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Government of Karnataka
Fiscal Architecture of India:
A Comparative Study of Finance Commission Reports
(13th & 14th)
Fiscal Policy Institute
Centre for Financial Accountability and
Decentralisation
2
Table of Contents
Preface .......................................................................................................................................................... 4
1. Executive Summary .................................................................................................................................. 5
2. List of Acronyms ...................................................................................................................................... 8
3. List of Tables .......................................................................................................................................... 11
4. List of Figures ......................................................................................................................................... 12
5. Introduction ............................................................................................................................................. 13
5.1. About the 14th Finance Commission ................................................................................................ 13
6. Objectives of the Study ........................................................................................................................... 15
7. Literature Review .................................................................................................................................... 16
8. Methodology Adopted ............................................................................................................................ 20
9. Findings and Discussion ......................................................................................................................... 21
9.1. Tax Devolution from the Union to the States .................................................................................. 21
9.1.1. Sharing of Union Taxes Comparison ........................................................................................ 22
9.1.2. Understanding the Degree of Tax Devolution Proposed by the 14th Finance Commission ...... 23
9.2. Local Bodies and Local Governments ............................................................................................. 25
9.2.1. Observations about the State Finance Commissions (SFCs) by the 13th Finance Commission 25
9.2.2. Reforms Suggested by the 14th Finance Commission to Strengthen the Local Bodies ............ 25
9.3. Grants-in-Aid ................................................................................................................................... 26
9.3.1. Grants-in-Aid Comparison ........................................................................................................ 27
9.3.2. Understanding Need-based Grants ............................................................................................ 27
9.4. Public Utilities ................................................................................................................................. 28
9.4.1. Public Utilities Comparison ...................................................................................................... 29
9.5. Public Sector Enterprises ................................................................................................................. 30
9.6. Co-operative Federalism .................................................................................................................. 32
9.6.1. Co-operative Federalism Comparison ...................................................................................... 32
9.7. Disaster Management ....................................................................................................................... 34
9.7.1. Disaster Management Comparison ........................................................................................... 34
9.8. Goods and Services Tax (GST) ....................................................................................................... 35
9.8.1. Goods and Services Tax (GST) Comparison ............................................................................ 36
9.9. Public Expenditure Management ..................................................................................................... 37
9.9.1. Public Expenditure Management Comparison .......................................................................... 38
3
9.10. Financial Roadmap for Fiscal Consolidation ................................................................................. 40
9.10.1. Financial Roadmap for Fiscal Consolidation Comparison ..................................................... 41
10. Observations on Compliance ................................................................................................................ 44
10.1. Observations Regarding Compliance in the MTFP 2013-17 of Karnataka with regard to
Recommendations of the 13th Finance Commission ............................................................................... 44
10.1.1. GSDP Calculation ................................................................................................................... 44
10.1.2. Adherence to Fiscal Responsibility ......................................................................................... 44
10.1.3. Debt Sustainability Indicators ................................................................................................. 44
10.1.4. Other Issues ............................................................................................................................. 45
10.2. Observations Regarding Compliance in the MTFP 2015-19 of Karnataka with regard to
Recommendations of the 13th and 14th Financial Commissions ............................................................. 45
10.2.1. General Overview of the Economy ......................................................................................... 45
10.2.2. Creation of the Fiscal Management Review Committee and its Observations ....................... 45
10.2.3. Key Fiscal Challenges for the State of Karnataka .................................................................. 46
10.2.4. Sharing of Union Taxes .......................................................................................................... 47
10.2.5. Centrally Sponsored Schemes (CSSs) .................................................................................... 47
10.2.6. Gross State Development Product (GSDP) Calculation ......................................................... 48
10.2.7. Adherences to Fiscal Responsibility Legislations (FRLs) ...................................................... 49
10.2.8. Debt Sustainability Indicators ................................................................................................. 50
10.2.9. Plan and Non-plan Expenditure .............................................................................................. 50
10.3. Observations Regarding Compliance in the MTFP 2016-2020 of Karnataka with regard to
Recommendations of the 13th and 14th Financial Commissions 10.3.1. Revision in Methodology of
GSDP Estimation and Calculation .......................................................................................................... 51
10.3.2. Debt Sustainability Indicators ................................................................................................. 51
10.3.3. Constitution of the 4th Karnataka State Finance Commission (SFC) ...................................... 51
10.4. Implementation of the Recommendations of the 13th and 14th Finance Commissions by the
Karnataka State Finance Commission (SFC) .......................................................................................... 51
11. Conclusion .......................................................................................................................................... 533
12. REFERENCES ................................................................................................................................... 544
13. Appendices .......................................................................................................................................... 577
13.1. Understanding IFMIS and PFMS ................................................................................................ 577
13.2. States with ratio values of own taxes/GSDP closer to that of Karnataka .................................... 578
4
Preface
This report, titled Fiscal Architecture of India: A Comparative Study of Finance Commission
Reports (13th & 14th), is the outcome of a research study through a short-term consultancy
engagement with the Fiscal Policy Institute (FPI), Government of Karnataka. This research study
was undertaken with a view to understand the implications of the approach followed by the 14th
Finance Commission in addressing issues along different dimensions and how it differed in doing
so from its predecessor, the 13th Finance Commission.
The 14th Finance Commission, which was a constitutionally mandated body headed by Dr. Y. V.
Reddy, was noted for its change in approach and degree of devolution of taxes. A more
comprehensive view to understand the differences between the recommendations of the 13th and
the 14th Finance Commissions was adopted by comparing the recommendations made in 10 areas.
In addition to this, how these recommendations impacted the state of Karnataka and the degree of
compliance by the state in terms of guidelines outlined in the applicable Medium Term Fiscal
Plans (MTFPs) for the time period were also examined. Important sections of academic literature
on Finance Commissions from the time-period of around the 13th Finance Commission were
summarized.
Dr. Kishinchand Poornima Wasdani was the short-term consultant who undertook this study by
compiling and analysing the required literature in the allotted span of time. This report is an
original work done by the short-term consultant and is the intellectual property of the FPI. The
findings of this study have been presented only at an event at the FPI to a restricted audience, and
have not been presented to other academic bodies or at any seminar or conference.
Shri. K. K. Sharma, IPoS
Adviser & Faculty, FPI
Smt. Prachi Pandey, IA&AS
Director FPI
5
1. Executive Summary
The 14th Finance Commission, headed by Dr. Y. V. Reddy, has been in the news for its departure
from tradition in terms of the methodology and degree of tax devolution to the states. It is often
mentioned that this commission proposed the highest percentage of tax devolution in fiscal history.
Although this is one of the primary reasons, there are many other areas in which the 14th Finance
Commission has made significant changes in the mode and focus of issues to be addressed, when
compared to its immediate predecessor, the 13th Finance Commission, which was headed by Prof.
Vijay L. Kelkar.
This study is an attempt to examine the differences in the recommendations proposed by the 13th
and the 14th Finance Commissions in ten different areas, namely: (i) sharing of union taxes; (ii)
local governments; (iii) grants-in-aid; (iv) pricing of public utilities; (v) public sector enterprises;
(vi) co-operative federalism; (vii) disaster management; (viii) goods and services tax (GST); (ix)
public expenditure management; and (x) financial roadmap for fiscal consolidation.
The 14th Finance Commission took into account a more dynamic approach towards population
and considered forest cover to be an important parameter while ignoring past fiscal discipline when
proposing the weights to be used for devolution. Although the proposed devolution figure of 42
per cent is 10 per cent higher than the figure proposed by the 13th Finance Commission, the degree
of difference in actual devolution may be around 3 per cent, as the total devolution by the previous
Finance Commission, when considering grants as well, would have been around 39 per cent. While
the 13th Finance Commission was harsh in its observations with regard to constitution and
recommendations of the State Finance Commissions (SFCs), the 14th Finance Commission
focused more on strengthening local bodies through innovative taxation proposals.
The structure of grants-in-aid has been significantly altered by the 14th Finance Commission, as
the previous Finance Commission had grants divided into plan and non-plan expenditure. In view
of the increased degree of devolution, the states are now free to decide on deployment of funds
with the additional fiscal space available. The 14th Finance Commission also made some key
recommendations in the use and pricing of public utilities such as electricity, transportation and
water. The 13th Finance Commission had highlighted some key lacunae in these areas, while the
14th Finance Commission proposed more concrete measures in terms of amendments of
legislations, setting up of authorized bodies, tariff revision and metering of consumption.
While the 13th Finance Commission made observations about the sorry state of the performance
of the Public Sector Units (PSUs) and proposed divestment in terms of their land holdings and
assets and increased monitoring by the Union, the 14th Finance Commission endorsed the view
and made proposals about more concrete methods to classify the PSUs and modes of divestment.
6
With the creation of the NITI Aayog which has replaced the erstwhile Planning Commission, the
outcome is an advisory body which cannot monitor the utilization of funds in the state.
The 13th Finance Commission was of the view to restore formula-based plan transfers and of
creating a new state finances division in the Ministry of Finance (MoF) to advise the Government
on centre-state fiscal arrangements and financial relations. In the background of the changing
relationship between the centre and the states, the 14th Finance Commission took a more
progressive view and proposed new institutional arrangements for strengthening and monitoring
the grants in important sectors identified among public services, emphazised the role of the
availability of natural resources to states in fiscal policy making, and proposed the expansion of
powers of the Inter-state Council. The 14th Finance Commission has also proposed innovative
ways of funding to augment the National Disaster Response Fund (NDRF), more freedom to the
states in the utilization of the State Disaster Response Fund (SDRF) and making the District
Disaster Response Fund (DDRF) non-mandatory as the needs of disaster-prone districts could be
different.
A key issue that is under discussion these days (in view of the recent Constitutional Amendment)
is that of the Goods and Services Tax (GST). While comparing the recommendations of the 13th
and the 14th Finance Commissions on GST, it could be noted that the recommendations were more
specific in case of the 13th Finance Commission, which suggested a grand bargain between the
Union and the States, the creation of a model GST framework, and the use of Information
Technology (IT) in managing tax processing effectively. While citing its inability to estimate the
losses to the states due to the absence of a Revenue Neutral Rate (RNR), the 14th Finance
Commission did recommend the provision of VAT compensation to the states along with suitable
temporary and long-term arrangements to enable the introduction of the GST regime.
Both the 13th and the 14th Finance Commissions supported streamlining of budgetary
classification in Public Expenditure Management (PEM). Both Commissions were of the view that
the Medium Term Fiscal Plans (MTFPs) of states could be used for better monitoring and
forecasting. The 13th Finance Commission was more focused on enforcement of fiscal discipline
and incentivization for the states on indicators of public scheme implementation, public health,
and provision of better judicial services, and recommended that states setup and maintain
employee and pensioner data bases for those under the old and new pension schemes. Some
innovative proposals by the 14th Finance Commission in this regard were the transition from cash-
based accounting to accrual-based accounting, the use of IT to create an Integrated Financial
Management Information System between the Union and the States, and the re-organization of
Pay Commissions as Pay and Productivity Commissions.
Given the classification of states and their special needs, the issue of managing deficits is often a
sensitive one. While the 13th Finance Commission was of the view that the Revenue Deficit of the
Union was to be reduced progressively and altogether eliminated by 2013-14, the 14th Finance
7
Commission was more specific in terms of the targets of Fiscal and Revenue Deficits of the Union
Government and in specifying eligibility norms for borrowing by the States in terms of their fiscal
discipline. However, both the Finance Commissions were of the view that the Fiscal Responsibility
and Budget Management (FRBM) Act needed to be amended to enable better fiscal consolidation
in view of an economically volatile environment and supported the creation of an independent
Fiscal Council to assess and monitor the implementation of fiscal policies.
Another aspect of this study involved the review of academic literature around the
recommendations of the 14th and previous Finance Commissions, from roughly around the last 15
years. The literature review has provided critical insights into the issues faced by the country in
the context of addressing issues of state deficits, bettering centre-state relations, and different
modes of devolution from the Union to the States.
The third aspect involved in this study has been the examination of the steps taken by the state of
Karnataka with regard to the recommendations of the 14th and previous Finance Commissions.
Interestingly, due to overlapping of the terms of the 3rd and 4th Karnataka State Finance
Commissions (SFCs) with those of the 13th and 14th Finance Commissions, a situation has been
created wherein the recommendations of these two Finance Commissions need to be adequately
reflected in the SFC Reports. Therefore, the Medium Term Fiscal Plan (MTFP) of the Government
of Karnataka which were applicable for the afore-mentioned time periods were selected and
compliances and steps taken in line with the recommendations of these Commissions were studied.
Although Karnataka has one of the best ratio values for States Own Tax Revenues (SOTR)/GSDP
as a percentage, there is scope for significant improvement in the revenues from non-tax receipts.
Also, the revenue surplus can come down due to increasing subsidy burdens and committed
expenditure (on salaries, pensions and interest payments). This points towards the requirement of
moderation in subsidy spending by the state.
Though the revenue scenario in Karnataka can be improved, the state is taking progressive steps,
as exhibited by the enactment of Fiscal Responsibility Legislations (FRLs) and the use of newer
methodologies to calculate the GSDP. The indicators and ratios for the state were found to be
better than the prescribed FRL norms. The debt sustainability indicators are also healthy. However,
the change in the mode of disbursal by the 14th Finance Commission has affected the state
adversely with regard to funding for schemes.
