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Article in The Financial Express
Authored by Dr.Jayaprakash Narayan

National Coordinator of
VOTEINDIA movement

Fiscal devolution-think outside the box
February 11, 2005

The Union budget for fiscal year 2005-2006 is due in just over two weeks. This is the period during which a lot of pressure is usually brought to bear on the Finance Minister (FM) to increase budgetary allocations for this or that panacea to transform India and eliminate mass poverty. With greater continuity and stability in the tax regime the usual excitement about tax rates and the guessing games have been missing in recent years. Therefore, much of the debate is about allocations, expenditure and fiscal deficits.

Two recent developments make the FM's task of containing fiscal deficits more difficult. First, the accent on increased social sector allocations will mean added expenditures. Employment guarantee scheme, education and healthcare will cost more than the normal allocations. And the expenditure on healthcare will have to be stepped up very substantially in the coming years, particularly from fiscal year 2006-07, if we are to build a credible, accessible and effective healthcare delivery system for the poor.

Second, the devolution proposals of the Twelfth Finance Commission (TFC), now approved by the Union Council of Ministers, impose an additional burden of about Rs.26,000 crores on the Union - through additional transfers and grants, and lost receipts and interest on account of state debt write-off or restructuring. Offsetting these trends are two positive factors which promote fiscal prudence. First, the education cess which raises substantial additional revenues of the order of Rs.5000 crore per annum, and second, the proposal to dispense with Central loans to states as part of plan assistance and allow states to borrow directly from the market subject to Union approval under Article 293 of the constitution.

On the whole, additional allocations to the social sector - particularly education and health care, greater devolution to states, education cess, and eliminating Central loan component in plan assistance - are welcome steps. But budgeting is not merely about allocations, resources and priorities. It should also be about who will spend the money, and how. Perhaps this is what the FM should focus on.

Take the case of local governments. Though the 73rd and 74th Amendments to the Constitution envisaged elected Panchayats and Municipalities as genuine local self-governments, in most states they exist with little power and few resources. And yet evidence is conclusive that people are more likely to pay for public goods and services at the local level, provided the link between the taxes and services is clear, and there is transparency and local accountability. In fact, people are also willing to pay specific health and education cess at local level, and mobilize additional resources through voluntary contributions if they are confident that the money is well-utilized, and that they will get the best value for every rupee spent. Despite this, the state governments, legislators, and bureaucracy are extremely reluctant to part with powers or resources. This is only to be expected, as there is always a propensity to concentrate powers, and a marked reluctance to delegate. This is particularly true when rent-seeking is institutionalized in most public services and corruption is integral to the system. The nature of incentives in public office and the process of power are at the heart of this crisis. No FM can alter this through budgetary mechanisms. However, the budget can create new incentives to ensure greater devolution and institutionalize transfer of resources in a politically palatable way.

The principle of subsidiarity, which lays down that whatever can be done best at a level close to the citizen should be done at that level and not at a larger level, is based on the simple insight that stake-holding and power-wielding should go together. Only then can authority fuse with accountability. But local governments have neither power over the subjects listed in the XI and XII Schedules, nor resources to fulfil their obligations. Estimates show that in 2002-03 all Panchayats put together had about 0.06 percent of GDP as their own resources! Clearly, a quantum leap is needed to make local governments responsive and effective.

The terms of reference of the Eleventh Finance Commission (EFC) required the Commission, for the first time, to make recommendations on the measures needed to supplement the resources of Panchayats and municipalities. The EFC accordingly, recommended grants totaling Rs.10,000 crores for local governments during 2000-05. The TFC built upon this precedent, and recommended Rs.25,000 crores for local governments during 2005-10. But this simply is not enough to make the third tier of governance effective. So, is there a way out?

Happily, the current budget offers a priceless opportunity. The States will get a bonanza of Rs.26,000 crores during 2005-06. This is the result of an enhanced share of central taxes and duties, up from 29.5 percent to 30.5 percent (Rs.4000 crore); consolidation of all central loans to states and rescheduling (Rs.7,000 crores in reduced interest and debt write off per year); and additional grants-in-aid to States (Rs.15,000 crore).

The most painless and effective way of empowering local governments would be to transfer this Rs.26,000 crores to local governments as a per capita grant. Conditions could be imposed about its utilization. For instance, this money could be utilized only for education, healthcare, infrastructure, and civic amenities. A non-lapsable health fund could be created for each district, and all public hospitals could be funded from this fund for services rendered. In other words, money will follow the patient, and there will be choice and competition.

Such a mechanism has several advantages. Sizeable resources - Rs.200-250 per capita - will go to local governments every year, but without an additional burden on states. Public expenditure will follow national priorities. The way the money is utilized will be dramatically altered, enforcing accountability. We can create ombudsmen for every district and impose strict prudential norms of spending and effective public auditing. Public services will improve. As part of the package, states can be asked to empower local governments to levy and collect more taxes. The local governments will be increasingly self-reliant. These are win-win-win solutions all the way.

What does it take to make this happen? We need to shed our fear of innovation and learn to think outside the box. A few procedural changes are required. But that is what a Finance Bill is about. Rarely do we have huge outcomes with no additional costs. Here is a priceless opportunity. Will the FM grab it? Will the Council of Ministers have the courage and perseverance to think afresh and change the way we manage public finances?



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