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Medium-term Fiscal Reforms Strategy for States
Draft Discussion Paper

Dr. N.C. Saxena
Former Secretary, Planning Commision,
June, 1999

CONTENTS

  1. Introduction
  2. Increased borrowing of states
  3. Revenue Receipts of Major States.
  4. Total Expenditure of Major States
  5. Special Problems of Finances of Special Category States
  6. Summing up

Part 2: The reform agenda

  1. Governance and fiscal deficit
  2. Prime Minister’s directions
    1. Finance Minister’s meeting
  3. Measuring fiscal performance
  4. Good governance
    1. Stability of tenure
    2. Transparency and corruption
    3. Reduction in size
    4. Professionalism
    5. Effective implementation of development programmes
    6. Accountability to the people
    7. Improving quality of life through greater attention to environment
    8. Decentralisation and redefining the role of government
  5. Summing up

 

I. Introduction

The deteriorating trend in State finances in recent years, in particular during the last two years, has reached an alarming proportion. Failure to contain rising wage bill, evasion of taxes, unsustainable interest liabilities, and reluctance to raise additional resources on the part of the States are some of the main causes. Tax wars among State Governments to attract private investments in the wake of economic reforms as well as competitive populism on the part of ruling parties and contenders for power led to this. Such tax wars resulted in significant revenue losses without commensurate gains in terms of private investments and associated economic gains. The explicit and implicit subsidies passed on to influential segments of the society through State budgets are substantial and are still growing. The combined net losses of State Electricity Boards have crossed Rs.10,000 crore.

The last blow has been the pay revision of employees forced upon the State Governments by the Centre’s unilateral decision to implement Fifth Pay Commission Report. The additional fiscal burden on account of pay revision is roughly estimated to be about Rs.20,000 crore per year for all the States together. Some of the major States are facing an impossible situation where their entire revenues are not enough to pay the wages of their employees. Several State Governments are indeed becoming ‘governments of the employees, by the employees and for the employees’ only. Overall, the pay revision has created a fiscal crisis of unprecedented dimensions for the State Governments. Even with sincere efforts to correct the situation, it may take several years for the States to come out of the current fiscal imbalance. Consequently, States are starved of funds to meet the essential investment needs in social and infrastructure sectors. Large borrowings are resorted to by several States just to meet the current expenditure. Almost all the indicators of fiscal health of the State economies are steadily deteriorating. Unless drastic measures to correct the situation are resorted to without delay several State finances will collapse. Planning Commission is therefore considering creating a fund from which assistance would be provided to those states which decide to embark upon a path of fiscal recovery. Implementation of the Plan, detailed in the second part of this paper will help the states fiscal health, release more funds for planned development, and improve governance at all levels.

II. Increased borrowing of states

With very little own funds and decelerating Central assistance, States have been depending more and more on high cost borrowings for financing their plans. As a result, the interest burden has been mounting. An aspect of the economic reforms has been increased reliance on market forces and private investments. The available statistics on private investments since 1991 indicate that they have been flowing mainly into those States which are more developed with better infrastructure and relatively efficient administration. The official aid flows from bilateral and multi-lateral agencies also show a similar trend of favouring more developed States. These are clear signals of diverging growth prospects of developed and developing States which do not augur well for the Indian economy and polity.

Financing patterns of State annual plans for 1997-98 and 1998-99 are presented in Table 1. The fifteen major States represented in Table 1 together account for over 93 per cent of the total population of India. There is great diversity among these States in terms of the size of population, which varies from just 1.2 million in Goa to as much as 139.1 million in Uttar Pradesh. While Goa’s population is only one-tenth of the population of the Capital Territory of Delhi, the population of States like Uttar Pradesh, Bihar, Maharashtra and other major States are comparable to those of some of the major nations of the world. The fifteen States are divided into three groups of five each based on the level of their per capita income.