8
2. List of Acronyms
Acronym Expansion
ADR Alternative Dispute Resolution
AMTM Assam, Meghalaya, Tripura and Mizoram
ATF Aviation Turbine Fuel
ATR Action Taken Report
BE Budget Estimate
BPL Below Poverty Line
C&AG Comptroller and Auditor General of India
CGA Controller General of Accounts
CSF Consolidated Sinking Fund
CSO Central Statistical Office
CSS Centrally Sponsored Scheme
CSR Corporate Social Responsibility
CST Central Sales Tax
DDRF District Disaster Response Fund
DES Directorate of Economics and Statistics, Government of Karnataka
DMF Disaster Mitigation Fund
DRF Disaster Response Fund
EU European Union
FC Finance Commission
FD Fiscal Deficit
FMRC Fiscal Management Review Committee
FRBM Fiscal Responsibility and Budget Management
FRL Fiscal Responsibility Legislation
FY Financial Year
GDP Gross Domestic Product
GoI Government of India
GSDP Gross State Domestic Product
GST Goods and Services Tax
GVA Gross Value Added
HDI Human Development Indicator
HSD High Speed Diesel
IFMIS Integrated Financial Information Management System
IMR Infant Mortality Rate
IP Interest Payments
ISC Inter-state Council
9
Acronym Expansion
ISP India Statistical Project
IT Information Technology
KFR Karnataka Fiscal Responsibility
LMMHA List of Major and Minor Heads of Accounts of Union and States
MCA Ministry of Corporate Affairs
MIS Management Information System
MoF Ministry of Finance
MS Motor Spirit
MTFP Medium Term Fiscal Plan
NCCF National Calamity and Contingency Fund
NDRF National Disaster Response Fund
NIF National Investment Fund
NITI National Institution for Transforming India
NPS New Pension Scheme
NREGS National Rural Employment Guarantee Scheme
NSS National Savings Scheme
NSSF National Small Savings Fund
NSSO National Sample Survey Office
NWMA Normal Ways and Means Advances
OG Outstanding Guarantee
OGD Open Government Data
PDS Public Distribution System
PEM Public Expenditure Management
PFMS Public Fund Management System
PMES Performance Management and Evaluation System
PPP Public-Private Partnership
PRI Panchayat Raj Institution
PSU Public Sector Unit
RBI Reserve Bank of India
RD Revenue Deficit
RE Revised Estimate
RGI Registrar General of India
RNR Revenue Neutral Rate
RoI Return on Investment
RR Revenue Receipts
RSBY Rashtriya Swasthya Bima Yojana
RTA Rail Tariff Authority
SDRF State Disaster Response Fund
SERC State Electricity Regulatory Commission
10
Acronym Expansion
SFC State Finance Commission
SJA State Judicial Academy
SOTR State's Own Tax Revenues
SPG State Plan Grant
SPSU State Public Sector Unit
SRS Sample Registration System
STPI Software Technology Parks of India
STT Security Transaction Tax
SWMA Special Ways and Means Advances
TL Total Liabilities
ToR Terms of Reference
UID Unique Identification Number
ULB Urban Local Body
USA United States of America
UT Union Territory
VAT Value Added Tax
WRA Water Regulatory Authority
11
3. List of Tables
Table No.
Table Description
Table 1 Parameter Weights adopted by the 13th and 14th Finance
Commissions (in per cent)
Table 2 Comparison of Recommendations on Sharing of Union Taxes by
the 13th and 14th Finance Commissions
Table 3 Comparison of Recommendations on Grants-in-Aid by the 13th
and 14th Finance Commissions
Table 4 Comparison of Recommendations on Public Utilities by the 13th
and 14th Finance Commissions
Table 5 Comparison of Recommendations on Public Sector Enterprises by
the 13th and 14th Finance Commissions
Table 6 Comparison of Recommendations on Co-operative Federalism by
the 13th and 14th Finance Commissions
Table 7 Comparison of Recommendations on Disaster Management by the
13th and 14th Finance Commissions
Table 8 Comparison of Recommendations on Goods and Services Tax
(GST) by the 13th and 14th Finance Commissions
Table 9 Comparison of Recommendations on Public Expenditure
Management by the 13th and 14th Finance Commissions
Table 10 Comparison of Recommendations on Financial Roadmap for
Fiscal Consolidation by the 13th and 14th Finance Commissions
Table 11 Adherence to Fiscal Responsibility Legislations by the State of
Karnataka
Table 12 SOTR as a percentage of GSDP for Five Selected States/UTs from
2009-10 to 2013-14
Table 13 Aggregate Subsidies and Transfers reported by Tamil Nadu in the
Medium Term Fiscal Plan 2011-12 (Indian Rupees in crores)
Table 14 Subsidy Spending by Four Selected States from 2009-10 to 2014-
15 (Indian Rupees in crores)
12
4. List of Figures
Figure No. Figure Description
Figure 1 Degree of Tax Devolution (in percentage) Proposed by
Successive Finance Commissions
Figure 2 Trends in SOTR as a percentage of GSDP for States/UTs
from 2009-10 to 2013-14
Figure 3 Trends in SOTR as a percentage of GSDP for Five Selected
States/UTs from 2009-10 to 2013-14
Figure 4 Trends in Subsidy Spending by Four Selected States from
2009-10 to 2014-15 (Indian Rupees in crores)
13
5. Introduction
After 69 years of independence and implementation of 12 Five-Year plans, the Government of
India heeded to the long standing demand of the States to give them the desired fiscal freedom to
decide upon the implementation of schemes. The 14th Finance Commission, constituted under
Article 280 of the Constitution of India, decided to devolve maximum money to States and to allow
them the freedom to plan their course of development in place of the previous practice of enforcing
the fiscal schemes from the Union. In other words, a fundamental shift in India’s Federal
relationship was made-reduction in Union-based planning (centralized planning) was replaced by
a corresponding increase in State-level planning (decentralized planning). The new Government
believes that economic development would be possible only through the development of the states
and its strong conviction about Cooperative Federalism are the major reasons behind the new
approach of the finance commission. It was with these beliefs that the recommendations of the 14th
Financial Commission have been wholeheartedly accepted.
Increased money will give the states the required freedom to tailor make the development schemes
to suit their needs. The increase in the devolution to 42 per cent would provide for a balance
between the degree of autonomy of states in determining their expenditures and yet allow for the
centre to make certain specific-purpose grants to the states. The 14th Finance Commission has also
addressed the request of the States to reduce the number of Centrally Sponsored Schemes (CSS)
as well as the outlays on them. This gives an extra physical space to the states to create productive
capital assets.
The rationale behind these changes lies in the weakening of the planning process. The chairperson
of the Finance Commission Dr. Y.V Reddy was probably aware that there were plans to abolish
the Planning Commission which was in charge of the Centrally Sponsored Schemes (CSSs) and
State plan grants, due to its continuous defiance to the directives to empower the States in line with
the needs of the modern economy. In view of the above, some degree of responsibility of planning
for the states was delegated to the respective states. Devolution of taxes and powers have also been
carried out in response to the desire of the states to allow them the desired freedom of planning
and implementation.
5.1. About the 14th Finance Commission
The 14th Finance Commission was constituted under the orders of the President of India in line
with Article 280 of the Constitution on 2nd January 2013, and submitted its report on 15th December
2014. The Commission was chaired by Dr. Y. V. Reddy, former Governor of the Reserve Bank of
India (RBI). The recommendations of this Finance Commission would be implemented over a
period of five years, from 1st April 2015 to 31st March 2020. The major functions of the Finance
Commission are:
14
(i) Tax devolution from the Union to the States: The Finance Commission governs the total
transfer of the taxes from the union to the states. It includes tax devolution under Article 280 and
Grants-in Aid under Article 275 of the Constitution.
(ii) Advisory role in financial assistance to Panchayat Raj Institutions (PRI) and Municipalities:
The decision of funding Panchayat Raj Institutions and Municipalities would be undertaken under
the prerogative of State Financial Commissions using the Consolidated Fund of the States. In order
to strengthen the finances of the States so that effective financial assistance could be provided to
Panchayat Raj Institutions (PRI) and Municipalities, the Financial Commission plays an advisory
role.
(iii) Grants-in-Aid (under Article 275): Finance commission is in charge of prescribing the norm
and the quantum of grants in line with the needs of States. In principal, it is the special purpose
grants (or Gap-filling Gants) given to States to meet the difference between the assessed
expenditure on the non-plan revenue account of each State and the projected revenue including the
share of a State in Central Taxes.
(iv) Other Functions: The other functions include all other matters referred by the President of
India. In case of the 14th Finance Commission, the matters referred include the following:
(i) Pricing of public utilities – how much to levy and how to levy.
(ii) Fiscal Deficit Review of both the Union and States
(iii) Disinvestment of the PSUs
(iv) Goods and Services Tax
(v) Climate change and sustainable development
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6. Objectives of the Study
The main objectives of this research study were:
1) Comparison of the 13th and 14th Financial Commission Report on the following parameters:
(i) Sharing of Union Taxes
(ii) Local Governments
(iii) Grants-in-Aid
(iv) Pricing of Public utilities
(v) Public sector enterprises
(vi) Co-operative Federalism
(vii) Disaster Management
(viii) Goods and Services Tax (GST)
(ix) Public expenditure management
(x) Financial Roadmap for Fiscal Consolidation
2) Discussions on the changes in the new Finance Commission report (14th): Alterations in the
existing schemes, deletions of existing schemes or policies and additions of new schemes and
policies if any.
3) Review of the existing academic literature on the 13th and 14th Finance Commissions.
4) Discussion on the operationalization of the recommendations of the Finance Commissions in
the State of Karnataka by considering the references made to these in the applicable Medium Term
Fiscal Plans (MTFPs).
16
7. Literature Review
This section highlights important reviews of academic literature in the context of challenges and
reforms from the time period of the constitution of the 13th Finance Commission and onwards.
Gurumurthi (2003) noted that gap filling approach followed by Eleventh and other previous
finance commissions had resulted in penalizing fiscally prudent states and in rewarding fiscally
in-disciplined states. It was observed that many countries such as Argentina, Hungary, Indonesia
and others have avoided the gap filling approach of fiscal transfers to their provinces. Another
area which required critical examination was the need to continue the current redistribution
between plan and non-plan expenditure in the budgetary classification. Isaac and Chakraborty
(2008) opined that 12th Finance Commission had witnessed an increase in the share of conditional
and tied transfers to the states and concluded that the existing inter-governmental transfer system
has resulted in an increasing vertical imbalance, conditional and tied grants through various
Centrally Sponsored Schemes, and posed a question mark to the basic autonomy of states. There
existed a need to develop an incentive-compatible transfer system by keeping in mind sub-national
fiscal autonomy. Asymmetric application of financing constraints on centre and states through
restrictions on sub-national borrowings was common in federal countries. Countries such as
Australia and Germany followed a co-operative framework for design and implementation of debt
control while USA followed rule-based control. Lahiri (2000) noted that India followed
administrative control and hard budget constraints had kept State deficits in check but also that the
Centre needs to improve its own fiscal discipline. Regarding sub-national fiscal rules, there were
two basic approaches: In the autonomous approach, the initiative for establishing rules arose from
individual sub-national governments, while in a coordinated approach, all sub-national
governments would be subject to uniform rules to ensure fiscal discipline under the surveillance
of central authority. In this regard, Kopits (2001) had stated that the autonomous approach adopted
in the bill without mentioning state or local jurisdiction seems a logical choice for India. However,
poor fiscal performance of some states and mixed success with past bailouts could press the case
for a co-ordinated approach.
As the vertical and horizontal imbalance among the different sub-national governments could lead
to uneven development of the economy, Hajra et al. (2008) suggested a few options. The 13th
Finance Commission should emphasize on the requirement of the quality of the fiscal adjustment
for higher capital expenditure and enhancement of infrastructure and social sector spending with
beneficial impact on growth and employment. It was also suggested that in the process of fiscal
transfers, the 13th Finance Commission could opt to include the efforts to increase non-tax revenue
as a criterion for horizontal devolution and could give due weight to the need to enhance social-
sector expenditure as a criterion for horizontal sharing. More purpose-specific grants which could
enable enhancement in the level of human development across the states could be considered in
addition to abolishing the post-devolution non-plan revenue deficit grant in view of the elimination
of revenue deficit in the post-FRL phase.
17
Based on a study of budget 2008-09, Ganguly (2009) attempted to address some issues before the
13th Finance Commission and tried to fill the gap in RBI’s assessment of state finances. Due to
recession and other factors, there was an imminent squeeze on the fiscal domain of the states and
as other committed expenditures were about to rise, states needed to undergo larger tax reforms
for broadening their tax base and softening of their fiscal targets for the short-term. Moreover, it
was required to reconsider the channel of the fund transfers from centre to states and thus centre-
state relations. In that continuation of the framework suggested by Ganguly (2009), Pethe (2009)
stated that the 13th Finance Commission needed to devise a formula that moves towards incentive
compatibility. Emphasis was laid on devolving greater proportion to states, given their mandate
for provision of social-sector public goods, diminishing discretionary fiscal space, and assigning
greater weight to the efficiency criteria within the statutory devolution formula. Further, the paper
suggested the computation of income-distance criterion by keeping in mind the intra-state variation
and that decentralization must be strengthened by adding a criterion to the statutory devolution
formula (Pethe, 2009).
Rao et al. (2008), studying the 13th Finance Commission, argued that as far as the transfer system
was concerned even if it may be difficult to make drastic changes in the relative shares of the
states, the commission should give up the tax filling approach. Though it was difficult to change
the share of the states in its recommendations, a paradigm shift could be made to change structure
of incentives and accountability could be included as an inherent part of the transfer system and
this could fully equalize expenditure on basic healthcare and education. While analyzing the 13th
Finance Commission, Chakraborty (2010) concluded that while the proposed increase in vertical
share would help the states, the horizontal distribution formula did not seem can make any
progressivity of transfers. The design of the horizontal distribution formula was such that the fiscal
capacity distance and index of fiscal discipline are in conflict with each other as the former tries
to increase the capacity of the states to spend more and the latter tries to limit their expenditure in
relation to own revenues. Reddy (2009) stated that the 13th Finance Commission was constrained
in making a realistic assessment of the resources and expenditure needs of the centre and the state.
A two-year period was recommended instead of a five-year period, as, during fiscal crisis resource
transfer to states may witness a contraction and it would be unfair to bind the states to such a
dispensation for five years.
Chakraborty (2010) noted that the approach and framework followed by the 13th Finance
Commission with regard to horizontal distribution, the revised road map for fiscal consolidation,
the design of grants to local bodies and various other specific transfers was different from that of
earlier Finance Commissions (FCs). The other strengths of the 13th Finance Commission were the
direct measure of fiscal capacity rather than the per capita income and its use in horizontal
distribution formula and the granting of a predicable share of resources from the central pool of
taxes to local bodies, unlike the ad hoc grants of absolute amount awarded by the earlier FCs.
However, it was also noted that the 13th Finance Commission undermined the fiscal autonomy in
case of bodies in lower levels of Government in a multi-level financial system, and some grants,
18
such as those for elementary education, had design problems and could not augment expenditure.
Further, the road map for fiscal consolidation that provides different fiscal adjustment paths to
different states to reach the target of a fiscal deficit of 3 per cent of GDP can be questionable. This
reinforces the view of the 12th Finance Commission, however, this should not be imposed as state-
specific levels of sustainable deficit differ depending on state-specific growth, the interest rate on
debt and the level of primary deficit.
Chakraborty and Bhadra (2010) noted that the economic recession had resulted in a decline in
fiscal transfers, and that stagnant revenue buoyancy has compressed fiscal space of the states.
Even after increasing the limits of the state level market borrowings, the sub-national fiscal
imbalance did not seem to be solved. The paper concluded that the 13th Finance Commission’s
recommendations of incentive grants linked to adherence to these state-specific adjustment paths
of main fiscal variables like revenue deficit, fiscal deficit and the outstanding debt to GSDP ratio
may impose unnecessary rigidities in state-level fiscal operations. A critique by Dholakia (2010)
on the research by Chakraborty and Bhadra (2010) said that a state’s role was very limited and was
not very significant, and that economic crises are better addressed at the national levels as was
demonstrated by the financial crisis. Even if states had their own fiscal agenda, they needed to
address medium and long-term fiscal objectives rather than short-term objectives. Dholakia (2010)
analyzed two important aspects of the recommendations of the 13th Finance Commission. The
increase in the weight of the Index of Financial Discipline from 7.5 per cent to 17.5 per cent in the
tax devolution scheme by dropping the tax-GSDP ratio, and the Fiscal Capacity Criterion (with
47.5 per cent weightage) replacing the equalization objective of the 12th Finance Commission
which had 50 per cent weightage. Such changes were not desirable as their outcomes would not
be satisfactory, with richer states receiving increased tax shares and relatively low-income states
receiving very low share of allocations.
