Fiscal Institutions and Fiscal Decentralization

Pinaki Chakraborty National Institute of Public Finance and Policy

New Delhi Email:pinaki@nipfp.org.in

Structure of the Presentation

• Why Decentralization is important for India? • A Brief Overview of Decentralization • Revenue and Expenditure Assignment:

– Aggregate Analysis and State-specific • Service Delivery Issues • Benefit Incidence • Challenges and Policy Implications

Significance of this study • Legal Fiat : Analysing decentralisation ex-post to 73rd and 74th constitutional amendments (1993)?

» Need a more comprehensive understanding

• Fiscal Fiat: Analysing asymmetry in functions and finance and the ‘unfunded mandates’.

• Equalisation and Federal Mechanism of Transfers : Higher levels of governments are using the institution of local-self-governments for the provisioning of various public services through specific purpose transfers. This process has serious implications for decentralization.

• Is fragmented transfer system working against fiscal equalisation?

• Any Empirical Link: Decentralisation and Human Development: – This lecture is probably an attempt to examine the link between decentralisation and human

development outcome with respect to education and health services delivery in India. – literature survey, – empirical analysis; – `Benefit Incidence’ analysis for health and education services in India based on unit

record NSS consumption expenditure data.

Decentralization and Service Delivery-Any Link • Assumption 1:

– Assumption of non-homogeneity: Step ahead from ‘One-size fits all’ policies. In countries with sharp spatial disparities and heterogeneous population, decentralization can play a pivotal role for efficient delivery of public goods and services.

• Assumption 2: • Assumption on Institution Design: Decentralization at ex-ante levels is

neither good nor bad for efficiency and equity in terms of public service delivery. The effects of decentralization are at ex-post levels, which in turn crucially depend on institution-specific design, the degree of decentralization and how decentralization policy (in terms of 3Fs) and institutions interact.

• Assumption 3: • Variant Assumptions of Voice and Exit: Whether participatory process of

democratic decentralisation has alter the pubic expenditure decisions, incorporating the revealed preferences of needy through the mechanisms of ‘Voice’ and ‘Exit’.

Decentralisation in India: The Legal Fiat • The 73rd and 74th CA mandated political decentralization.

• State-specific design and implementation on sectoral, administrative and fiscal fronts. • The CA have extended a legal status to decentralisation at rural and urban levels. • The 73rd CA of 1992 and the Provisions of the Panchayats (Extension to the Scheduled Areas) Act of 1996

(PESA) establishes mandatory provisions for rural decentralization .

• The elements of Rural D -three-tier local government structure -State Election Commissions (SEC) and State Finance Commissions (SFC) -PRI elections with feminization of governance -Gram Sabha (village assembly) -periodic local auditing • The 74th Amendment provisions for Urban Local Bodies (ULBs) with a Municipal Corporations and

Municipalities. • Both PRIs and the ULBs have been assigned 29 and 18 subjects as per the Eleventh and Twelfth Schedule

of the Constitution respectively.

• Currently, all state governments have adopted the legislation and have held at least one election of the PRIs. The state decentralization models are similar.

• All States have a State Election Commission and State Finance Commission (SFC) as stipulated and constituted Panchayati Raj bodies as per the new provisions.

• District Planning Committees (DPCs), mandated to formulate local level development plans are also existent in almost all states.

Revenue & Expenditure Assignments

• Three tier federal structure of India : Termed as quasi-federal • Asymmetric assignment of revenues and expenditures have

resulted in large vertical and horizontal fiscal imbalances and they are growing

• Post economic-reform increase in fiscal inequality is alarming • Despite decentralization, there has been increasing

centralization of expenditure decisions, especially in health and education service delivery.

• Centralization also created parallel institutions at the state level bypassing the elected state and local governments

Table 1: Expenditure Assignment: Relative Shares of Federal, Provincial and Local Governments

(In Per cent)

1998-99 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Centre 47.47 47.25 42.67 43.30 45.51 44.40 47.70

States 46.79 46.57 50.99 50.02 47.87 48.68 45.19

Local 5.74 6.18 6.34 6.68 6.62 6.92 7.11

TOTAL 100.00 100.00 100.00 100.00 100.00 100.00 100.00

Table 2: Revenue Assignment: Relative Shares of Federal, Provincial and Local Governments

(In Per cent)

1998-99 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Centre 55.89 55.40 56.03 55.21 55.33 56.13 58.11

States 41.10 41.00 40.47 41.43 41.38 40.83 39.07

Local 3.01 3.60 3.50 3.37 3.29 3.04 2.82

TOTAL 100.00 100.00 100.00 100.00 100.00 100.00 100.00

However, pace of implementation and design for effective service delivery mechanism differs across states.