Anticipated plan outlays at current prices for 1997-98 are given in column 2 and the structure of their financing are given in columns 3 to 5. For all the 15 major States taken together, central assistance accounted for about 40 per cent of plan financing and borrowings accounted for over 78 per cent of plan financing. The contribution of States own funds was (-) 18 per cent. It implies that about 18 per cent of the borrowings/central assistance was diverted by the States for meeting current expenditure on non-plan account. Such diversions were maximum in Punjab (154%) followed by Uttar Pradesh (77%), Madhya Pradesh (64%) and West Bengal (61%), Gujarat, Maharashtra, Karnataka, Kerala and Rajasthan had made positive contributions of own funds for plan financing. Borrowings as a share of plan outlay exceeded 100 per cent in the case of Punjab, West Bengal, Madhya Pradesh and Uttar Pradesh.

The State plan outlays for 1998-99 as approved by the Planning Commission and the structure of their financing for the 15 States are given in columns 6 to 9 of Table 1. The States own funds, however, received a further beating in 1998-99 as compared to the previous year. About 25 per cent of the borrowings/central assistance are expected to be diverted by the States for meeting the non-plan revenue expenditure. Only one State viz., Karnataka is expected to provide a positive contribution of own funds for plan financing. Five States viz., Goa, Haryana, Punjab, Tamil Nadu and Rajasthan are projecting more than 100 per cent borrowings for financing the approved plan. It is noteworthy that there is hardly any difference among the three groups of States in terms of source of financing of the projected plans. Indeed, three out of five States which projected more than 100 per cent borrowings are from the high income group.

In the Eighth Plan, negative own funds and high level of borrowings were limited to a few States, mostly low income States and others with fiscal stress due to special reasons. By 1997-98 the share of negative contributions and borrowings have gone up for all States taken together and they have become more prevalent. For 1998-99, even at the projected levels these tendencies have further aggravated.

 Table 1: Financing Pattern of Annual Plan 1997-98 and 1998-99

Annual Plan 1997-98

Annual Plan 1998-99

States

Antici-pated outlay at current prices

Percen-tage share of Central Assista-nce

Perce-ntage share of own funds of the States

Percen-tage share of borro-wing of the States

Appro-ved outlay at current prices

Percen-tage share of Central Assist-ance

Perce-ntage share of own funds of the States

Percen-tage share of borro-wings of the States

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

High Income States

1. Goa

184

41.1

-9.2

68.1

291

26.8

-50.9

124.1

2. Gujarat

4500

22.9

22.6

54.4

5450

25.9

-1.6

75.8

3. Haryana

1421

43.2

-20.6

77.5

2260

42.2

-42.6

100.4

4. Maharas-htra

8393

20.6

16.9

62.5

11601

16.1

-0.1

84.1

5. Punjab

1415

43.6

-153.9

210.3

2500

27.5

-57.3

129.8

Middle Income States

1. Andhra Pradesh

3617

59.4

-18.5

59.1

4679

65.7

-44.8

79.0

2. Karnataka

4151

22.0

14.7

63.3

5353

22.3

10.3

67.4

3. Kerala

2891

21.6

12.3

66.1

3100

24.8

-18.1

93.3

4. Tamil Nadu

4052

41.1

-7.8

66.7

4500

37.9

-54.9

117.1

5. West Bengal

3388

54.1

-60.9

106.8

4595

59.5

-59.2

99.7

Low Income States

1. Bihar

3201

53.9

-52.4

98.5

3769

53.6

-28.0

74.4

2. MP

2152

58.9

-64.3

105.3

3700

56.4

-55.4

99.0

3. Orissa

2169

64.7

-25.4

60.8

3084

52.1

-13.8

61.7

4. Rajasthan

3748

31.1

0.9

68.1

4300

32.6

-36.7

104.1

5. UP

4892

61.3

-77.3

116.0

10260

42.3

-21.8

79.5

Total 15 States

49172

39.5

-17.7

78.2

69442

37.3

-24.9

87.6

Source: Derived from data available in the Planning Commission, Government of India

III. Revenue Receipts of Major States.

We shall now turn to an examination of the revenue receipts of the major States. Revenues of the States can be broadly classified into tax and non-tax revenues. Tax revenues are composed of States own tax revenues and share in Central taxes. Non-tax revenues comprised States own non-tax revenues and grants from the Centre. The major components of revenue receipts of the 15 major States are presented in Table 2.

