Rural Fiscal Decentralisation in Karnataka State M. Govinda Rao H. K. Amar Nath B. P. Vani Institute for Social and Economic Change National Institute of Public Finance and Policy ACKNOWLEDGEMENTS A major shortcoming in Indian fiscal literature is the lack of attention to the fiscal issues at local levels, particularly in rural areas. Much of the literature on fiscal decentralisation is focussed on fiscal arrangements between the centre and the states. Very little is known about public finances of Panchayat Raj institutions and fiscal relationship between state and local governments. The few studies that look at these issues are descriptive and impressionistic and are not based on reliable data. Thus, our understanding on the sub­ state rural fiscal decentralisation is based on prescriptive and impressionistic literature. This study is an attempt to undertake a comprehensive analysis of sub-state rural fiscal decentralisation and Panchayat finances in Karnataka. The analytic of the study is the principles or normative implementation rules of fiscal decentralisation expounded in the literature. It does not take fiscal decentralisation as good or bad a priori, but explores ways and means to enhance its efficacy by identifying policies and institutions and implementation mechanisms. It bases the analysis on the data and information specifically collected by us from 636 Gram Panchayats in four districts. Our foremost gratitude is to Sri. M. Y. Ghorpade, Hon’ble Minister for Rural Development and Panchayat Raj (RDPR) in Karnataka. Mr. Ghorpade, truly is a champion of decentralisation. The keen interest he has shown in the design and implementation of the study and in inquiring about the progress of the study stand testimony to his unflinching commitment to the cause of decentralisation and to understand the process and its shortcomings towards reforming the system. In an otherwise grim situation on fiscal decentralisation, the unflinching commitment of the leadership is a silver lining. The authors of the report would like to thank the World Bank for sponsoring the study on fiscal decentralisation in Karnataka. The authors had extremely useful discussions with the World Bank officials and consultants from time to time. More specifically, Geeta Sethi and Luis Constantino took personal interest in the study. Very detailed comments on individual chapters were given by Roy Bahl, Dean, Andrew Young School of Policy Studies as a World Bank consultant. Prof. Bahl took keen interest in the study and helped it in various stages right from its inception. We have gained immensely from his deep knowledge in and wide international experience of dealing with fiscal decentralisation policies and institutions. The study has benefitted immensely from the detailed comments of Amaresh Bagchi, who went through the draft with meticulous care. Thanks are also due to Fitz Ford, with whom the team had useful discussions. The study was initiated in Institute for Social and Economic Change (ISEC), but at final stages had to be transferred to the National Institute of Public Finance and Policy (NIPFP) as the Project Director left ISEC and joined NIPFP. The authors would like to thank Mr. T. R. Satishchandran, Chairman, ISEC and Dr. Gopal Kadekodi, Director. ISEC for continuing the support for the study. Mr. Ranganathan, Registrar, ISEC, has been instrumental in making us understand the administrative setup in the Rural Local Bodies, with his rich experince as government servant in various capacities in Zilla Panchayat. The detailed study of this nature within a reasonable time period would not have been possible without the continued interest shown by Mr. Raghunandan, Secretary, RDPR in Karnataka. He took keen interest in the study throughout and wherever possible implement some of the recommendations as soon as draft chapters were made available to him for comments. The team was a beneficiary to Mr. Raghunandan’s deep insights into policies and institutions pertaining to decentralisation. He not only facilitated the collection of data by issuing detailed instructions to Zilla Panchayat (ZP) authorities, but also deputed officials of his department to help in the data collection wherever needed. We are indeed grateful to his team of committed officials particularly to Mr. B.S.Hiremath and Mr.R.S. Phonde from RDPR and Mr. M. Venkateshappa, Chief Accounts Officer, Kolar, and Mrs. Vasundara Devi, Chief Planning Officer, Mandya, who have immensely contributed to the study. The study of this nature is information intensive and the information has to be collected from