• Unevenness among states in terms of degree of autonomy to the local bodies

• Decentralization has been most successful in the state of Kerala, followed

closely by West Bengal and Karnataka. • Differences in design between states primarily on the relative sizes, roles

and importance of gram, block and Zila Panchayats.

• For example, Andhra Pradesh has prioritized the district level, while Rajasthan has given maximum importance to the block level. In other states Gram Panchayats are most important.

• In terms of pace of implementation, Kerala has transferred more fiscal resources to PRIs

as untied grants than any other state achieving faster degree of decentralisation.

• Maharashtra has moved faster in bringing sectoral staff under the control of PRIs.

State Funds Functions Functionaries Andhra Pradesh 17.24 (5) 58.62 (17) 6.90 (2) Assam -- 100.00 (29) -- Bihar 27.59 (8) 86.21 (20) -- Chhattisgarh 34.48 (10) 100.00 (29) 31.03 (9) Goa 20.69 (6) 20.69 (6) -- Gujarat 51.72 (15) 51.72 (15) 51.72 (15) Haryana -- 55.17 (16) -- Himachal Pradesh 6.90 (2) 89.66 (26) 37.93 (11) Karnataka 100.00 (29) 100.00 (29) 100.00 (29) Kerala 89.66 (26) 89.66 (26) 89.66 (26) Madhya Pradesh 34.48 (10) 79.31 (23) 31.03 (9) Maharastra 62.07 (18) 62.07 (18) 62.07 (18) Orissa 31.03 (9) 86.21 (25) 72.41 (21) Punjab -- 24.14 (7) -- Rajasthan 62.07 (18) 100.00 (29) 62.07 (18) Tamil Nadu -- 100.00 (29) -- Uttar Pradesh 13.79 (4) 41.38 (12) 20.69 (6) Uttaranchal -- 37.93 (11) 37.93 (11) West Bengal 41.38 (12) 100.00 (29) 41.38 (12)

Note: Figures in Parenthesis are absolute number of subjects Source: MoRD, GOI

Status of Devolution of Subjects in the PRIs (As on 31.01.2004)

(as Percentage of total Subjects)

0

10

20

30

40

50

60

2002-03 2006-07 2007-08

• AP, Haryana and Punjab show highest share of own revenue to total revenue of rural local bodies

• Kerala also has a higher share of own revenue in total revenue compared to Karnataka and WB, where degree of decentralization is higher

• The trends show a decline in mobilising own revenue for most states apart from Karnataka and Punjab

• Consequently, dependence on transfers is high in most of the states.

• Large part of the expenditure comes from higher governmental levels as tied transfers resulting in reduced flexibility for localised plan implementation

Share of Own Revenue of Local Bodies in total revenues: Major states (Per cent) (PRI)

Source: fincomm.nic.in

Source: fincomm.nic.in

0 20 40 60 80

100

2002-03 2006-07 2007-08

• ULBs situated in a better position than the PRIs.

• Own revenue generation is high in most of the states

• Concern over similar trends of declining trends of own revenue collection in all states except Rajasthan

• Although Kerala, WB and TN show almost stable shares

The Share of Own Revenue of Local Bodies in total revenues: Major states (Per cent) (ULB)

INTERPRETING THE LEGAL AND FISCAL FIATS OF SFC

• The new fiscal devolution framework makes it mandatory for all states to constitute SFC once in every 5 years

• The SFC would be responsible for the task of reviewing the financial position of local governments and making recommendations.

• Major responsibilities and tasks for the SFCs may be chartered as follows:

(a) Review the finances of the local bodies in-keeping with the functional responsibilities (b) Determine revenue-sharing between State on one hand and PRIs and ULBs on the other (c) Evaluate the vertical gap at various levels and deal with tax assignments (d) Suggest measures for improving the financial position of panchayats and ULBs (e) Design methods for the inter se distribution of the share of PRIs and ULBs on an equitable and efficient basis

• In Kerala and WB, administrative and political decentralization have been quite strong due to their respective state history of strong local level bodies functioning even before the legislation of the PRIs/ULBs.

• In Karnataka the process of decentralization gained momentum with the introduction of the ‘concepts of ‘efficiency and equity’ in service delivery.