The 13th Finance Commission has forayed much beyond the domain of a FC by recommending as
many as 12 different types of grants with a host of conditionalities. However, as per Rao G (2010),
response to the report has been muted and there is hardly any serious analysis and discussion except
on the recommendations related to GST. The other major concern of the 13th Finance Commission
Report is the abundance of conditionalities imposed and the questions over the design and
implementations of these conditions, in addition to monitoring compliance. As a result, some
states have raised the issue of autonomy as it may not be possible to implement all conditionalities.
Moreover, some of the conditions can be met only in long-term and not in the award period of 13th
Finance Commission. It is questionable how conditions could be enforced when there are no
incentives, as State Governments and local bodies could lose grants if the conditions are not
fulfilled. Regarding GST regime, there should be some freedom and choices to the states. Rao K
(2010) noted that it was desirable to retain some commitments on the same. The classification of
goods and services in to different categories should remain the same across all States and at the
Union Government-level, and there should be harmonization in compliance and administration.
For the floor rates, references could be taken from Canada or the European Union (EU). Das-Gupta
19
(2010) criticized the 13th Finance Commission for not having chosen the best possible route to
ensure public expenditure more outcome-oriented, even though a number of suggestions were
made in its report to achieve output-oriented outlays.
Kumar (2015) observed that the recommendations of the 14th Finance Commission had brought in
a new era of co-operative federalism between the Union and States. Grants to local bodies and to
11 states that had a revenue deficit would provide a huge fillip, but would also discourage the
Union to become involved in the affairs of the states henceforth. Sharma (2015), in a study on
federalism, has also noted that the true essence of collaborative federalism would work only when
there are “balanced, transparent and distortion-free system of inter-governmental fiscal relations”.
By considering both the plan and non-plan share of revenue requirements in the divisible pool,
there will be a burden on the Union which would lose Rs.1 50,000 crore to the States in 2015-16
when compared to 2014-15 (Sharma, 2015).
D’Souza (2015) reviewed the recommendations of the 14th Finance Commission, and noted a
significant difference from the earlier Finance Commissions, in that the Terms of Reference (ToR)
of the 14th Finance Commission did not restrict the Commission’s mandate only to the non-plan
revenue of the States, nor was there a requirement to consider commitment of the Union
Government to provide budgetary support to the plan. Other critical issues that helped the 14th
Finance Commission were the option to consider demographic changes since 1971, the assessment
of the Fiscal Responsibility and Budget Management (FRBM) Acts that were in force. The 14th
Finance Commission was also “obliged to review public enterprises and prioritize them”, and this
would lead to a list of non-priority public enterprises that could be put up for divestment (D’Souza,
2015).
This represented a shift in paradigm from the earlier approach of increasing plan transfers for
Centrally Sponsored Schemes (CSSs). This shift has been made without an increase in aggregate
transfers, but by a change in the composition of untied Transfers. He also observed that the 14th
Finance Commission has increased the share of untied grants to the States, enabling them to decide
on their financial future (D’Souza, 2015).
Another important change in the recommendations of the 14th Finance Commission was the move
away from the “historical distinctions between general and special category states”, while at the
same time providing for a grant of Rs. 1,94,821 crore to the North-eastern states. This was done to
account for any fiscal imbalances that could arise out of the high cost of public service delivery
and low revenue capacity. However, it was also noted that the use of the income distance formula
may not be the best manner to devolve funds, as this may not encourage the preservation of
incentives for better performance by the States during the period (D’Souza, 2015).
Regarding the Inter-state Council (ISC), D’Souza (2015) adopts a cautious tone, suggesting that it
needs to be a more consultative body to address the proposed issues of identifying sectors for
1 The abbreviation “Rs.” used in this Report denotes Indian Rupees.
20
grants and recommending resources for the North-east while taking into consideration economic
and environmental concerns. This view has found support by Sharma (2015), who suggests that
the ISC can be viewed as a “constitutional entity which can provide the institutional backing to the
vision of collaborative federalism in India.” It has been proposed that the ISC would be entrusted
with “decision-making responsibilities and tasks such as policy research and investigation”, and
must have a more expanded role, functioning as a collaborative body.
On the issue of the proposed bi-annual public debt report, especially in the context of a national
debate on the creation of a Debt Management Agency, it is critical to note that the Government
would need to manage targets for reduction in debt (medium or long-term objective) and targets
for inflation and growth (short-term objective). D’Souza (2015) has re-stated the observations of
the 14th Finance Commission, that while the role of the Union in disciplining States with regard to
fiscal discipline has been noteworthy, its own allegiance to the rules has not been impressive.
The survey by Sharma (2015) also found support a proposal to convert the Finance Commission
into a permanent body, as this would provide for annual projections and allocations with an
increased level of monitoring, which would be considerably different from the five-year
projections that are currently in vogue. Respondents also suggested that there needs to be a culture
of transparency and accountability through periodic dissemination of public information on
performance of public services.
8. Methodology Adopted
A qualitative research methodology has been used in this research study. Wherever possible, the
parameters present in the recommendations of the 13th and 14th Finance Commissions under
similar heads have been compared and presented on the basis of similarity in terms of the concerns
they intend to address. Observations on compliance by the State of Karnataka regarding these
recommendations in the applicable Medium Term Fiscal Plans (MTFPs) have been made.
Wherever necessary figures for comparable parameters have been employed and analyzed using
percentage analysis technique. Data for the study has been drawn from published academic and
Government or Government-approved sources.
21
9. Findings and Discussion
In this section, the key areas in which the prominent recommendations of the 14th Finance
Commission have been made are discussed, and have also been compared with those of the 13th
Finance Commission wherever applicable.
9.1. Tax Devolution from the Union to the States
Tax devolution is done at two levels: Vertical Tax Devolution – denoting the transfer of funds
from the Union to the States, and Horizontal Tax Devolution – denoting the transfer of funds across
and within the States.
(i) Vertical Tax Devolution: Money transfer from Union to States was handled by the Planning
Commission and the Finance Commission. Following the disbandment of the Planning
Commission, its role is handled by the Finance Ministry. The Finance Commission recommends
the Tax Devolution and Grants-in-Aid, whereas the Finance Ministry deals with the Centrally
Sponsored Schemes (CSSs), State Plan Grants (SPGs) and Implementation of State Five-year
schemes.
(ii) Horizontal Tax Devolution: The 14th Finance Commission has proposed an ideology of
Progressive Horizontal Devolution to check against Income and Regional Imbalances. The
reasoning for Horizontal Devolution is as follows with their respective weightages:
a) Consider the populations of the states in 1971: 17.5 per cent.
b) Demographic Change in 2011 (due to population growth and out migration): 10 per cent.
c) Income Distance: Per capita GSDP of the state compared to that of the best states – Goa,
Sikkim and Haryana. The more the income distance, the more is the money disbursed: 50 per
cent.
d) Area of the State: 15 per cent.
e) Forest cover of the State: To account for losses in the opportunity cost due to non-urbanization
– 7.5 per cent.
Table 1 shows the differences in parameter weights adopted by the 13th and 14th Finance
Commissions.
Table 1: Parameter Weights adopted by the 13th and 14th Finance Commissions
(in per cent)
Parameter 13th Finance Commission 14th Finance Commission
Population (1971) 25 17.5
Population (2011) 0 10
Income Distance 47.5 50
Area 10 15
Forest Cover 0 7.5
Fiscal Discipline 17.5 0
22
The key issues while disbursing money to the States were:
(i) Formula based unconditional transfer of taxes to the State.
(ii) Different states have different requirements, and so the approach of ‘one size fits all’ is not
correct
(iii) The Union Government would do away with the Centrally Sponsored Schemes (CSS) in
favour of new arrangement with the States to devolve mutually benefit schemes.
The key recommendation of the 14th Finance Commission is the devolution of 42 per cent of
Union taxes from the Union to the States. These taxes recommended for devolution by the 14th
Finance Commission will NOT include the following taxes:
(i) Taxes levied by the Union but collected and kept by the States under Article 268. These taxes
do not go into the Consolidated Fund of India.
Examples: Stamp Duties on cheques, promissory notes, insurance policies and share transfers.
Excise Duties on medicinal and toiletry preparations with alcohol and narcotics.
(ii) Taxes levied and collected by the Union but assigned to the States under Article 269 of the
Constitution.
(iii) Interstate Commerce - Central Sales Tax (CST) – belongs to the exporter state but is retained
by the Union.
(iv) Taxes under Article 270 and Surcharges levied under Article 271 would not fall under the
purview of devolution of taxes.
(v) Divisible Pool of Central Taxes – All the Central Taxes such as Corporation Tax, Income Tax,
Excise Duty, Service Tax, Customs Duty, STT and Wealth Tax.
This recommendation of the 14th Finance Commission represented a huge leap over the similar
recommendation made by the 13th Finance Commission, which suggested the devolution of 32 per
cent of taxes from the Union to the States. The following table discusses the difference between
the recommendations of the two Finance Commissions for the sharing of the taxes.
9.1.1. Sharing of Union Taxes Comparison
Table 2 shows the key differences between the recommendations of the 13th and the 14th Finance
Commissions in the area of Sharing of Union Taxes.
23
Table 2: Comparison of Recommendations on Sharing of Union Taxes by the 13th and
14th Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
States share in net proceeds of Union Tax
revenue 32 per cent.
States share in net proceeds of Union Tax
revenue increased to 42 per cent. Highest
increase by any Finance Commission.
Rs.3,37,808 crore was transferred as tax
devolution.
Rs.5,23,958 crore to be transferred as tax
devolution.
States with high fiscal discipline
benefited.
States with high forest cover to be
benefited by horizontal devolution.
13th FC accounted for 7 per cent of net
transfers from Centre to State in ways of
grants.
14th FC scrapped away 7per cent grants
and diverted it through increase in tax
devolution.
Centrally sponsored schemes were funded
by the Union.
Through net increase in transfer to states.
States will be held responsible for
centrally sponsored schemes.
Note on Dissent by Prof. Abhijit Sen, Member of the 14th Finance Commission – Prof. Abhijit Sen
was not in agreement with quantum of tax devolution. According to him only 38 per cent of taxes
must be allocated for vertical distribution. The allocation of a high level of taxes of 42 per cent
will force the Union to cut down its plans over a period of time. Also the gap between the rich and
poor states will increase and create faults in federalism.
9.1.2. Understanding the Degree of Tax Devolution Proposed by the 14th Finance
Commission
Figure 1: Degree of Tax Devolution (in percentage) Proposed by Successive Finance
Commissions
(Source: Adapted by the author from Gurumurthi (2016))
29.00 29.50 30.5032.00
42.00
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
40.00
45.00
X XI XII XIII XIV
24
Figure 1 shows the trend in degrees of devolution of taxes (in percentage on the Y-axis) proposed
by successive Central Finance Commissions (from the 10th to the 14th Finance Commissions, as
represented by the respective roman numerals on the X-axis). For the span from the 10th Finance
Commission until the 13th Finance Commission, the percentage increase in devolution was 3
percentage points, i.e., from 29 per cent to 32 per cent. This has suddenly increased by 10
percentage points to 42 per cent in line with the recommendations of the 14th Finance Commission.
In mathematical terms, this presents itself to be a radical increase in devolution, especially in the
background of the incremental approach followed by the past few Finance Commissions. This has
been acknowledged to be the biggest ever increase in tax devolution (Government of India, 2015).
However, an examination of the trend alone does little to explain the actual reasoning behind this
step.
The 14th Finance Commission has shifted from the approach used by the previous Finance
Commissions regarding the devolution of taxes, in that the entire revenue expenditure needs of a
State have been considered without making a distinction between plan and non-plan expenditures
(14th Finance Commission, 2014). This was also made possible due to the distinction in the Terms
of Reference, which, unlike in the past, did not “restrict the Commission to meeting non-plan
revenue expenditure requirements alone” (Bakshi and Upadhyay, 2015; D’Souza, 2015). In view
of this comprehensive approach undertaken by the 14th Finance Commission, the Post-devolution
Revenue Deficit Grants are intended to cover the entire revenue deficits of the States, as applicable
(14th Finance Commission, 2014).
The shift in paradigm, from the earlier approach of increasing transfers for Centrally Sponsored
Schemes (CSSs) has been made possible through a difference in composition of untied transfers,
and cannot be seen only as an increase in the aggregate (D’Souza, 2015). To understand the
increase in devolution from another perspective, the total transfers (including devolution and
grants) specified by the 13th Finance Commission, was around 39 per cent (“Accelerating
devolution”, 2015). This figure is comparable to the 42 per cent devolution proposed by the 14th
Finance Commission with a shift in its approach, and does not seem to indicate a radical increase.
It is therefore, misleading to compare the recommended devolution figures specified by the 13th
and 14th Finance Commissions, according to Prof. M. Govinda Rao, member of the 14th Finance
Commission, as it does not present the full picture (Bakshi and Upadhyay, 2015). So, while there
has been a radical increase in the level of tax devolution due to the novel approach followed by
the 14th Finance Commission, only a thorough understanding of the reasoning behind the exercise
can help in determining the actual nature of increase in tax devolution.
25
9.2. Local Bodies and Local Governments
9.2.1. Observations about the State Finance Commissions (SFCs) by the 13th Finance
Commission
An earlier attempt of maintaining Fiscal disciple was by creating SFCs which did not take off very
well with the States. The 13th Finance Commission made some observations with regard to the
financial autonomy provided to the States in decision-making about the funds allocated to them
and the current state of affairs. This trend had been following based on observations from previous
commissions also:
(i) 73rd Constitutional Amendment in 1992 mandates the creation of State Financial Commissions
(SFCs) which would advise the state on distribution of funds from the State’s Consolidated Fund.
SFCs were supposed to have been constituted within a year of the amendment and thereafter at
regular intervals of 5 years. However, this has not been done at regular intervals.
(ii) The recommendations of these State Finance Commissions (SFCs) have not been implemented
by the states in the specified time-frame. It was noted that the Action Taken Report (ATR) about
the recommendations made by the State Finance Commissions (SFCs) had not been tabled in the
State Legislatures.
(iii) Some states implemented the recommendations of the SFCs, but this was not done in the
specified time-frame.
(iv) There is an observable lack of synchronicity between the State Finance Commissions and the
Finance Commission constituted by the Union Government.
