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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

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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

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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


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


10.2.9. Plan and Non-plan Expenditure .............................................................................................. 50


Recommendations of the 13th and 14th Financial Commissions 10.3.1. Revision in Methodology of

GSDP Estimation and Calculation .......................................................................................................... 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

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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

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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.

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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

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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.

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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

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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

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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

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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


Table 5 Comparison of Recommendations on Public Sector Enterprises by


Table 6 Comparison of Recommendations on Co-operative Federalism by


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)

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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)

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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:

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(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).

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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.

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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


Commissions in the area of Grants-in-Aid.

Table 3: Comparison of Recommendations on Grants-in-Aid by the 13th and 14th Finance

Commissions


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


Commissions in the area of Public Utilities.

Table 4: Comparison of Recommendations on Public Utilities by the 13th and 14th

Finance Commissions


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


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


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


Finance Commissions


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


Finance Commissions


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


Commissions in the area of Co-operative Federalism.

Table 6: Comparison of Recommendations on Co-operative Federalism by the 13th and 14th

Finance Commissions


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


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


Commissions in the area of Disaster Management.

35

Table 7: Comparison of Recommendations on Disaster Management by the 13th and 14th

Finance Commissions


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


Commissions in the area of Goods and Services Tax (GST).

Table 8: Comparison of Recommendations on Goods and Services Tax (GST) by the 13th



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



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


Commissions in the area of Public Expenditure Management.

Table 9: Comparison of Recommendations on Public Expenditure Management by



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




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




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


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


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




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




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


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



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


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


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


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


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).


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


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


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).


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.


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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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


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


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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