Brief Overview of the Fiscal Position of the Local Bodies in Karnataka, WB and Kerala and Review of

Recommendations of three SFCS

Source: www.fincommindia.nic.in

94.5 94.4 94.5 94.8 93.9 94.6

55.4

75.3 73.9 71.8 70.3 68.5

126.9 133.4

126.2

77.1

120.1

106.3

0

20

40

60

80

100

120

140

160

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala West Bengal

96.9 88.4

122.8

109.7 109.5 107

71.5 87.9 82.9

88.5

102.9 105.8 109 105.6 117.4 119 119.3

125.2

0

20

40

60

80

100

120

140

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala West Bengal

Fund Utilization of the Local Bodies (PRIs) Fund Utilization of the Local Bodies (ULBs)

• Fund utilisation levels in all these three states are very high, which is a positive sign for greater degree of decentralisation

• West Bengal leads in this respect followed by Karnataka for both PRIs and ULBs

0

5

10

15

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

0

5

10

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

0

2

4

6

8

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

0

20

40

60

2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

0

5

10

15

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

0

50

100

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

0

50

100

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

A.

B.

C.

D.

E.

F.

G.

Dependence of Local Bodies on Higher Governments for Funds in PRIs A. Own Tax revenue, of which B. Tax revenue, C. Non-Tax revenue, D. Central transfers, E. EFC/TFC, F. Assignments and Devolutions, G. Grant-in-Aids as % of Total Revenue

Dependence of Local Bodies on Higher Governments for Funds in ULBs

30

40

50

60

70

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

15

25

35

45

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

10

15

20

25

30

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

0

5

10

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala

0

2

4

6

8

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

0

50

100

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Karnataka Kerala WB

0

50

100

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

Kerala WB

A.

B.

C.

D.

E.

F.

G.

A. Own Tax revenue, of which B. Tax revenue, C. Non-Tax revenue, D. Central transfers, E. EFC/TFC, F. Assignments and Devolutions, G. Grant-in-Aids as % of Total Revenue

0

2

4

2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

As percentage of revenue expenditure

as percentage of education expenditure

Education and Health Specific Fiscal Transfers from State to local bodies: Kerala

Source: State Finance Accounts 2007-08, GOI

0

2

4

2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

As percentage of revenue expenditure

as percentage of health Expenditiure

-10

0

10

20

30

40

2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Transfers as compensation and assignments to local bodies (PRIs and ULBs combine) Total transfers to LSGs as percentage of social sector expenditure with Compensation and assignments Total transfers to LSGs as percentage of total revenue expenditure

Transfers to PRIs on education

Transfers to PRIs on Health

Transfers to local bodies on PRIs and ULBs combine

• It is clear that in Kerala transfers as percentage of total revenue has increased markedly since 2005-06

• It mainly comprises of transfers to local bodies for social sector expenditure

• But also it shows that health and education specific transfers are on the decline

Education and Health Specific Fiscal Transfers from State to local bodies: Karnataka

0 20 40 60 80

2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

As percentage of revenue expenditure

as percentage of education expenditure

0

10

20

30

40

50

60

2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Transfers as compensation and assignments to local bodies (PRIs and ULBs combine)

Total transfers to LSGs as percentage of social sector expenditure with Compensation and assignments

Total transfers to LSGs as percentage of total revenue expenditure

Transfers to PRIs on education

Transfers to local bodies on PRIs and ULBs combine

• In Karnataka, education specific transfers are very high

• There are as such no health specific transfer to local bodies

• Transfers as percentage of social sector expenditure and total revenue expenditures are also very high

• Compensation and assignments comprise of a substantial proportion of transfers

Education and Health Specific Fiscal Transfers from State to local bodies: West Bengal (WB)

0

1

2

3

4

2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 2007-2008

Total transfers to LSGs as percentage of social sector expenditure with Compensation and assignments

Total transfers to LSGs as percentage of total revenue expenditure

• In WB, Fund devolution to local bodies have always been low. • Transfers both as share of social sector expenditure and revenue expenditure,

as can be seen is around only 3 and 1 percent respectively • There are no records for any education or health specific transfers to the PRIs

or ULBs • In terms of fiscal decentralisation the state clearly lags behind Kerala

Karnataka

GENERAL CRITIQUE OF STATE FINANCE COMMISSIONS AND POLICY SUGGESTIONS

• Delay in Constituting SFCs and Consequent Delays in Report Submission • Quality of SFC Reports • Inadequate data availability • Comparability issues between state SFC reports due to difference in approach and

structure of reports

Policy Suggestions and Way Ahead in strengthening the role of SFCs: a. Untied nature of grants to the local level to strengthen the flexibility of finances b. Strengthening of homogeneous templates of SFCs across States. c. Strengthen the data base at the local level. d. Capacity building at local level, especially for the SFC. e. Reduce arbitrariness in the fiscal devolution of local body grants. f. Judicious use of specific purpose grants.