9.2.2. Reforms Suggested by the 14th Finance Commission to Strengthen the Local Bodies
The 14th Finance Commission has recommended the following Tax Reforms within the States
with the objective of increasing the revenue of the State and ensure the maintenance of Fiscal
discipline in the State.
(i) States must devolve some of their taxes to the Panchayat Raj Institutions (PRIs). They could
also empower local bodies to collect taxes.
(ii) States must share the mining royalties earned in a region with the Panchayat Raj bodies in that
region. Likewise Property Tax and Advertising Tax must also be shared.
(iii) States can expand Entertainment Tax. They can either devolve the taxes earned on Cable
Television, Internet Cafes and Boat Rides to the PRIs or empower the local bodies to collect taxes
on these.
(iv) Professional Tax: It has been recommended that the Professional Tax under Article 276 of
the Constitution be raised to Rs. 12,000/- per annum when compared to the existing Rs. 2,500/-
26
per annum. Local bodies are already levying Professional Taxes in the states of Kerala and Tamil
Nadu.
(v) Property Tax
a) Property tax is often not raised with a view to keep the voters happy. However, the value of
property also rises and it must be taxed accordingly.
b) Assessment of Property Tax must be done every 4-5 years.
c) Stringent Action must be recommended against the defaulters.
d) As per Article 285(1): Union properties cannot be taxed by a state/local body. While the 13th
Financial Commission recommended that these properties be taxed, the 14th Financial
Commission has recommended that local bodies should be compensated in this exercise.
(vi) North-Eastern States
a) As per sections 9 and 9A of the 73rd amendment of the Constitution of India dealing with PRIs
and Local Bodies, the devolution of taxes does not apply to the states of Assam, Meghalaya,
Tripura and Mizoram (AMTM).
b) Article 275(1) of the Constitution needs to be amended so that the recommendations of the
14th Finance Commission for the PRI would hold.
(vii) Municipal Bonds
a) To create smart cities, there is a need for Municipal Corporation to have a corpus of funds.
b) Large Municipal Corporations are recommended to launch Municipal Bonds directly in the
market.
c) For smaller municipal corporations, the States are expected to create a market intermediary
company that would act on their behalf in the open market and handle the issue and sale of
Municipal Bonds.
(viii) Sector-specific Grants such as those for strengthening the Police and the Judiciary will not
be given anymore to the states, in view of the high degree of devolution of 42 per cent of taxes.
9.3. Grants-in-Aid
Grants-in-aid refer to grants made by the Union to the States in excess of the allocation of taxes to
the States by the Finance Commission with an objective of the Strengthening the Finance position
of urban and rural local bodies like Municipalities and Panchayat Raj Institutions (PRIs)
respectively.
(i) Vertical Devolution: The 14th Financial Commission has mandated a disbursal of Rs. 2.87 lakh
crore as grants-in-aid in excess of the recommended devolution of 42 per cent of taxes. Rs. 2 lakh
crores have been demarcated for disbursal to Rural Local Bodies and Rs. 87,000 crores have been
earmarked for disbursal to Urban Local Bodies.
(ii) Horizontal Devolution: The Horizontal devolution is done by calculating the formula with 90
per cent weightage for the state’s population in 2011 and 10 per cent weightage for the state’s area.
27
(iii) Rural and Urban Local Body Grants: Rural Local Bodies will receive grants through a fixed
basic proportion of 90 per cent and a performance-based proportion of 10 per cent. Urban Local
Bodies will receive grants through a fixed basic proportion of 80 per cent and a performance-based
proportion of 20 per cent. Performance will be evaluated based on the submission of audited
reports and the degree of effectiveness of implementation of schemes.
9.3.1. Grants-in-Aid Comparison
Table 3 shows the key differences between the recommendations of the 13th and the 14th Finance
Commissions in the area of Grants-in-Aid.
Table 3: Comparison of Recommendations on Grants-in-Aid by the 13th and 14th Finance
Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
The normal central assistance was given
by the Planning Commission.
All the grants were subsumed as vertical
devolution increased to 42 per cent.
Grants to state was divided into plan and
non-plan expenditure
Grants are now proposed to rural and urban
local bodies as performance grant and
grants for disaster relief and revenue
deficit.
Funds were diversified into sector-specific
and state-specific grants
Both sector specific and state specific
grants have been scrapped. It now focuses
on need based grants. Freedom of
deployment is with the state.
9.3.2. Understanding Need-based Grants
The term ‘need-based’ is related to the sector-specific requirements and grants of the States. A
brief background is necessary to understand this issue better. The Report of the 13th Finance
Commission was very specific in recommending grants to States for achieving targets in different
areas such as incentivization of the UID, reduction of infant mortality, improvement in justice
delivery, training of police personnel and innovation in public systems, to name a few (13th Finance
Commission, 2009). On the other hand, the 14th Finance Commission has categorized requests for
sector-specific grants into four areas: general administration (judiciary and police), environment,
and social sectors (including elementary education, health, drinking water and sanitation) (14th
Finance Commission, 2014).
Finance Commissions have noted that as the requirements to be addressed for each state in
different sectors to address are different, this has led to considerable inter-state disparity.
Equalizing the grants for States, even in specific areas, is an exercise in itself. As an example, the
14th Finance Commission Report cites the case of the 12th Finance Commission, which attempted
this exercise for grants in the areas of elementary education and healthcare, but finding it very
28
difficult to do so, ended up recommending grants to cover only 15 per cent of the short fall in the
education sector and 30 per cent of the short fall in the healthcare sector. When these grants are
examined in terms of their relative magnitudes, it has been noted that the grants recommended by
the 13th Finance Commission in the healthcare and elementary education sectors were estimated
to be only 1.57 per cent and 1.95 per cent of the total likely revenue expenditure of all states, i.e.,
not a significant proportion (14th Finance Commission, 2014). This serves as a pointer to increasing
the financial autonomy of States by providing them with the required fiscal space to design and
implement their schemes.
The 14th Finance Commission has stated that while the case of the environment has been dealt with
by accounting for the forest cover in the State in the formula for horizontal devolution, handling
disparities in requirements of the States in the other three areas must be done by utilizing the
additional fiscal space available to the States in view of the increased level of tax devolution. In
addition to the dropping of the distinctions between plan and non-plan expenditures, a post-
devolution deficit grant of Rs. 1,94,821 crores has been recommended for eleven states (14th
Finance Commission, 2014).
The experiences of previous Finance Commissions with sector-specific grants have not been
encouraging. Disbursal of grants to the States in specific sectors was usually accompanied by
requirements of matching contributions from the States, or with certain conditions. Finance
Commissions broadly specified the guidelines, while actual implementation details were left to the
State and Union Governments. The other key concern is that as the Finance Commission is not a
permanent body, the delivery of sector-specific and monitoring of schemes/States for satisfying
the requisite conditions has not been consistent over the years. Therefore, while agreeing that the
States would require assistance from the Union Government to meet their needs in the specified
sectors, it has been noted that the mechanism of meeting sector-specific requirements of States is
not best addressed through Finance Commissions (14th Finance Commission, 2014).
Grants in the areas of health, education, drinking water, and sanitation must be designed and
monitored by the States in tandem with the Union Government. The 14th Finance Commission has
hinted that the implementation of grants in these areas must be based on principles of co-operative
federalism. The Commission has also added that grants for specific projects or schemes by the
states would not be considered, as these were best left to the States themselves (14th Finance
Commission, 2014).
Thus, ‘need-based’ in the context of grants can be understood as those areas mentioned above
which need to be addressed by the States in view of the additional level of fiscal devolution
provided by the 14th Finance Commission in its recommendations.
9.4. Public Utilities
This section focuses on the improvements suggested by the 14th Finance Commission in the
accountability and pricing of key public utilities such as Electricity, Transportation and Water.
29
(i) Electricity: States often provide farmers with incentives such as free electricity, but they do not
compensate (or delay compensation) the Electricity Companies for the losses they incur on account
of these State provided subsidies. The 14th Finance Commission recommended that the Electricity
Act of 2003 must be amended to enforce penalties for the States in case of delay or non-
compensation for subsidies provided to the Electricity Companies and to ensure the enforcement
of creation and operationalization of State Electricity Regulatory Commissions (SERCs) and State
Electricity Regulatory Commissions Fund in all the states. This has not yet been followed by many
states.
(ii) Railways: The Rail Tariff Authority (RTA) is an advisory body as per the Railways Act of
1989. The Railway Ministry can take its advice but is not bound by it. The 14th Finance
Commission has recommended that the RTA be made a statutory body for the regulation of rail
fares across the country.
(iii) Roadways: There needs to be an Independent Regulating Body for the Road Sector, which
monitors and determines the fares for taxis, buses, rickshaws, and also educates the consumers on
their rights to avail good transportation services.
(iv) Water: The 14th Finance Commission has recommended that all states must set up a Water
Regulatory Authority (WRA). The WRA will determine the prices (fees and service charges) of
water usage in three categories – drinking, irrigation and industrial uses and to monitor the
consumption of water, a Water Meter will be installed at the expense of the Customer in his/her
office/home.
9.4.1. Public Utilities Comparison
Table 4 shows the key differences between the recommendations of the 13th and the 14th Finance
Commissions in the area of Public Utilities.
Table 4: Comparison of Recommendations on Public Utilities by the 13th and 14th
Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
Electricity Board at loss as power being
distributed without meters too
14th FC is focused on achieving 100 per cent
metering for all electricity consumers.
Electricity Act of 2003 does not have any
provision for levying penalties for delays in
payment of subsidies by State Govt.
Act is to be amended to facilitate levy of
penalties.
WRA existed in few states only. All states urged to set up WRA so that water
pricing of water for domestic and irrigation can
be controlled independently and in a judicious
manner.
30
Table 4: Comparison of Recommendations on Public Utilities by the 13th and 14th
Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
Water charges collected on the basis of
property tax.
Water charges should be determined on
volumetric basis and this is possible only if
water meters are fixed.
Tariff revision was controlled by elections if
any.
Tariff revision must be revised once a year in
April irrespective of election year or not.
Increase in fuel costs and power purchase was
subsumed by Electricity board.
Increase in Fuel cost, power purchase must be
passed to consumers twice a year.
9.5. Public Sector Enterprises
The focus of the issues dealt with in regard to the Public Sector Enterprises in the reports of the
13th and the 14th Finance Commission are outlined in the Table 5.
Table 5: Comparison of Recommendations on Public Sector Enterprises by the 13th and 14th
Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
A List of all Public Sector enterprises that
yield a lower rate of return on assets than a
norm to be decided by an expert committee to
be put in place by the GoI
Emergence of new realities – open
markets, entry of the private sector,
economic integration and technological
developments – to be considered when
deciding the priorities of the Central PSUs.
A new public enterprise policy with focus
on fiscal costs and benefits is to be built.
The significantly underperforming asset of
Central PSUs is their institutional land. As full
data regarding this is not available with the
ministries, a land bank must be put in place
recording all the inventory of land held by the
PSUs. This land resource must be properly put
to use, or else sold for use in other public
projects.
Government should assess the opportunity
costs to retain the current level of
investments in PSUs, which could be done
using different methods, also factoring in
the liabilities. After this is done, a decision
on the level of Government ownership of
public enterprises can be taken.
31
Table 5: Comparison of Recommendations on Public Sector Enterprises by the 13th and 14th
Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
The operations of 1160 state PSUs has not
been very encouraging. They have an
accumulated loss of Rs. 65924 crore. Only
PSUs of nine states have earned aggregate
profits. Viability of the loss-making State
Public Sector Units (SPSUs) have to be
addressed and the states must move forth for
the closure of the non-core SPSUs.
Government should have a transparent
public sector worker’s policy to address the
employee issues in the context of
divestment/relinquishment of ownership.
More than 70 per cent of SPSUs have
accounts in arrears and their audits have been
pending since long stretches of time. State
Governments are directed to ensure the
clearance of all accounts of PSUs in
consultation with the Comptroller and Auditor
General of India (C&AG).
Classification of public enterprises as
“high-priority”, “priority”, “low-priority”
and “non-priority” based on certain criteria
as strategic activity, assignment of
sovereign natural resources RoI, provision
of public utilities etc for high priority and
priority enterprises, and indicative criteria
of market conditions and socio-economic
considerations for “low-priority” and “non-
priority” enterprises. Future plans for such
enterprises must be made accordingly.
States should consider setting up of a holding
company which would absorb all the assets
and liabilities of non-working PSUs and work
to liquidate them.
Open auction must be carried out for the
sale of non-priority unlisted public
enterprises along with their assets and
liabilities.
States must constitute a Task Force/Standing
Committee on Restructuring under the
Chairmanship of the chief Secretary to advise
the Finance Department on restructuring,
divestment and privatisation of State PSUs.
New Policy to be put in place regarding
level of Government investments in PSUs
based on their priority classification. This
may include some purchase of shares to
increase the levels of Government
ownership.
Minimum dividend of 5 per cent on
Government equity should be paid by SPSUs
to enhance their financial viability.
Reiterated the recommendations of 13th
Finance Commission on winding up the
NIF.
Ministry of Corporate Affairs (MCA) must
monitor all Central and State PSUs for
compliance with statutory obligations.
Small share of disinvestment proceeds must
go to the states in which the units being
divested are located in.
32
Table 5: Comparison of Recommendations on Public Sector Enterprises by the 13th and 14th
Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
The disinvestment receipts must go into the
Consolidated Fund for utilization on capital
expenditure. The National Investment Fund
(NIF) must be wound up.
As part of review of PSUs, new policy must
enforce regulations on borrowing by the
enterprises, payment of dividends and
transfer of excess reserves.
Logic of 14th FC recommendations on PSUs
be adopted by the states in addition to
following the recommendations of the 13th
FC on State PSUs.
Setting up of a Financial Sector Public
Enterprises Committee to examine and to
recommend the appropriate future fiscal
support to Financial Public Sector
Enterprises, recognizing their future needs.
9.6. Co-operative Federalism
In addition to the tax devolution by the Finance Commissions there are also the Centrally
Sponsored Schemes, State Schemes and Plan Expenditures. While the erstwhile Planning
Commission could decide about the utilization of the disbursed taxes in the state, the NITI Aayog
(which replaced the Planning Commission in 2015) is currently only an advisory body and not
empowered to decide on the utilization of the disbursed funds in the state. Additionally, the
Finance Commission also does not have the authority to regulate Social-sector schemes. Therefore,
the 14th Finance Commission recommends that the Inter-State Councils, which are dealt with under
Article 263 of the Constitution, be empowered to be able to decide on the design of social sector
schemes and on their distribution criteria. The 14th Finance Commission also recommends the need
to focus on the development of the North-Eastern states and the environment.
9.6.1. Co-operative Federalism Comparison
Table 6 shows the key differences between the recommendations of the 13th and the 14th Finance
Commissions in the area of Co-operative Federalism.
