmapriya: Through a detailed exploration of the Karnataka state budget and an expenditure tracking exercise that focuses on 30 Gram Panchayats (GP) in Mulbagal Taluka, Kolar district, this study tracks trends in fiscal decentralisation in the state, and attempts to identify the specific quantum of monies spent in the jurisdiction of Gram Panchayats contrasted with the money that Gram Panchayats actually receive.  Here is what we found:

  • A significant proportion of money that should be devolved to Panchayats is in fact appropriated by the state government. To explain this further—the total budgetary allocation for Karnataka in the Financial Year (FY) 2014-15 was Rs 1, 50,379 crore (Budgeted Estimates). Based on an analysis of functions devolved to Panchayati Raj Institutions (PRIs), as mandated by the Karnataka Panchayati Raj Act 1993, our study estimates that approximately 33% of the total budget ought to have been devolved to PRIs. However, in actual fact, the state budgeted an allocation of only 17% of its total budget for expenditure by PRIs. 
  • Consequently, Gram Panchayats are accountable for a miniscule proportion of the total monies spent in their political constituencies. Our survey found that the average expenditure (including all administrative and Panchayat activity) within a single GP in Mulbagal in FY 2014-15 was approximately Rs 6 crore. However, only 3% or Rs. 20 lakh of this amount was spent directly by a GP. 
  • Worse, GPs are unaware of the nature and extent of funds spent in their own jurisdiction. This makes it impossible for GPs to track and hold authorities accountable for such expenditure. 
  • Finally, even money that GPs are expected to receive directly from the centre into their accounts are being slowly re-appropriated by the state. 

You then took the findings of this case study in Karnataka back to various stakeholders. Can you share their responses to it?

Padmapriya: We shared the findings with: i) policy makers at the state government level, ii) Gram Panchayat Unions in Karnataka; iii) the Ministry of Panchayati Raj at the centre. At all levels, the response was very encouraging:

  • At the state level, the planning department, finance department, and the treasury have responded proactively by taking some of our recommendations on board, including tracing all the expenditure at the location where it occurs, which will help in aggregating data to a GP.
  • The Gram Panchayat Unions had never been given information of this nature. About 16 Gram Panchayats from North Karnataka have now come forward to do a research of this kind thus enabling them to track expenditures in their jurisdictions.  
  • The Ministry of Panchayati Raj was very receptive as well, and we are in conversation with them to explore if such a study can be replicated in other states.