the various districts. We are thankful to Dr. Verashekharappa, Assistant Professor, ISEC who helped in organising the fieldwork. Mrs T.M.Radha assisted not only in the collection of information but also in processing of voluminous data and making sense out of them. Mr. Keshaya Naik and Mr. Muni Reddy helped in the collection and processing of data from panchayats. The authors would like to gratefully acknowledge the contribution of all these persons, while bearing full responsibility for any shortcomings in the study. M. Govinda Rao H. K. Amar Nath B. P. Vani iii List of Abbreviations ARWS Augmented Rural Water Supply Scheme BCM Backward Classes and Minorities CEO Chief Executive Officer CP Central Plan Scheme CSS Centrally Sponsored Scheme CV Coefficient of Variation DDP District Development Program DPAP Drought Prone Area program. DPC District Planning Committee DRDA District Rural Development Agency EAS Employment Assurance Scheme EFC Eleventh Finance Commission. GDDP Gross District Domestic Product GP Gram Panchayat GSDP Gross State Domestic Product IAY Indira Awas Yojana IWDP Integrated Waste Lands Development Programme ISM&H Indian System of medicine and Health JGSY Jawahar Gram Samruddi Yojane JRY Jawahar Rozgar Yojana KPTCL Karnataka Power Transmission Corporation Ltd MLA Member of Legislative Assembly MNP Minimum Neeeds Program NABARD National Bank for Agriculture and Rural Development. OBB Operation black board PHC Public Health Centre. PMGY: Prime Minister Grameena Yojana RGHCL Rajiv Gandhi Housing Corporation Ltd SC Schedulted Castes SCP Special Componenet Plan SFC State Finance Commission SGRY Sampooma Grameena Rozgar Yojana SGSY Swama Jayayanti Grama Swarozgar Yojana ST Scheduled Tribes TFC Tenth Finance Commission TP - Taluk Panchayat RDPR — Rural development and Panchayat Raj ZP - Zilla Panchayat TABLE OF CONTENTS I. Rural Fiscal Decentralisation in Karnataka State History and Institutons 1-22 1.1 Introduction 1 1.2 Objectives of the Study 3 1.3 Evolution of Fiscal Decentralisation in Karnataka 6 1.4 Constitutional Amendment and Structure of Decentralisation in Karnataka 8 1.5 The Assignment System 9 1.6 Intergovernmental Transfers 10 1.7 Planning and"Budgeting System 15 1.8 Plan of the Study 19 Annexure - Chapter I 23 II. Conceptual Issues, Data and Methodology 24-30 II. 1 Introduction 24 11.2 Information Requirements in the Context of Objectives of the Study 24 11.3 Sources of Data for Fiscal Analysis at Local Level 26 11.4 Choice of Sample Panchayats for Study 28 11.5 Some Methodological Issues 29 III. Functional Assignments to Panchayats 31-48 III. 1 Functional Assignment 31 111.2 Role of Local Governments in Expenditure Implementation 33 111.3 Analysis of Schemes 37 111.4 Overlapping Functions and Activity Mapping 40 111.5 Overlapping Functions and Finances 42 111.6 Fiscal Decentralisation, Local Autonomy and Efficiency in Service Delivery 45 III. 7 An Exercise in Improving Efficiency: Consolidation of Schemes 48 Annexure: Chapter 3 49-76 IV. Analysis of Panchayat Revenues: Level, Composition and Determinants 77-105 IV. 1 Introduction 77 IV.2 Revenue Powers of Panchayats 79 IV.3 Level and Composition of Revenues of GPs 83 IV.4 Determinants of Revenues 95 IV.5 Augmenting Revenues: Reforms in Policies and Institutions 104 Annexure: Chapter IV 106 - 119 v V. Fiscal Transfers to Panchayats 120-144 V. 1 Transfer System for Local Governments: Conceptual Issues 120 V.2 The State Finance Commission 122 V.3 The Transfer System for Rural Local Governments in Karnataka 125 V.4 Analysis of Transfers 127 V.5 Inter-Panchayat Variations inGrants 138 V.6 Conclusions 141 VI. Analysis of Expenditures in Gram Panchayats 145-167 VI. 1 Introduction 145 VI.2 Expenditures Incurred By the Three Tiers of panchayats 146 VI.3 Determinants of GP Expenditures 159 VI.4 Determinants of Expenditures on Selected Services 159 VI.5 Conclusions 162 Annexure: Chapter VI 168 VII. Conclusions and Recommendations 169 - 179 VII. 1 Introduction 169 VII.2 Functional Assignment: Overlapping and Consolidation 170 VII.3 Augmenting Revenues: Reforms in Policies and Institutions 172 VII.4 Issues in Intergovernmental Transfers 173 VII.5 Improving Efficiency in Public Spending at Local Levels 175 VII.6 Strengthening Fiscal Decentralization: Some Reform Issues 176 References 180 -181 vi LIST OF TABLES Table II.1 Characteristics of Sample Districts Tabic III.l Estimated Allocation to Rural Local Bodies in Karnataka Table III. 2 Allocation to District Sector Plan Outlay in Karnataka Table III. 3 Frequency Distribution of District sector Schemes in Karnataka Table