Table 6: Comparison of Recommendations on Co-operative Federalism by the 13th and 14th
Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
Creation of a council of financial ministers,
fiscal council, local body ombudsman etc.
The Commission can recommend a
specific-purpose grant for sectors
overlapping responsibilities between the
Union and the States but not be involved in
the transfer.
33
Table 6: Comparison of Recommendations on Co-operative Federalism by the 13th and 14th
Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
Creation of a new state finances division in the
Ministry of Finance (MoF) to provide policy
advice on matters pertaining to inter-
governmental fiscal arrangements and
financial relations.
Grants in the areas of health, education,
drinking water and sanitation identified as
important sectors among public services,
must be carefully designed and
implemented through a new institutional
arrangement between the Union and the
States.
Setup an on-going research programme on
issues of fiscal federalism in India to provide
inputs to MoF.
New institutional arrangements to
strengthen cooperative federalism by
identifying sectors in the states that could be
eligible for Union grants and indicating the
criteria for inter-state distribution. States
must be provided flexibility to implement
the designed schemes.
Reduce the number of schemes sponsored by
the centre and restore formula-based plan
transfers.
As North-Eastern states have some similar
economic and political characteristics, and
largely depend on the resource from from
the Union Government, the new
institutional arrangement must consider
identifying and recommending resources
for inter-state infrastructure schemes there.
Role of Natural Resources further
emphasized. As states lose out on taxes and
income on account of preserving the forests
and provision of services to the public on
account of forest cover, new institutional
arrangement must also take into
consideration economic and environmental
concerns in decision-making.
Recommended the expansion in the powers
of the Inter-State Council, a
recommendatory body, with enhancing its
powers to cover the allocation of financial
resources to the states to supplement the
transfers recommended by the Finance
Commission.
34
9.7. Disaster Management
The National Disaster Management Act of 2005 had created a Disaster Response Fund (DRF) and
a Disaster Mitigation Fund (DMF), at three administrative levels – the Union, the State and the
District. However, the DMF has not been implemented by many states, and so the
recommendations of the 14th Financial Commission focus on the DRF. Thus, the important
developments are with regard to the National Disaster Relief Fund (NDRF), State Disaster Relief
Fund (SDRF) and District Disaster Relief Fund (DDRF) as below:
(i) National Disaster Response Fund (NDRF): The 13th Finance Commission merged the
National Calamity and Contingency Fund (NCCF) with the National Disaster Response Fund
(NDRF). The 14th Finance Commission recommends a new arrangement for the collection of
corpus for the NDRF. The NDRF is collected as a cess on customs and excise currently. This will
change once GST comes into implementation. This necessitates a new arrangement for the
collection of the funds for the NDRF. The 14th Finance Commission recommends that private
donations to the NDRF must be encouraged with a tax exemption for the donor. There is also a
recommendation that the Companies Act be suitably amended to enable companies to route their
CSR funds to the NDRF. The 14th Finance Commission has also recommended the addition of the
following calamities: Heat waves, coastal erosion, bamboo flowering, snake bites and attacks by
monkeys and elephants.
(ii) State Disaster Response Fund (SDRF): Under Article 275(1), Union grants to the SDRF can
be recommended by the Finance Commission. There are two categories of states on the basis of
which the grants on this issue can be made: General Category (75:25 ratio) and Special Category
(90:10 ratio). The 14th Finance Commission has recommended that all the states be disbursed
money in the 90:10 ratio. The disbursal of the money to the States would be based on the Hazard
Risk Vulnerability Index – a vulnerable state would get more money. A total of Rs. 61,000 crores
is recommended to be disbursed to the SDRFs.
(iii) District Disaster Response Fund (DDRF): The 14th Finance Commission has stated that the
DDRF be made non-compulsory. This is to be done as some districts which may not be calamity-
prone would end up collecting funds for management of disasters that are not really probable, and
this money could be utilized in some other useful areas.
9.7.1. Disaster Management Comparison
Table 7 shows the key differences between the recommendations of the 13th and the 14th Finance
Commissions in the area of Disaster Management.
35
Table 7: Comparison of Recommendations on Disaster Management by the 13th and 14th
Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
The following calamites were considered
under disaster management: cyclones,
droughts, earthquakes, fires, floods, tsunamis,
hailstorms, landslides, avalanches, cloud
bursts and pest attacks.
Cold waves and frosts were added to the list
in the 14th Finance Commission report.
The Union’s share is paid in two instalments.
The second instalment is paid only on receipt
of report giving the details of expenditure
Timely and immediate help of the Union
Government is suggested.
Current allocation of SDRF (State Disaster
Response Fund) is Rs. 33581 crore.
Suggested increase in SDRF by 50 per cent to
Rs. 50,372 crores.
Common set of norms for all states is an
unfair practice
Labour and cost of relief materials vary from
state to state Hence to set a common norm for
all states is an unfair practice. States should be
given a free hand to set their own norms of
utilization of SDRF.
States compulsory transferred funds to
districts via DDRF (Disaster Management
Relief Fund) irrespective of their need.
DDRF should not be made mandatory.
Compulsory transferring for funds to DDRF
results in thin funds and also funds may lie idle
in districts which are not affected by any
disaster. This in turn deprives the districts
affected by natural calamity.
9.8. Goods and Services Tax (GST)
With regard to the Goods and Services Tax (GST), it can be noted that the recommendations of
the 13th Finance Commission seem to be more specific in nature and those of the 14th Finance
Commission. This could possibly have been due to the evolving nature of requirements with regard
to the GST Scheme at the time of constitution and operation of the 13th Finance Commission. The
14th Finance Commission is specific in recommending the creation of a Compensation Fund and
regarding the compensation to be provided to the states in terms of the Value Added Tax (VAT).
Barring these, the other recommendations are more generic in nature. On the other hand, the 13th
Finance Commission probably had the benefit of foresight in recommending specifics such as the
grand bargain and the terms to be followed by the states, and was also instrumental in suggesting
a model GST framework. The 13th Finance Commission also highlighted the role that Information
Technology and electronic processing would play in the implementation of an effective GST
regime, and suggested putting in place an effective IT infrastructure to manage the tax processing
36
and to issue electronic passes for vehicles passing through state borders to enable electronic tax
collection and disbursal.
9.8.1. Goods and Services Tax (GST) Comparison
Table 8 shows the key differences between the recommendations of the 13th and the 14th Finance
Commissions in the area of Goods and Services Tax (GST).
Table 8: Comparison of Recommendations on Goods and Services Tax (GST) by the 13th
and 14th Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
Emphasized the conclusion of a ‘Grand
Bargain’ between the State and Union
Governments as the introduction of the GST
would have long-term fiscal implications for
both of them.
Recommended a change in the attitude of the
Union Government – bearing the fiscal burden
imposed on it due to the introduction of the
GST regime was to be seen as a long-term
investment and not merely as a sinking fund.
A compensation amount (GST Grant) of Rs.
50,000 crores was suggested to be disbursed in
a staggered manner to the states from 2010-11
to 2014-15: Rs. 5000 crores in the first year and
Rs. 11250 crores per year for the remaining
four years.
Penalties were to be imposed on States for any
non-compliance in line with the Grand Bargain
between the Union and the States.
Provision of VAT Compensation to the states
must be increased from the duration of three
years to five years with the scheme of 100 per
cent compensation being paid to the states in
the first 3 years, 75 per cent in the fourth year
and 50 per cent in the fifth year.
Recommended the authorization of the
Empowered Committee of State Finance
Ministers into a statutory council and the role
of a 3-member committee in quarterly
disbursal of compensation.
As the structure and the Revenue Neutral Rate
(RNR) of the GST have not been finalized, the
14th Finance Commission was unable to
estimate the revenue structure and the losses to
the states.
Suggested a Model GST Framework with the
final calculation proposing a single rate of 5
per cent of Central GST and 7 per cent of State
GST. Also proposed an implementation
schedule for the same. The GST Tax Base was
estimated to be Rs 31,25,325 crores using an
average of forecasts from five studies.
Suggested the creation of an autonomous GST
Compensation Council with a limited period of
operation to retain the confidence of the States.
Suitable protectionist measures were proposed
in terms of an additional levy imposed on High
Speed Diesel (HSD), Motor Spirit (MS),
Aviation Turbine Fuel (ATF), alcohol and
tobacco by both the Central and State
Governments with no input tax credits.
Long-term constitutional provisions to be put
in place with the suitable temporary
arrangements to enable smooth introduction of
the GST regime.
37
Table 8: Comparison of Recommendations on Goods and Services Tax (GST) by the 13th
and 14th Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
In case of non-implementation of the model
GST as suggested or implementation of the
GST regime in another form, the compensation
fund of Rs. 50,000 crores was not to be
disbursed.
9.9. Public Expenditure Management
In the report of the 14th Finance Commission, the focus is on three areas of Public Expenditure
Management (PEM): budgeting and accounting standards, classification of receipts and
expenditures, and the linking of outlays to outcomes. Key indicators about outputs must be
specified and must be monitored within a defined accountability framework. The commission also
noted that efforts are currently on to link outputs, outlays and outcomes through a real-time
computerized platform including a Management Information System (MIS) and a Performance
Management and Evaluation System (PMES), and that budgetary innovations such as zero based
budgeting, performance budget and outcome-based budgeting were used from time-to-time. The
12th Finance Commission highlighted the need to move to an accrual-based accounting system
from a cash-based accounting system, and the need to adopt better budgetary procedures and better
monitoring of Public Expenditure programs. This view had been endorsed by the 14th Finance
Commission as well.
The issue of Budgetary Classification, which was addressed by both the 12th and 13th Finance
Commissions, has found support with the 14th Finance Commission as well, which has
recommended creation of a few uniform Object Heads such as salary, maintenance, subsidies and
grants-in-aid, across both the Union and States. States have to take the burden of pay revisions
much more when compared to the Union, as the fiscal impact of this is more severe on them.
Previous Pay Commissions had made recommendations to enhance the productivity of the
employee by using technology in delivery of public services and in creating public assets. The 14th
Finance Commission has been more specific in suggesting pathways to implement better Public
Expenditure Management while taking some cues from the recommendations of the 13th Finance
Commission, which used more broad-based recommendations across other heads to suggest ways
to enhance efficiency of Public Expenditure Management (PEM).
The 13th Finance Commission observed that better governance was the key to ensuring better
management of public expenditure. However, to incentivize changes in governance, better and
more dynamic parameters were required as proxies for fiscal capacity, fiscal need and revenue
effort. The 13th Finance Commission noted that the absence of such indicators were a lacunae in
this regard, and recommended the availability of such data-based indicators to consider reforms in
the area of Public Expenditure Management. However, there were propositions in the areas of
38
incentivizing through grants and in improving outcomes through improved district governance and
transparency in Government accounts.
The 14th Finance Commission observed that the grants that States receive from the Union is often
close-ended and states need to commit a certain percentage of their budget as matching
contributions. Thus, the priorities of States in allocating funds for Budgetary Allocations is often
dependent on Union Government programs, and the utilization of these funds is often possible
only when the funds are released by the Union Government. The states also need to bear the impact
of any cancellation or discontinuing of CSSs. This necessitates better cash management on the part
of both the Union and the States, which need to take into account the Fiscal Responsibility
Legislations and forecasts in the Medium Term Fiscal Plans (MTFPs). As States bear the brunt of
the recommendations of Pay Commissions while paying salaries, and those of pension payments,
the 14th Finance Commission recommended States switch over to the New Pension Scheme (NPS)
if they have not already done so.
9.9.1. Public Expenditure Management Comparison
Table 9 shows the key differences between the recommendations of the 13th and the 14th Finance
Commissions in the area of Public Expenditure Management.
Table 9: Comparison of Recommendations on Public Expenditure Management by
the 13th and 14th Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
Recommended uniformity in the Budgetary
Classification Code and a standardized list of
appendices to the Finance Accounts. The
suggested Classification Code must be
uniform across states.
Review the existing classification of the
revenue and capital expenditure heads.
Ensure a uniform set of Object Heads are
used to facilitate comparison between States.
Other than the uniform Object Heads, states
must have the flexibility to open more heads
based on their requirements.
Public expenditure by the creation of funds
outside the consolidated funds of the states
was discouraged. In some cases, this caused
a conflict of interest as large amounts of
funds were set up to support sectors which
should have been covered under the budget,
but these expenditures were not under the
purview of the State Legislatures. Any
expenditure through such funds and civil
deposits therefore required to be audited
under the purview of the C&AG.
The Public Fund Management System
(PFMS) developed by the CGA enabled
tracking of all plan funds to the Consolidated
Funds of the States, but was not linked to
their treasuries. There must be a move
towards end-to-end sharing of fiscal
information through an Integrated Financial
Management Information System (IFMIS)
between the Union and States. This would
help in monitoring sector-specific grants
better.
39
Table 9: Comparison of Recommendations on Public Expenditure Management by
the 13th and 14th Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
A strict demarcation must be made regarding
the type of expenditure that constitutes
current (or recurrent expenditures) and those
which constitute public expenditure.
Responsibility for preparation of outcome
budgets at the level of actual spending must
be assigned to the Government at the relevant
level.
The practice of transfer of budgetary
allocations from the consolidated fund to the
civil deposits at the end of the Financial Year
must be stopped.
Minimize the spending by the states at the
end of the Financial Year to avoid lapses.
Timely preparation and tabling of the
accounts in both the Union and State
Legislatures must be carried out in line with
the recommendations of the C&AG.
Measures to report the compliance costs of
major tax proposals in MTFPs must be
introduced by the Union Government. This
could be done from the 2013-14 Budget
onwards.
A more disciplined and scientific approach
needs to be adopted by both the States and
the Union to improve their forecasts in the
MTFPs, which must take into account past
trends. Forecasts in the MTFPs are to be
translated as Annual Targets in the Budget,
rather than as projections.
Incentivized the issue of Unique
Identification Number to certain categories
of citizens – BPL, old age pensioners - from
States who participate in certain schemes
such as NREGS, Rashtriya Swasthya Bima
Yojana (RSBY) and the Public Distribution
System (PDS). A grant of R. 2989 crores to
States was proposed in this regard.
Pay Commissions be re-designated as ‘Pay
and Productivity’ Commissions. There must
be a focus on linking technology with skills
and incentives. Increase in remuneration
must be linked with the increase in
productivity. A consultative mechanism
must be put in place through the Inter-state
Council to evolve a national policy for
salaries and emoluments.
Specified a system to incentivize States on
the reduction in Infant Mortality Rates (IMR)
with data for the year 2009 from the Sample
Registration System (SRS) of the Registrar
General of India (RGI) being used as a base
line. A total grant of Rs. 5000 crores was
recommended over three years, 2012-15.
Consider the recommendations of the Second
Administrative Reforms Commission
(2005), and decide upon how these
recommendations could be implemented to
enhance internal audit and control systems in
line with them.