Framework of benefit incidence analysis and service delivery

• The analytical framework: • Effectiveness of public service provisioning has its roots

in institutional mechanism in which agents in service provisioning are accountable.

• In a way the root of these logic can be found in 2004 World Development Report, Making Services Work for Poor People (World Bank, 2004), whereby the five facets of accountability was discussed not in watertight compartments, viz., (i) delegation, (ii) finance, (iii) performance, (iv) information and (v) enforceability.

Challenges of unfunded mandate for service delivery

• Sequence of decentralization – Reversing the sequence of decentralization, from ‘functions

precede finance’ to ‘finance precedes functions’ to avoid ‘unfunded mandates’?

– Empirical evidences brought out by the Report (especially in the context of Kerala) revealed that the reverse sequence might also encounter the problems of accountability, if there is elite capture of funds devolved or any corruption which creates disequilibrium at the decentralized levels. It is equally important to ensure information symmetry for enforceability.

• Challenges of ‘Partial decentralisation’: – local governments remain dependent on fiscal transfers are

less accountable to their electorates. – when decentralization is partial, citizens look up to their

national governments for service delivery. – Conditional grants for service delivery is reducing the local

government function into agency function

Decentralization and Education Service Delivery

• Despite decentralization two sets of factors contributing to high dropout rates:

– Cost of schooling – the cost of what parents perceive as “quality education” and the opportunity cost of the child not contributing to the daily bread in the family in some way, is high.

– The second set of factors relate directly to the school when the dropouts were due to “child not interested in studies” and “unable to cope and failure in studies”.

• The Report acknowledges that – while the local government may run the day-to-day

functioning of schools, the upper-tier government can have the economies of scale to design curricula and prescribe and enforce minimum quality standards is fallacious.

– Parallel institutions like implementing agencies for education service delivery reduced the role of both the second and third tire of government substantially

Decentralization and Health Service Delivery • Theoretically decentralizing health care sector

can be beneficial; reasons are fivefold, via – (a) increasing local ownership and accountability; (b)

improving community participation and responsiveness to local needs; (c) strengthening integration of services at the local level; (d) enhancing the streamlining of services; and (e) promoting innovation and experimentation (Aitken, 1999). However, the cross country experience gives inconclusive evidences.

• Does public expenditure on health lead to better health outcome?

– The empirical evidence is inconclusive. The Q-squared factors – quantity and quality – of health care affect health outcome.

Decentralization and Health Service Delivery

• Empirical evidence suggests that health care delivery is quite dysfunctional in India:

– For instance, a series of World Bank surveys reveal that in several Indian states, a very high level of absence (43 percent) of health care providers in India Primary Health Centers. Also, Banerjee, Duflo and Glennerster (2008) in their paper revealed that the public health care system in India is plagued by high staff absence, low effort by providers, and limited use by potential beneficiaries who prefer private alternatives.

• Again recent efforts to improve delivery is outside the institutional structure of decentralization

» NRHM is the classic example of the failure of decentralization in providing delivery of health services

Benefit incidence

• Benefit Incidence Analysis • Both spatial and intertemporal BIA undertaken in this

report revealed that public sector is still a significant sector where the poorest quintiles utilize the service provisioning.

• ‘Seemingly’ equitable nature of incidence should be understood with caution as the poor are compelled to utilize the public sector provisioning of education and health care due to price and non-price factors.

• Non-price factors include the supply side and demand side constraints of distance, intrahousehold behavioural patterns, availability of quality private provisioning at affordable costs.

Benefit Incidence:

• The higher income quintiles’ behaviour: • ‘voting with feet’ (exit strategy) is a matter of concern

due to the non-utilization of ‘voice’ element in the service provisioning of public sector in health and education.

• The BIA concentration curve analysis revealed that public sector still forms a significant component in utilization of education and health care, especially among the poor income quintiles.

Challenges and Policy Implications

• Accountability of public spending is still an area of urgent concern:

– attempts by sectoral Ministries to prepare Results-Based Framework documents.

– Monitoring outcome than inputs remain a crucial area of intervention.

– “Linking resources to results” is the core of any accountability framework.

– Despite the growing recognition of accountability frameworks, the effectiveness of public expenditure is hardly analyzed across sectors. The studies still focus more on ‘financial inputs’ and ignore the output and outcome analysis.

• Need to reduce arbitrariness in transfer • Conditional transfers need to be reduced and should be part

of the budgetary process at the lower level