Devolution is bankrupt

Now even the World Bank says money should flow to local bodies directly

By Richard Mahapatra
Published: Wednesday 15 September 2004

Devolution is bankrupt

-- A World Bank report on fiscal decentralisation to Panchayati Raj Institutions (pris) has reinforced the argument that decentralised governance in India will not work without genuine fiscal decentralisation. India: Fiscal Decentralization to Rural Governments analysed fiscal decentralisation in Kerala and Karnataka -- India's most proactive states on rural democracy -- to recommend that the fund flow mechanism from the Union government to villages should be overhauled. "During our survey it was clear that fiscal decentralisation is crucial to sustain self-governance at the village level," says Luis Constantine, World Bank's lead operations officer and a member of the team which prepared the report.

After studying the financial condition of panchayats in the two states and identifying problems in their financial management systems, the report recommends a national agenda for effective fiscal decentralisation.
Flawed system "Despite India's commitment to rural decentralisation, panchayats cannot live up to their potential because of the flawed structure of the fiscal decentralisation system," says the report, which was released in June 2004. Researchers found that both states have an inefficient financial management system, which hinders policymaking and planning in villages and makes decentralisation unmanageable and unaccountable.

The report blames the fiscal policies of state and Union governments for the financial mess rural governments are in. According to the 73rd and 74th constitutional amendments, implementing the Panchayati Raj Act is a state subject. This means state governments control panchayats and unless they improve their financial position, local governments won't get grants or revenue. This has been happening since 1997 when government workers got such a huge pay hike that states had little funds left for development.
Grant but no power And when pris get resources, they don't have the autonomy to spend it according to their needs. Local bodies in Karnataka have numerous responsibilities according to the Constitution, but almost no freedom to spend money. About 70 per cent of the money meant for local governance is kept back by the Karnataka government for salaries and incidental expenses. Local bodies control less than 10 per cent of the total rural spending. "As a result, local communities have not engaged with the process of planning and accountability to the extent hoped for by policy makers," the report says.

The situation in Karnataka proves that without fiscal autonomy and decentralisation, local governments can never operate like elected governments. Gram panchayats in Karnataka manage 428 schemes sponsored by the state and Union governments. Guidelines for these schemes are, however, so strict that they discourage local governments from implementing programmes in their own way. Without any say over spending, local governments have become implementing agencies of state and Union governments.

Hardly any panchayat in Karnataka and Kerala generates revenue on its own and is autonomous from the state government. Panchayats in these states have power to raise tax but they have not been able to use this power effectively (see table: State vs state). Panchayat revenue formed less than one per cent of the state gross domestic product in both places. Local governments are unable to use their financial powers because they don't have the capacity to administer a revenue system, officials don't enforce tax laws and the tax base is low.

State vs state
How Kerala, Karnataka compare in devolution of powers to panchayats
Devolution Karnataka Kerala
Functions All 29 prescribed in the constitution 15
Budgetary expenditure of PRIs 20 percent of total state expenditures 18 per cent
Budgetary expenditure at the gram panchayat level 0.38 percent of state GDP 1.4 per cent
Fiscal decentralisation Control panchayat spending in a major way gram panchayats have more expenditure autonomy

State governments call local bodies' inability to use their limited financial powers as 'fiscal indiscipline' and restrict fund flow. The report, however, says the fault is not with local governments but the manner in which their finances are evaluated. "As things stand at present, recommendations for fiscal reform may be made based on data that misrepresent the situation. Most important, assessment of the fiscal health of the local governments may be substantially incorrect, leading to misguided attempts at reform."

"In the absence of reliable information on the revenues and expenditures of local bodies, neither the states nor the Center can lead a reasonable fiscal decentralisation programme." There is no mechanism to monitor the performance of local governments or find information on their expenditure. Data with central and state finance commissions (sfcs) inflates the resources local governments have, and state governments then stop funds to pris. This could explain the constant cut in budgetary allocation for rural governments. "Neither the panchayats, nor sfcs, nor the government of India, nor state rural development and panchayat departments know the actual amount of funds available to panchayats, or their expenditure pattern."

Six solutions
Strengthening sfcs, broadening the tax base and granting more powers to pris are among the six broad strategies which the World Bank believes can create better fiscal decentralisation. Stronger sfcs are important because each state needs an organisation to track the performance of local bodies, check their finances and prepare an annual report on inter-governmental fiscal relations.

Allowing panchayats to tax agricultural land and local business can increase their tax base. Non-tax earnings like user charges, rents and license fees and a streamlined property tax mechanism, too, can increase their resources. For enabling local governments to reach the tax target set by state governments, the report recommends incentives like fund pools.

The Bank has also suggested a rethink on the three-tier structure of rural governments. Comparing India's system with other countries, it observes: "Three tiers of rural local governments below the state level with overlapping responsibilities, as in India, is costly, invites duplication of effort, and confuses the accountability objectives of the government's decentralisation program." (see table: Judging decentralisation)

Judging decentralisation
World Bank says good fiscal decentralisation follows 11 principles globally. Here’s India’s performance in Panchayati Raj based on some of those rules
International Principles India
Responsibility for expenditure and discretion in spending Responsibility is there but hardly any autonomy in spending
Finance follows function Function has come but no finance
Monitoring and evaluation of inter-governmental fiscal system There is no effective system in place and PRIs suffer due to this
Inter-governmental fiscal system should be flexible Strict bureaucratic implementation curbing local innovation

The report says that the role of district and block panchayats must be identified clearly so that gram panchayats can be screened from their interference. "Thought might be given to defining more clearly the role of the districts and blocks as either primarily deconcentrated arms of the state government, or as autonomous governments representing the preferences of their constituents."

For better fiscal decentralisation, the report says gram panchayats must be given more power as they "can best detect and respond to people's preferences and needs". Panchayats should be freed from implementing programmes of state or Union governments. "States should avoid devolving responsibilities to panchayats for schemes designed completely by a higher-level government, transferring to local government staff that they did not recruit and cannot fire, or asking them to spend their resources maintaining assets that they did not create."

The report comes at the right time. India is debating on what the fund flow to local bodies should be, and no less than the prime minister is taking part in this debate. The United Progressive Alliance's common minimum programme says allotting funds to local bodies is a key issue. Donor groups and lending agencies realise that funds for rural development programmes have to be channelised through local bodies in the future.

There is a national consensus that users groups of development programmes in villages should be put under pris. This means users groups, which have been set up for World Bank-assisted programmes, would have to work under under gram panchayats. Rural development programmes, therefore, will only succeed when there is fiscal decentralisation.

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