40
Table 9: Comparison of Recommendations on Public Expenditure Management by
the 13th and 14th Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
Improvement in justice delivery is proposed
through cumulative grants of Rs. 5000 crores
for the following measures:
a) Increase working hours of courts: Rs.
2500 crores.
b) Support Lok Adalats: Rs. 100 crores.
c) Establishing ADR Centres and training of
mediators/conciliators: Rs 750 crores.
d) Legal Aid provision to the marginalized to
access the justice system: Rs. 200 crores.
e) Training of judicial officers and public
prosecutors and creation of court managers:
Rs. 700 crores.
f) Augmentation or Creation of State Judicial
Academies (SJAs): Rs. 300 crores.
g) Maintenance of heritage court buildings:
Rs. 450 crores.
Transition from cash-based accounting to
accrual-based accounting for both the Union
and State Governments. Setup the necessary
infrastructure for capacity building to train
accounting professionals in accrual-based
accounting in this regard. Consider the views
of the List of Major Heads of Accounts of
Union and States (LMMHA) Committee of
2010.
All states were advised to setup and maintain
employee and pensioner data bases. Separate
data bases need to be built for pensioners
who draw pensions under the defined benefit
scheme and for those under the New Pension
Scheme (NPS). A grant of Rs. 10 crore for
each General Category state and Rs. 5 crore
for each Special Category state to be
provided for this purpose.
States that have not yet switched over to the
New Pension Scheme (NPS) to do so at the
earliest as it would help by transferring future
liabilities to the New Pension Fund and
factors current liabilities according to the
revenues of the States.
A grant of Rs. 616 crores at the rate of Rs. 1
crore per district was recommended for all
the State Governments to address any gaps in
the statistical infrastructure that was not
addressed by the India Statistical Project
(ISP).
9.10. Financial Roadmap for Fiscal Consolidation
The 13th Finance Commission had put in place a road map that envisaged the elimination of the
Revenue Deficits of the Union and State Governments (for those states with deficits) in a phased
manner. The 13th Finance Commission also suggested that there must be a window to enable
fiscally weak States that cannot raise funds from the market to borrow from the Union
Government.
41
As per the projections of the 14th Finance Commission, the introduction of the GST and
rationalization of the tax structure and improvements in the macroeconomic conditions, the Union
Government is expected to eliminate Fiscal Deficit much earlier than 2020. The 14th Finance
Commission also urged improvement in the quality of fiscal management in terms of receipts and
expenditures. Both the Union and the State Governments must be held accountable by each other,
though it has been stressed that the role of the Union Government’s pre-dominant role in fiscal
management must be acknowledged.
With the introduction of the flexibility in the limits of the fiscal deficit, the 14th Finance
Commission has reiterated that the additional deficit of up to 0.5 per cent each year can be availed
only in case there is no revenue deficit in the current and previous year.
9.10.1. Financial Roadmap for Fiscal Consolidation Comparison
Table 10 shows the key differences between the recommendations of the 13th and the 14th Finance
Commissions in their proposed Fiscal Roadmap for Financial Consolidation.
Table 10: Comparison of Recommendations on Financial Roadmap for Fiscal Consolidation
by the 13th and 14th Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
68 per cent of GDP target for combined debt of
Union and States to be achieved by 2014-15.
Revenue Deficit of the Union must be reduced
in a progressive manner and eliminated
altogether by 2013-14.
Fiscal Deficit of the Union Government
estimated to be 3.6 per cent in 2015-16 to be
fixed at 3 per cent of GDP for the remainder of
the award period. The Revenue Deficit is
expected to reach a level below 1 per cent of
GDP by 2019-20.
Medium Term Fiscal Plan (MTFP) must be
converted into a statement of commitment
rather than a statement of intent. There needs to
be greater integration between the MTFP and
the Annual Budget exercise.
Borrowing for States are to be enunciated as
follows:
a) Fiscal deficit for all states anchored at 3 per
cent of GSDP.
b) Eligibility for an additional 0.25 per cent in
the current year case their debt-GSDP ratio is
less than or equal to 25 per cent in the preceding
year.
c) Further eligibility of 0.25 per cent in the
current year in case interest payments are less
than or equal to 10 per cent of revenue payments
in the preceding year.
d) The eligibility of the states for the additional
deficit is dependent on their revenue deficits
being nil for the current and the previous year.
42
Table 10: Comparison of Recommendations on Financial Roadmap for Fiscal Consolidation
by the 13th and 14th Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
The FRBM Act must specify courses of action
to be taken in case of macroeconomic and
structural shocks in the economic environment.
There must be specific devolution schemes to
the enable the states to receive the financial aid
in case of such shocks.
Consider amending the FRBM Act to omit the
definition of effective revenue deficit with effect
from 01 April 2015 with the focus on balancing
the revenues and expenditure account enunciated
in the FRBM Act. As an alternative to amending
the FRBM Act, the Union Government may
replace it with a Debt Ceiling and Fiscal
Responsibility Legislation, invoking Article 292
in the preamble.
FRBM process implementation must be
monitored independently by the Union
Government, initially through a committee and
later through an annual independent public
review process. It was suggested that this body
could evolve into a Fiscal Council.
FRBM Act to be amended to support the setting-
up of an independent Fiscal Council to undertake
ex-ante assessment of the fiscal policy and
implementation of budget proposals.
Disinvestment receipts must be transferred to
the consolidated fund henceforth. The transfer
of disinvestment receipts to the public account
must be discontinued.
Stronger mechanism for ensuring compliance
with fiscal targets and enhancing the quality of
fiscal adjustment through the design of an
incentive-compatible framework for the Union
and State Governments to hold each other
accountable.
Revenue Deficit (RD) and Fiscal Deficit (FD)
for General Category States must be brought to
(in terms of GSDP) to nil and 3 per cent
respectively by the year 2014-15.
State Governments amend their respective
FRBM Acts to set statutory flexible limits for
Fiscal Deficit.
Fiscal Deficit for Special Category States with
High Base FD to be progressively reduced to 3
per cent of GSDP.
Both the Union and State Governments need to
bring out a bi-annual statement on the debts of
the State and Union Governments with a
comparable basis and place it in the public
domain.
Loans from the National Small Savings Fund
(NSSF) contracted till 2006-07 to be reset at a
Rate of Interest of 9 per cent for those loans
outstanding at the end of 2009-10.
State Governments to be excluded from the
operations of the NSSF with effect from 01 April
2015, except in cases where they need to
discharge their debt obligations incurred until
date.
43
Table 10: Comparison of Recommendations on Financial Roadmap for Fiscal Consolidation
by the 13th and 14th Finance Commissions
13th Finance Commission (2009) 14th Finance Commission (2014)
National Savings Scheme (NSS) to be
transformed into a market-aligned scheme.
Acknowledged the need for a Consolidated
Sinking Fund (CSF) for the Union Government,
but stated that this must be deliberated upon
based on the earlier experience of CSFs at the
State-level.
44
10. Observations on Compliance
10.1. Observations Regarding Compliance in the MTFP 2013-17 of Karnataka with
regard to Recommendations of the 13th Finance Commission
10.1.1. GSDP Calculation
The GSDP for the year 2012-13 for the State of Karnataka was assumed to be Rs.5,20,766 crore
in line with the projections of the 13th Finance Commission. For the Financial Year 2013-14, the
Government of India estimated the GSDP for Karnataka to be Rs. 6,01,633 crore based on
estimates from the Central Statistical Office (CSO), taking into account a growth rate of 14.5 per
cent. This figure has been used for the estimates. The nominal GSDP was expected to grow at a
rate of 14.5 per cent every year for the Financial Years 2014-15, 2015-16 and 2016-17 according
to the estimates of the 13th Finance Commission. The Inflation Rate has been projected to come
down from 7.5 per cent in Financial Year 2013-14 to 5.5 per cent in Financial Year 2016-17
(Government of Karnataka, 2013).
10.1.2. Adherence to Fiscal Responsibility
In line with the recommendations of the 13th Finance Commission, the Government of Karnataka
has amended the Karnataka Fiscal Responsibility (KFR) Act (vide Amendment in 2011), to
incorporate year-wise ceilings for key debt indicators as a part of Fiscal Responsibility Legislations
(FRLs), such as Fiscal Deficit, Revenue Deficit and Outstanding Debt as a percentage of GSDP
till 2014-15. This change has been made according to the directions of the Government of India
(Government of Karnataka, 2013).
10.1.3. Debt Sustainability Indicators
The 13th Finance Commission had prescribed the debt-to-GSDP ratio for Karnataka to be within
25.2 per cent for the year 2014-15. The year-wise ceiling for this ratio to be adhered to was to be
25.7 per cent. This ratio was estimated at 22.66 per cent and 22.59 per cent in the Budget Estimates
(BE) and Revised Estimates (RE) for the year 2012-13, showing that the state is ahead in terms of
the indicators. Karnataka State has adhered to the limit of 3 per cent of GSDP for the Fiscal Deficit,
as prescribed by the 13th Finance Commission. During the Financial Years 2008-11, the
Government of India permitted increased borrowing to enable growth of the economy. For the FY
2012-13, the Budgetary Estimates and the Revised Estimates pegged this ratio to be 2.94 per cent
and 2.93 per cent respectively (Government of Karnataka, 2013).
The 13th Finance Commission mandated two indicators to be monitored to assess the debt
sustainability of the state, the ratios of Interest Payments to Revenue Receipts (IP/RR) and Total
Liabilities to GSDP (TL/GSDP). The Karnataka Fiscal Responsibility (Amendment) Act of 2011
prescribes the ceiling for outstanding debt to be 26 per cent in Financial Year 2011-12 and
downwards to 25.2 per cent in Financial Year 2014-15. The IP/RR ratio has been below 11 per
cent since FY 2009-10, and in FY 2012-13, it was expected to reduce further to around 8.1 per
45
cent in terms of Revised Estimates. Therefore, the state was well ahead of the targets prescribed
by the 13th Finance Commission in terms of debt management (Government of Karnataka, 2013).
10.1.4. Other Issues
The cash balance of the state is maintained by the Reserve Bank of India (RBI) at Nagpur. As the
state had not availed of any Special Ways and Means Advances (SWMA) and Normal Ways and
Means Advances (NWMA) since 2007-08 due to a comfortable cash position, the surplus cash was
invested in the Government of India’s 14-day Treasury Bills, which had a low yields of 5-6 per
cent. In line with the advice of the C&AG of India and the 13th Finance Commission, any additional
balance available with the Government was being invested in 91-day Treasury Bills of the
Government of India (Government of Karnataka, 2013).
The MTFP also contains some forward statements on a balanced approach towards inter se
allocations amongst States to be adopted by the Finance Commission, with a suggestion that this
could include equal weights for equity and efficiency considerations. The equity aspect comprises
of need factors such as population, area and HDI, and the efficiency considerations comprise of
tax effort and fiscal discipline. As the States were expected to suffer financially with the proposed
implementation of the Goods and Services Tax (GST), it was suggested that these losses be
suitably assessed and that the creation of a proposed GST Council and a mechanism be devised to
recommend the broad contours and mode of compensation to be awarded to the States
(Government of Karnataka, 2013).
10.2. Observations Regarding Compliance in the MTFP 2015-19 of Karnataka with
regard to Recommendations of the 13th and 14th Financial Commissions
10.2.1. General Overview of the Economy
Based on the projections of the 13th Finance Commission, the Government of Karnataka had
assumed the GSDP for the Financial Year 2014-15 to be at Rs. 6,85,207 crores at current prices in
the MTFP for 2014-18. These figures were conveyed by the Ministry of Finance. For the Financial
Year 2015-16, the Government of Karnataka did not receive any figures formally from the Union
Government, and the formula prescribed in the 14th Finance Commission Report was used to
calculate a revised GSDP for FY 2015-16, that worked out to 12.4 per cent in nominal terms over
the earlier GSDP figure and came to Rs. 7,36,237 crores. The State has adopted this figure to
finalize the ceilings for the fiscal and debt parameters (Government of Karnataka, 2015).
10.2.2. Creation of the Fiscal Management Review Committee and its Observations
According to the requirements of the KFR Act, a Fiscal Management Review Committee (FMRC)
has been constituted to review the Fiscal and Debt position of the State under the Chief Secretary.
This FMRC discussed the impact of the recommendations of the 14th Finance Commission due to
the Centrally Sponsored Schemes on the state.
The recommendations of the 14th Finance Commission resulted in drastic reduction of transfers
through Centrally Sponsored Schemes (CSS). On increased flexibility and autonomy available to
46
the States, the FMRC emphasized the need to setup a Review Committee to assess the continuity
of certain CSSs, in particular, those from Category B, in which the Central share has been reduced
below 50 per cent. This Committee was expected to be set up once the sharing practice between
the Union and State Governments had been firmed up in line with the recommendations of the 14th
Finance Commission. This committee would have two mandates (Government of Karnataka,
2015):
a) Dovetail existing development goals of the state with the CSSs wherever feasible.
b) Creation of flexible fiscal space in cases in which the dovetailing of such CSS schemes are
not possible.
The FMRC also emphasized on the contraction of the borrowing space available for the State in
view of the recommendations of the 14th Finance Commission, and suggested that different means
be explored for the increase in surplus revenues for funding the capital expenditure of the State.
This would require the constant monitoring of tax collection efforts and a periodical review of the
departments to improve the collections of non-tax revenues by levying user charges and fees
(Government of Karnataka, 2015).
The ratio of the Total Liabilities/GSDP ratio for the FY 2015-16 was 23.01 per cent as per
Budgetary Estimates and rose to 23.41 per cent in FY2015-16 as per the Revised Estimates, closer
to the 25 per cent limit specified in the KFR Act. Hence, any payments made to the Public Sector
Enterprises (PSEs) or any Special Purpose Vehicles (SPVs) of the State as part of the Extra
Budgetary Resources (linked to off-budget borrowings) to PSEs/SPVs must be done after a careful
consideration of the importance of their requirement and their capability to repay the lent amounts
(Government of Karnataka, 2015).
There may be considerable changes to the manner in which funds would be allocated and disbursed
in view of the formation of the NITI Aayog and the disbanding of the Planning Commission. The
FMRC suggested that all the Administrative Departments should evaluate their schemes to ensure
that there is optimum utilization of the technological, financial, and human resources to cater to
the beneficiaries. The Administrative Departments need to come out with time-bound action plans
in this regard.
Those schemes which required allocations over multiple Financial Years needed to be approved
based on the fiscal sustainability of the total expenditure rather than that for the year of approval
only. Not doing so could lead to the build-up of large amounts of fiscal stress due to large unfunded
expenditure commitments (Government of Karnataka, 2015).