III. 4 Schemes Implemented by Gram Panchayats Table III. 5 Scheme-wise Outlay in Different panchayats Tabie IV. 1 Total Revenues in Different Panchayat Tiers in Karnataka - 2000-01 Table IV. 2 Level of Revenues in Gram Panchayats Table IV. 3 Level and Composition of Revenues of Gram Panchayats Table IV. 4 Percentage of tax revenues in own revenues - Frequency distribution of GPs 2000-01 Table IV. 5 Composition of Own Revenues - Frequency Distribution of GPs Table IV. 6 Distribution of GPs in Terms of Ratio of Property Tax Collection to Demand Table IV. 7 Cost of Tax Collection in GPs in Karnataka Table IV. 8 Distribution of GPs According to Ratio of Cost of Collection to Tax Collected Table IV. 9 Coefficients of Variation in GP Revenues in 2000-01 Table IV. 10 Regression Results of GP Revenues in Four Districts Table IV.ll Regression Results for Individual Districts Table IV. 12 Taluk Specific effects in GPs in Four Districts Table V.l Transfers to Rural Local Bodies in Karnataka Table V.2 Per Capita Transfers to All Rural Local Governments Table V.3 Composition of Transfers to Rural Local Bodies Across Different sectors Table V.4 Devolution of Plan Transfers To Gram Panchayats at District Level 2000-01 Table V. 5 Per Capita Devolution of Funds to Tali^: Panchayats: 2000-01 (Rupees) Table V.6 Composition of transfers to TPs in Karnataka 2000-01. Table V.7 Per capita Transfers to ZPs in Karnataka 2000-01 (Rupees) Table V.8 Composition of Transfers to ZPs in Karnataka 2000-01 (Per Cent) Table V.9 Determinants of Grants in GPs. Table V.10 Regression Results of Transfers for Individual Districts Table VI. 1 Total Expenditures in Different Panchayat Tiers in Kamataka-2000-01 Table VI.2 Degree of Fiscal Autonomy Table VI.3 Composition of Expenditure in Gram Panchayats Table VI.4 A Frequency Distribution of GP based on JGSY Expenditure Per BPL Household Table VI.4B Frequency Distribution of GPs based on Per capita JGSY Expenditures Table VI.4C Frequency Distribution of GPs based on Per capita Expenditure on Core Services Table VI.4D Frequency Distribution of GPs based on Per capita Expenditure on Public Works Table VI.4E Frequency Distribution of GPs based on Per capita Total Expenditure Table VI.5 Determinants of Expenditure Table VI.6 Determinants of Expenditure Public Works including JGSY Table VI. 7 Determinants of JGSY Expenditure Table VI. 8 Determinants of Core Services Expenditure LIST OF ANNEXURES Annexure 1.1 Formula for Allocating Financial Resources to District Sector Schemes Annexure III. 1 Local Government Expenditure in Karnataka Annexure III.2 Frequency Distribution of Schemes in TPs and ZPs in Terms of Value of Schemes Annexure III.3 Roles of Different Levels of Government and Different Tiers of Rural Local Bodies in Implementing Important Schemes Annexure III.4A Distribution of Schemes by Sector and Tier 2001-02 Annexure III.4B Distribution of Schemes by Sector and Tier 2002-03 Annexure III.4C Fund Allocation to Schemes 2001-02 Annexure III.4D Fund Allocation to Schemes 2002-03 Annexure III.5 State Sector Schemes that can be Transferred to Local Bodies Annexure III.6 Fiscal Autonomy in Rural Local Bodies in Karnataka: Composition of Outlay Annexure IV. 1 Finances of Panchayats among Three Tiers 2000-01 Annexure IV.2 Finances of Gram Panchayats - 2000-01 Annexure IV..3 Frequency Distribution of GPs as per share of Tax Revenues in Own Revenue 2000-01 Annexure I V.4 Composition of Per capita Revenues Annexure IV.5 Level and Composition of Revenues in Panchayats Annexure I V.6 (A) Frequency of GPs based on cost of collection - 2000-01 Annexure I V.6 (B) Frequency of GPs based on cost of collection - 2000-01 Annexure IV.6(C) Frequency of GPs based on cost of collection - 2000-01 Annexure IV.7A Cost of Collection of Property Tax by Gram Panchayats Annexure IV.7B Cost of Collection of Revenues by Gram Panchayats Annexure VI. 1 Frequency Distribution of GP based on JGSY Expenditure Per BPL Household Chapter I Rural Fiscal Decentralisation in Karnataka State History and Institutions I.l Introduction There has been a worldwide trend towards decentralisation in recent years. Many countries have experienced devolution of administrative, political and fiscal responsibilities to lower levels of government. Dissatisfaction with the prevailing centralized systems of service delivery, transition from centralized planning to market economy, deepening democratic principles and increasing need to recognize social, economic and political diversities in different regions within the countries are some of the important reasons cited for this