10.2.3. Key Fiscal Challenges for the State of Karnataka
The Key Fiscal Challenges identified for the State of Karnataka for the FY 2015-16 were as
follows:
47
a) Narrowing of the revenue surplus gap in view of the increasing subsidy burden and
committed expenditure in terms of salary, pension and interest payments. Nearly 14 per
cent of the revenue expenditure was spent on subsidies in FY2014-15. A major chunk of
these subsidies (61 per cent) comprised of Energy subsidy, Food subsidy, Co-operative
subsidy and Transport subsidy. Expenditure on subsidies needed to be moderated in the
medium and long-term to make it sustainable.
b) Though the ratio of own taxes/GSDP is among the highest for the State of Karnataka, the
receipts of non-tax revenues have not increased along expected lines. Only incremental
growth is possible in this regard, and this would require a re-prioritization of expenditures.
c) The State does borrow to meet the competing needs for various priority sectors. These
borrowings are not open-ended but are limited by a ceiling posed by the legislation (KFR
Act, as amended in 2011). The ratio parameters of the Fiscal Liabilities and Total Deficit
to GSDP must be reined in within the specified limits. All unfunded or partially funded
liabilities must be monitored to ensure that expenditure is sustainable.
d) Supplementary requirements of Departments must be aligned to their needs and must be
minimized during the budgetary cycle.
Administrative Departments were advised to ensure that appropriate estimates are made of their
requirements for the ensuing year at the time of budgeting. While citing any additional
requirements of funds, it was suggested that departments needed to identify “corresponding
surrenders in their overall budgetary provisions by identifying low priority expenditures.” It was
also recommended that they move over to a 3 or 5-year planning and implementation cycle and
explore possibilities of Public-Private Partnership (PPP) wherever feasible (Government of
Karnataka, 2015).
10.2.4. Sharing of Union Taxes
The increase in the degree of devolution of Union Taxes to the States, as prescribed by the 14th
Finance Commission would result in an increase in the share of Union Taxes being devolved to
Karnataka from the existing 4.33 per cent to 4.71 per cent; an additional Rs. 8229 crores would
be devolved to the State (Government of Karnataka, 2015).
10.2.5. Centrally Sponsored Schemes (CSSs)
In the memorandum submitted to the 14th Finance Commission, the State of Karnataka had
highlighted the issue of centralization in the allocation of funds and the general decline in the share
of State plans. It was suggested that the number of Centrally Sponsored Schemes be reduced and
that there be a move towards formula-based transfers.
The 14th Finance Commission suggested that a three-tier scheme classification be adopted to
delineate those schemes which have Union support and those which do not. Support has been
retained to Category A schemes; Union support will continue but with a modified funding pattern
for Category B schemes, while for Category C schemes, Union support has been delinked
(Government of Karnataka, 2015).
48
In the Budgetary Estimates for FY 2015-16 of Rs. 16,245 crores, the State of Karnataka would
have received Rs.11,721 crores as the share of the Union. With the revisions made due to the 14th
Finance Commission, the projected receipt of the State from the Union will likely be Rs.7031
crores, with a deficit of Rs.4689 crores (Rs.76 crores in Category A, Rs.4185 crores in Category
B, and Rs. 428 crores in Category C). The State has committed its own resources in funding CSS
in critical sectors such as Agriculture, Drinking water, Education, Nutrition etc., resulting in an
additional commitment of Rs. 4689 crores (Government of Karnataka, 2015).
10.2.6. Gross State Development Product (GSDP) Calculation
The 14th Finance Commission has recommended that the borrowing limits for a state be calculated
as a percentage of the GSDP. The GSDP for a given year ‘(y-1)’ and the fiscal year (y) must be
estimated by applying the annual average growth rate of GSDP in the years (y-2), (y-3) and (y-4)
on the base GSDP (at current prices) of (y-2). State estimates of the GSDP published by the CSO
must be used for this purpose. The 14th Finance Commission has also notified the following
changes (Government of Karnataka, 2015):
a) Fiscal deficit of all States to be anchored at an annual limit of 3 per cent of GSDP. States
can avail borrowings at 0.25 per cent above the annual limit if their debt-to-GSDP ratio in
the previous year is less than or equal to 25 per cent.
b) This additional eligibility will also be available in case the States have interest payments
that are less than or equal to 10 per cent of their revenue receipts in the preceding year.
c) If both of the conditions are fulfilled, then the States can avail of a maximum of 3.5 per
cent of GSDP in a given year.
d) However, the flexibility in availing either or both of the provisions would be available to
the State only if there is no revenue deficit in the year in which the borrowing limits are to
be fixed, and in the immediately preceding year.
e) Non-utilization of the sanctioned borrowing limit of 3 per cent of GSDP in any of the first
four years of the award period prescribed by the 14th Finance Commission means that the
option of availing the unutilized amount would be exercisable the following year, but
within the award period.
f) Figures for both the interest payments and revenue receipts to determine the interest
payments-revenue receipts ratio to determine additional borrowing limits must be based
solely on the Financial Accounts Data for the year ‘(y-2)’.
The Department of Economics and Statistics (DES), of the State of Karnataka depends on the CSO
for information in certain sectors for estimating the GSDP of the State. This includes estimates for
the software and IT-related services sector. The CSO provided Gross Value Added (GVA)
methodology for Karnataka estimates it to be 15-16 percent while the share in software export is
33-35 percent. The CSO method of using the employment in this sector as a base to estimate the
GSDP is not appropriate and the State had raised a point in its memorandum to use software
exports as a base. However, there has been no comment in this regard from the 14th Finance
Commission. This has resulted in restriction of the borrowing space for the State of Karnataka,
49
which may not be able to utilize the additional 0.5 percent of GSDP for its fiscal deficit
(Government of Karnataka, 2015).
10.2.7. Adherences to Fiscal Responsibility Legislations (FRLs)
The following table shows the adherence on the part of the State of Karnataka with fiscal indicators
when compared to those levels in line with the KFR (Amendment) Act, 2011. Please see the below
Table 11 [(Table No. 6) and excerpt from pages 27-28] of the Medium Term Fiscal Plan (MTFP)
for the period 2015-19 of the State of Karnataka (Government of Karnataka, 2015):
Table 11: Adherence to Fiscal Responsibility Legislations by the State of Karnataka
Particulars Statutory Norm Compliance by State
Revenue
Deficit (RD)
Reduce RD to Nil by 31st March, 2006. Achieved in FY2004-05 itself. Maintained
adequate Revenue Surplus thereafter.
Fiscal Deficit
(FD)
Reduce FD to not more than 3 per cent
of estimated GSDP by 31st March,
2006.
Maintained FD below 3per cent since
FY2004-05*
Total
Liabilities to
GSDP Ratio
(TL/GSDP)
To ensure that TL/GSDP does not
exceed 25.2 per cent of GSDP by 31st
March, 2015.
Already achieved this in FY2010-11 much
ahead of timeline prescribed.
Outstanding
Guarantees
(OGs)
OG on 1st April of any year should not
exceed 80 per cent of Revenue Receipts
of second preceding year.
Since enactment of Karnataka Guarantee
of Ceiling Act, 1999 this limit has never
been breached.
*Except in the FY 2009-10 where it was exceeded based on the advice of the Central
Government.
“Adherence to fiscal prudence during challenging economic environment
As seen at Table 6, the State has adhered to the path of Fiscal Consolidation and has met all the
fiscal and debt targets much ahead of the timeline laid out in the roadmap. It has consistently
recorded Revenue Surpluses since 2004-05. It was only in the years 2008-09 and 2009-10, based
on the advice of the Central Government, the Fiscal Deficit limit of 3 per cent was enhanced to
3.5 per cent of GSDP in 2008-09 and to 4 per cent of GSDP in 2009-10 to give a fillip to the public
spending to tide over the prevailing economic slowdown.
Further, for the year 2011-12, recognizing the difficulties faced by the State Government in
compressing the fiscal deficit by 1 per cent in one year itself, the Government of India had advised
the State Government to comply with the fiscal responsibility norms over a two year period. As a
result, for the year 2011-12, the State Government had been advised to incur a fiscal deficit of up
to 3.44 per cent and only from the FY11-12 onwards would fiscal deficit be maintained below 3
per cent as per the KFR Act.
Even with this additional available fiscal space, the 3 per cent fiscal deficit ceiling was exceeded
only in the year 2009-10. For all the other years thereafter, Fiscal Deficit was kept below 3 per
50
cent and Revenue Surplus was maintained. The revenue surplus and borrowing space available
was utilized towards capital expenditure.” (Government of Karnataka, 2015, Pg. 27).
The 13th Finance Commission had prescribed the debt-GSDP ratio to be 25.2 per cent by the year
2014-15 for the State of Karnataka. This ratio, projected as per Revised Estimates for the State for
the Financial Year 2014-15 is at 23.26 per cent and is way below the mark (Government of
Karnataka, 2015).
10.2.8. Debt Sustainability Indicators
The 13th Finance Commission recommended that two indicators be used for debt sustainability,
the ratio of Interest Payments to Revenue Receipts (IP/RR) and that of Total Liabilities to GSDP
(TL/GSDP). The IP/RR ratio is to be kept below 15 per cent. Since 2011-12, this has been below
10 per cent and as per the Budgetary Estimates for the FY2014-15 it was estimated to be 8.74 per
cent, with the expectation to further come down to 8.55 per cent as per the Revised Estimates for
2014-15 (Government of Karnataka, 2015).
Liabilities stood at Rs. 1,59,388 crores, and as borrowings in future need to be fully spent on capital
asset creation, the State needs to adhere to this. The ratio of Total Liabilities/GSDP is 23.26 per
cent (Revised Estimates 2014-15) and is within the norms of the 13th Finance Commission limit
of 25 per cent to be achieved by the FY 2015-16. A ceiling of 25.2 per cent for this ratio as been
incorporated in Section 4 of the KFR Act (Government of Karnataka, 2015).
The borrowings of the State are from the open market, Government of India loans, NSSF loans,
loans from other Financial Institutions and financing from Public Accounts. Borrowings by the
State are done in concurrence with the permission of the Government of India vide Article 293(3)
of the Constitution of India. Further recommendation of the 14th Finance Commission that the
States be excluded from the operations of the National Small Savings Fund (NSSF) with effect
from April 1, 2015, and that their involvement be restricted only to discharging the debt obligations
incurred by them until that date. The State of Karnataka is already ahead on the fiscal indicators
prescribed by the 13th Finance Commission and would continue to maintain the prescribed targets
(Government of Karnataka, 2015).
10.2.9. Plan and Non-plan Expenditure
The 14th Finance Commission has not made a distinction between the plan and non-plan
expenditure, but has recognized the distinction between revenue and capital expenditure, taking a
comprehensive and symmetric view of the Union-State relations (Government of Karnataka,
2015).
The plan expenditure has been increasing from 38.06 per cent in FY2008-09 to nearly 44.42 per
cent (Revised Estimates) in 2014-15. Additionally, the share of capital expenditure in total
expenditure has crossed 15.09 per cent in as per Revised Estimates in 2014-15. The State remains
focused on improving the outcomes of expenditure to improve the Human Development Indicators
(HDIs) and the socio-economic growth (Government of Karnataka, 2015).
51
10.3. Observations Regarding Compliance in the MTFP 2016-2020 of Karnataka with
regard to Recommendations of the 13th and 14th Financial Commissions
10.3.1. Revision in Methodology of GSDP Estimation and Calculation
On the basis of the method recommended by the 14th Finance Commission, it was estimated in
MTFP 2015-19 that the GSDP of the State of Karnataka would grow at 7.4 per cent in real terms
for the year 2015-16 and at 11.3 per cent by 2016-17. However, the real GDSP growth rate turned
out to be 6.2 per cent, attributable primarily to the dip in the growth of the agriculture sector (4.7
per cent).
In the FY 2016-17, the methodology used to compute the GDP has been changed. Estimates will
be calculated based on the year 2011-12. Also, GSDP estimates are being prepared at Market
Prices as per the new CSO estimates.
Estimates on the workforce in the “Computer-relates Services” sector had been hitherto taken from
the Employment and Unemployment Survey of NSSO in the 2004-05 series. Now, GSDP
calculations on estimates from this sector are based on the proportion of software exports with
information collected from the Software Technology Parks of India (STPI). Using the
methodology proposed by the 14th Finance Commission, Advance Estimates of GSDP for the FY
2015-16 are estimated to be Rs. 12,11,080 crores by the Directorate of Economics and Statistics
(DES) of the Government of Karnataka (Government of Karnataka, 2016).
10.3.2. Debt Sustainability Indicators
The Interest Payments to Revenue Receipts (IP/RR) ratio was estimated at 9.17 per cent in 2016-
17 (Budgetary Estimates) and was expected to be around 9.30 per cent in the Revised Estimates.
(Government of Karnataka, 2016).
10.3.3. Constitution of the 4th Karnataka State Finance Commission (SFC)
The MTFP for 2016-2020 also specifies that according to the Constitutional mandate, a State
Finance Commission (SFC) that needs to recommend the procedure for devolution of resources to
the Panchayat Raj Institutions (PRIs) and Urban Local Bodies (ULBs) must be constituted every
five years. The 4th State Karnataka State Finance Commission has been constituted in this regard
and is expected to submit its report in the middle of the Financial Year 2016-17 (Government of
Karnataka, 2016).
10.4. Implementation of the Recommendations of the 13th and 14th Finance
Commissions by the Karnataka State Finance Commission (SFC)
The 3rd Karnataka State Finance Commission (SFC) was constituted by the Governor of Karnataka
on 28th August 2006, under the chairmanship of Mr. A. G. Kodgi. The final term-ending date of
the Commission was 31st December 2008, when its report was submitted (Government of
Karnataka, 2008). The 13th Finance Commission (i.e., Central Finance Commission), under the
52
chairmanship of Prof. Vijay L. Kelkar, was constituted by the President of India on 13th November
2007, and submitted its Report on 29th December 2009 (13th Finance Commission, 2009). As there
is an overlap of the time-lines during which the two commissions operated, the 3rd Karnataka SFC
Report did not take into account the recommendations of the 13th Finance Commission, as they
had not yet been published prior to the preparation of the SFC Report.
The 14th Finance Commission under the chairmanship of Dr. Y. V. Reddy was constituted by the
President of India on 2nd January 2013, and submitted its Report on 15th December 2014 (14th
Finance Commission, 2014). It was reported on 23rd December 2015 that the Government of
Karnataka had constituted the 4th Karnataka SFC under the chairmanship of Mr. C. G.
Chinnaswamy (“4th State Finance Commission”, 2015), and that the term of the 4th Karnataka SFC
had been extended until 30th September 2017 (“Fourth State Finance Commission”, 2016). The
term of the 4th Karnataka SFC is still in progress. As the recommendations of both the 13th and the
14th Finance Commissions are now published, it is possible that the 4th Karnataka SFC may take
some of them into account while making its recommendations.
In view of the above developments, the effectiveness of implementation of the recommendations
of the 13th and 14th Finance Commissions by the Karnataka SFC can only be examined once the
recommendations of the 4th Karnataka SFC have been finalized and published.
53
11. Conclusion
It can be noticed that there were both concerns and criticisms expressed in the literature, the
Finance Commissions have had their own reasoning, which reflects in their recommendations.
While the recommendations of the Finance Commissions have been forward looking in their
intentions to achieve a more equitable and sustainable balance between both burdens and fiscal
decision-making powers of both the Union and the States. Literature on the recommendations of
the 14th Finance Commission can be stated to be of an optimistic but of a cautious nature.
The State of Karnataka has made changes to its version of the FRBM Act, the KFR Act, to
incorporate statutory limits on indicators prescribed by the Finance Commissions from time-to-
time for availing benefits. The State is healthy in the terms of its debt sustainability indicators, and
has also taken a progressive step to estimate the GSDP based on software exports in the current
financial year, using the methodology prescribed by the Finance Commission. The impact this has
on the economy of the state needs to be seen.
It must also be noted that as this Report involves a study and comparison of the Recommendations
of the 13th and 14th Finance Commissions and their adherence as stated in the Medium Term Fiscal
Plans (MTFPs) of the Government of Karnataka, and is therefore a descriptive report and not a
prescriptive one. This report describes the existing state of affairs and does not forecast any
projections or propose any revision in the existing fiscal architecture for the future.
54
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57
13. Appendices
13.1. Understanding IFMIS and PFMS
While putting forth their concerns in the area of Public Expenditure Management (PEM) to the
14th Finance Commission, the States, which had been forwarded the details of the proposed
accounting classification system that was prepared by the committee reviewing the List of Major
and Minor Heads of Accounts of Union and States (LMMHA), had shared details on using
Information Technology (IT) in increasing the efficiency of PEM (14th Finance Commission,
2014).
As it was decided that Centrally Sponsored Schemes’ (CSS) funds would be transferred to the
State treasuries from 2014-15 onwards, a need was felt for having a computerized interface with
these State treasuries. The transition to an accrual-based accounting system, when combined with
the emergence of newer heads of account classification, and more uniform formats of the Chart of
Accounts (as proposed by the Controller General of Accounts (CGA)), would also necessitate the
transition to a bigger and more inclusive IT platform that could be used to track fund transfers.
This led to the proposal by the Ministry of Finance for creation of an Integrated Financial
Management Information System (IFMIS) (14th Finance Commission, 2014).
The Public Fund Management System (PFMS) was developed by the CGA to keep track of plan
allocations to the Consolidated Funds of the States and their respective agencies. The newly
proposed platform, IFMIS, would integrate the existing fund allocation processes of the CGA
along with the other changes discussed in the above paragraph, and would also provide
transparency of data with other stakeholders such as the Reserve Bank of India (RBI) and other
banks. Development of an IFMIS would require efforts on the part of both the State and the Union
Governments, including computerization of all State treasuries, addition of greater functionality
over and above the PFMS, and interfacing at different points between the computerized systems
of the States and the Union (14th Finance Commission, 2014).
In the final analysis, some changes would be required to be made to the PFMS in its present form,
and inter-linking of IT accounting systems between the Union and the States would need to be
carried out. As per our understanding, the IFMIS would be the final system in place, which would
subsume the existing functions of the PFMS along with the required enhancements.
13.2. States with ratio values of own taxes/GSDP closer to that of Karnataka
To assess the issue of moderation in subsidy spending, the first course of action was to study the
ratios of own tax revenues to Gross State Domestic Product (GSDP) to determine those states
having ratio values closer to that of Karnataka’s. Data from the Planning Commission, hosted on
Open Government Data (OGD) Platform India (Government of India, 2014) was used. Initially, a
trend line of the ratios of the State’s Own Tax Revenues (SOTR) as a percentage of GSDP was
plotted based on this data to observe the closeness of trends of this ratio for the Financial Year
ranging from 2009-10 to 2013-14. The data set available had the ratio values for the Financial
58
Years 2009-10 and 2010-11, Pre-Actual values for the Financial Years 2011-12 and 2012-13, and
Budget Estimate (BE) for the Financial Year 2013-14 (see Figure 2).
A closer examination of the trends revealed that the states which were close to Karnataka on the
ratio values were: Gujarat, Madhya Pradesh, the Union Territory (UT) of Puducherry and Tamil
Nadu. Table 12 shows the values of the ratios of SOTR/GSDP as a percentage for these states/UTs
for the Financial Years 2009-10 to 2013-14.
Table 12: SOTR as a percentage of GSDP for Five Selected States/UTs from 2009-10 to
2013-14
States/UTs 2009-10
2010-
11
2011-12
(Pre-
Actual)
2012-13
(Pre-
Actual)
2013-14
(BE)
Gujarat 6.20 6.97 6.98 7.65 7.75
Karnataka 9.06 9.37 10.21 10.36 10.72
Madhya Pradesh 7.59 8.13 8.65 8.22 7.40
Puducherry 7.05 8.20 9.06 11.76 9.50
Tamil Nadu 7.62 8.17 8.92 9.59 10.08
(Source: Government of India, 2014)
Figure 2: Trends in SOTR as a percentage of GSDP for States/UTs from 2009-10 to
2013-14
59
(Source: Government of India, 2014)
0
2
4
6
8
10
12
14
2009-10 2010-11 2011-12 (Pre-Actual)
2012-13 (Pre-Actual)
2013-14 (BE)
Andhra Pradesh
Arunachal Pradesh
Assam
Bihar
Chattisgarh
Delhi
Goa
Gujarat
Haryana
Himachal Pradesh
Jammu & Kashmir
Jharkhand
Karnataka
Kerala
Madhya Pradesh
Maharashtra
Manipur
Meghalaya
Mizoram
Nagaland
Orissa
Puducherry
Punjab
Rajasthan
Sikkim
Tamil Nadu
Tripura
Uttar Pradesh
Uttarakhand
West Bengal
60
Figure 3 shows the trends for values of SOTR as a percentage of GSDP for the five selected
states/UTs shown in Table 12.
Figure 3: Trends in SOTR as a percentage of GSDP for Five Selected States/UTs from 2009-
10 to 2013-14
(Source: Government of India, 2014)
It could be observed from Figure 3 that the trend for the ratio of SOTR/GSDP was highest for the
state of Karnataka, except during the Financial Year 2012-13. During 2012-13, the value of this
ratio for Puducherry (UT) registered a sharp increase of over 2.7 per cent, rising to 11.76 per cent,
and then declined close to its earlier value in the next Financial Year, 2013-14.
The trend in ratio values for Tamil Nadu followed close behind that of ratio values for Karnataka.
During the Financial Year 2009-10, the difference between the ratios of the two states was 1.44
percentage points, but this difference had narrowed down to 0.64 percentage points by the
Financial Year 2013-14. The trend of ratio values in case of Gujarat seemed to parallel that of the
ratio values for Karnataka, with the difference in value hovering around 3 percentage points.
Though the ratio values for the state of Madhya Pradesh were close to that of Tamil Nadu’s during
6.20
6.97 6.98
7.65 7.75
9.069.37
10.21 10.3610.72
7.598.13
8.658.22
7.407.05
8.20
9.06
11.76
9.50
7.628.17
8.92
9.5910.08
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
2009-10 2010-11 2011-12 (Pre-Actual)
2012-13 (Pre-Actual)
2013-14 (BE)
Gujarat
Karnataka
Madhya Pradesh
Puducherry
Tamil Nadu
61
the Financial Years 2009-10 through 2011-12, the trend seemed to taper downwards, surpassing
the ratio of Gujarat to register the lowest value among the states/UTs in the Financial Year 2013-
14.
The key issue involved in further analysis was the availability of data on subsidy spending for
these states/UTs. We required the figures on subsidy spending for matching or overlapping years,
and the data also needed to be from either Government or Government-approved sources. In this,
we were further limited by the non-availability of subsidy spending data for Puducherry (UT)
during the period of operation of the 13th and 14th Finance Commissions. Moreover, in view of the
small size of Puducherry, it needed to be considered that while the ratio of SOTR/GSDP as a
percentage could be comparable or higher than those of the states, the levels of subsidy spending
would certainly not be at levels comparable to those of the states in the short-list. Hence, we
considered the states of Gujarat, Karnataka, Madhya Pradesh and Tamil Nadu for further analysis.
Even when the data on subsidy spending was available, the manner in which it was reported posed
further challenges. In case of Madhya Pradesh, state subsidy spending was clubbed with the
Grants-in-Aid received from the Union Government to give total subsidy figures for the Financial
Years 2007-08 to 2011-12 in the report on state finances of Madhya Pradesh submitted to the 14th
Finance Commission. For the Financial Years 2012-13 and 2013-14, the state subsidy spending
was calculated by subtracting the total subsidy figure reported from the total value of Grants-in-
Aid received from the Union Government, by using the Revised Estimates (REs) and Budget
Estimates for the respective Financial Years. These estimates were provided in a budget document
laid by the Finance Minister before the State Legislative Assembly. In the case of Tamil Nadu, the
document citing the figures of the Tamil Nadu Medium Term Fiscal Plan denoted subsidy
spending to be under a head “Subsidies and Transfers”. In the absence of the reporting of a
composite figure for Grants-in-Aid received from the Union Government, the state spending on
subsidies could not be determined (see Table 13). Hence, the report on state finances of Tamil
Nadu submitted to the 14th Finance Commission, which provided the state subsidy spending
figures for the Financial Years 2010-11, 2011-12, and 2012-13, was used.
The following data sources were used to determine the subsidy spending figures for analysis for
each state:
(a) Gujarat: Report of the Comptroller and Auditor General of India for the year ended 31 March
2015.
(b) Karnataka: Medium Term Fiscal Plans for 2015-19 and 2016-2020.
(c) Madhya Pradesh: Report on Evaluation of State Finances prepared for the 14th Finance
Commission.
(d) Tamil Nadu: Report on Tamil Nadu State Finances submitted to the 14th Finance
Commission.
62
Table 13: Aggregate Subsidies and Transfers reported by Tamil Nadu in the
Medium Term Fiscal Plan 2011-12 (Indian Rupees in crores)
Indicators 2009-10
Accounts
2010-11
(RE)
2011-12
(BE)
2012-13
Projection
2013-14
Projection
Subsidies and
Transfers
19615 25811 25623 28185 32413
(Source: Medium Term Fiscal Plan of Tamil Nadu 2011-12, cited in Srivastava and
Shanmugham, 2012)
Table 14 provides a comprehensive picture of the details of the subsidy spending (in Indian Rupees
in crores) for the four states from 2009-10 to 2014-15.
Table 14: Subsidy Spending by Four Selected States from 2009-10 to 2014-15
(Indian Rupees in crores)
State
2009-
10
2010-
11 2011-12 2012-13 2013-14 2014-15
Gujarat (Government of
Gujarat, 2015) 4975 5600 6715 6610 9674
Karnataka (Government of
Karnataka, 2015,
2016) 8074 9287 13175 16329 15334
Madhya Pradesh (Agarwal, 2014;
Government of
Madhya Pradesh,
2013) 5728 7632 9554
12583
(RE)*
12830
(BE)* Tamil Nadu
(Shanmugham,
Ganesh Prasad and
Venkatachalam, 2014) 7739 8698 9592 *computed values.
As the subsidy spending values for the state of Madhya Pradesh for the Financial Years 2012-13
and 2013-14 were computed, we could prima facie say that of the chosen states, Karnataka was
most likely the only state that had accounted for subsidy spending over Rs. 10,000 crores per
annum. The subsidy spending in case of Karnataka was also the highest among the chosen states.
The 10,000-crore mark was crossed for the first time during the Financial Year 2012-13 by the
states of Karnataka and Madhya Pradesh (computed). In the Financial Years 2010-11, 2011-12
and 2012-13, the subsidy spending figures for Karnataka and Madhya Pradesh were very close,
with Madhya Pradesh being the highest spender in the Financial Year 2011-12, overtaking
63
Karnataka’s figures slightly. Though the ratio of SOTR/GSDP as a percentage for Madhya Pradesh
began tapering downwards from the Financial Year 2012-13 onwards, the annual subsidy spending
(computed) seems to have plateaued around Rs. 12,000 crores.
It must be noted that in the Financial Year 2012-13, Tamil Nadu had begun narrowing the gap
between Karnataka and itself on the values of the ratios of SOTR/GSDP as a percentage was
considered. In this background, the subsidy spending in Karnataka was 1.37 times that in Tamil
Nadu during the Financial Year 2012-13. This could represent a cause for concern for Karnataka,
but in the absence of data on Tamil Nadu’s subsidy spending for further years, we cannot really
say whether it is a harmful trend, but Karnataka must definitely exercise caution in this regard, as
the gap between the two states on the ratio of SOTR/GSDP as a percentage is narrowing with
Tamil Nadu catching up.
On a positive note, the subsidy spending figure for Karnataka shows a decline of Rs. 995 crores in
the Financial Year 2014-15 when compared to the previous Financial Year, 2013-14. This trend
may represent a beginning in exercising moderation in subsidy spending by the state, but this can
be conclusively determined by examining the effectiveness of implementation of the subsidy-
related policies. Figure 4 shows a plot of the trends in subsidy spending of the four states for the
data in Table 14.
Figure 4: Trends in Subsidy Spending by Four Selected States from 2009-10 to 2014-15
(Indian Rupees in crores)
(Source: Author Calculations and Various Issues, as stated in Table 14)
49755600
6715 6610
9674
8074
9287
13175
16329
15334
5728
7632
9554
12583 12830
7739
8698
9592
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
2009-10 2010-11 2011-12 2012-13 2013-14 2014-15
Gujarat
Karnataka
Madhya Pradesh
Tamil Nadu
64
The comparison of values of states’ own tax revenue to GSDP ratios as a percentage and their
subsidy spending figures provides an interesting contrast in terms of revenues and expenditures.
However, moderation in subsidy spending must not be viewed strictly from the econometric
perspective alone. The Government of Karnataka (2013) has cited the case of power subsidies as
an example. Electricity consumption by farmers (using below 10 HP IP sets) has been covered by
a power subsidy, whose value has grown over time. However, ensuring that the subsidy is used for
the purpose for which it is granted, and is not spent on addressing operational inadequacies in
power distribution, requires proper estimation of power consumption by metering pump sets and
separating feeders. Secondly, it must be ensured that the provision of subsidy correctly reaches the
targeted individuals and not bogus applicants. For this, established and verified databases such as
the Unique Identification Number (UID), Resident Data Hub and Direct Cash Transfer Scheme
could be used (Government of Karnataka, 2013). Grant of power subsidy to farmers is just one
example of an area in which subsidies can be moderated. Effective monitoring of all subsidy
schemes by ensuring proper spending and verification of the beneficiaries would go a long way in
contributing towards moderation in subsidy spending. Thus, monitoring of policy execution is as
important as policy creation, and especially so in case of subsidy-related policies.
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