phenomenon. This trend towards decentralisation is seen in countries with federal constitutions as well as in unitary countries, it has spanned across countries with varying levels of development; it is seen as much in transitional countries and even military dictatorships as in democratic countries (Litvack, Ahmad and Bird, 1998). In keeping with this global trend, in India too there has been a trend towards greater devolution of powers to urban and rural local governments particularly since the 1990s. Of course, attempts to decentralise the administrative system and establishself governing institutions has a much longer history in India and there have been sporadic attempts at devolving powers and rights to rural and urban local governments, particularly after independence. However, the impetus gained momentum with the statutory recognition of local bodies as institutions of rural and urban self-government after the 73rd and 74th Constitutional amendments in 1992. Although this was not done as a component of structural reform, the attempt at decentralisation coincided with other market-oriented reform effforts The worldwide trend towards decentralisation has been accompanied by animated discussions about its gains and losses. Many analysts find inherent merit in decentralisation; often it is considered to be a constituent of human well being and therefore, an end in itself. In many countries, policy makers see decentralisation a panacea for many ills afflicting the society. It is perceived as an important means to enable efficient allocation of resources, improve governance, accelerate economic growth, reduce poverty, achieve greater gender equity and empower weaker sections of society. In contrast, arguments against decentralisation have focused on the weakening the capacity of the central governments to 1 undertake macroeconomic stabilization, efficiency loss due to poor administrative capacity of local governments to undertake the functions assigned to them and potential for increased corruption (Prud’homme, 1995 Tanzi, 1996, 2001). The empirical studies are yet to settle the issue of the impact of decentralisation on efficiency, growth and governance. The efficacy of a decentralised system in improving governance, achieving empowerment and enhancing efficiency in service delivery, and impacting on growth and poverty depends on the nature of the institutions and more particularly the power structure in local areas. In the literature, the economic argument for decentralisation is rooted in the premise that it will enhance efficiency. Decentralisation enables wider choice and ensures better matching of public service - tax bundles with the preferences of people. The choice can be exercised either by ‘exit’ (Tiebout, 1956) or by ‘voice’ (Oates, 1999) mechanisms. However, the welfare enhancing argument for decentralisation is rooted in the ‘common good’ doctrine in which social welfare is maximised by an organicist state or a benevolent dictator. If on the other hand, ‘self interest’ doctrine is applied, in a monolithic structure in w hich different agents of the government are motivated by self interest, the oligopolistic power structure can result in bureaucratic, political elite or interest group capture (Breton, 1995, Bardhan, 2003, Bardhan and Mookheijee, 1990). In order for decentralisation to enhance efficiency and improve welfare, it is important to have a composite state that satisfies preconditions of intergovernmental competition (Breton, 1995). It is very well recognized that decentralisation is a complex and a multifaceted phenomenon. The typology of decentralisation includes deconcentration, delegation and devolution (Parker, 1995). In deconcentration, the decision making power is with higher level government and the lower level governments are merely employed by the higher level government to implement its policies and programs. In delegation, the decision making power is delegated to the lower level governments by the higher level government in respect of specified functions. It is only in devolution that decision making power is shared between higher and lower level governments. The concept of decentralisation has administrative, political and fiscal dimensions. The three dimensions are interdependent and the effectiveness of decentralisation requires calibration of the three dimensions together. Although it is possible to deal with each of the dimensions independently, reforms in one aspect of decentralisation can not be carried out beyond a point unless there are accommodating changes in others. Without political 2