Table 2: Revenue Receipts of the States in 1996-97 (Rs. Crore)

Tax revenue

Non-tax revenue

State

States Own Tax Revenue States share in Central Taxes Total tax revenue States own non-tax revenue Grants from Centre Total non-tax revenue Total revenue
(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

High Income States

1. Goa

303

90

393

347

70

417

810

2. Gujarat

6065

1175

7240

1573

855

2428

9668

3. Haryana

2143

432

2575

3133

340

3473

6048

4. Maharashtra

11715

2275

13990

3755

1510

5265

19255

5. Punjab

2735

528

3263

1945

361

2306

5569

Middle Income States

1. Andhra Pradesh

4882

2939

7821

1625

1748

3373

11194

2. Karnataka

5768

1730

7498

1342

782

2124

9622

3. Kerala

3899

1242

5141

514

490

1004

6145

4. Tamil Nadu

7984

2165

10149

886

926

1812

11961

5. West Bengal

4259

2420

6679

418

1130

1548

8227

Low Income States

1. Bihar

2251

4078

6329

1061

648

1709

8038

2. Madhya Pradesh

4104

2636

6739

1975

1300

3275

10014

3. Orissa

1342

1566

2908

482

897

1379

4287

4. Rajasthan

3124

1766

4890

1361

1309

2670

7560

5. Uttar Pradesh

6306

6072

12378

1319

2331

3650

16028

 

All India/All States

71102

35038

106139

23543

23154

46697

152836

Source: Based on the budgetary documents of the Central and State Governments.

The principal component of revenue receipts of the major States is own tax revenues. Column 2 of table gives state-wise figures of own tax revenues. The absolute amount of own tax revenues of the States vary considerably across the States from just Rs.303 crore in Goa to as much as Rs.11,715 crore in Maharashtra. It is noteworthy that States like Gujarat and Karnataka collect more tax revenues than larger States like Bihar, Madhya Pradesh and West Bengal. Similarly, Tamil Nadu with less than 40 per cent of the population of Uttar Pradesh collects more tax revenues than the latter. Of course, the level of prosperity as measured by per capita income may have a major influence on the level of tax revenues. For a fair comparison of tax efforts among the States the own tax revenues as a percentage of the net State domestic products (NSDP) have been worked out. As against the average tax-NSDP ratio of 7.5 per cent for the 15 States, the ratio was highest at 13.9 per cent for Kerala, followed by Tamil Nadu (11.5%), Karnataka (11.4%) and Goa (11.0%). All the five low income States have tax-NSDP ratios below the 15 States average. Uttar Pradesh and West Bengal share the lowest ratio of 6 per cent followed by 6.1 per cent in Orissa and 6.3 per cent in Bihar. It is interesting to note that two of the high income States viz., Haryana and Punjab have tax-NSDP ratios below the average level for 15 States. Even Maharashtra which has raised the maximum tax revenues has a tax-NSDP ratio of 7.8 per cent which is only marginally above the all States average.

A comparison of per capita own tax revenues of the three groups of States indicates substantial differences. For high income States per capita tax revenues vary from Rs.2164 in Goa to Rs.1152 in Haryana. For middle income States, the same vary from Rs.1342 in Tamil Nadu to Rs.571 in West Bengal. The corresponding variation in the case of low income States is from Rs.629 in Rajasthan to Rs.242 in Bihar. The per capita tax revenue in Goa is almost nine times that in Bihar. Also, it is important to highlight the fact that Punjab with double the per capita income of Kerala collects per capita less tax revenue than that of Kerala.

The principal source of States own tax revenues is sales tax which accounts for about 60 per cent of the total. The other major components of States own tax revenues according to their revenue share are State excise, registration and stamp duty, motor vehicle and passenger tax, electricity duty, land revenues, profession tax, entertainment taxes and other sundry taxes. In the wake of economic reforms, several States competitively announced various tax concessions, especially sales tax concessions, to attract private investments. These tax wars resulted in considerable reduction in the buoyancy of growth of tax revenues of the States without commensurate gains in terms of private investment. A few States, particularly Andhra Pradesh and Haryana, introduced total prohibition for a few years. Considering the ineffectiveness of enforcing prohibition and the associated losses of excise revenues, these States have either repealed prohibition or introduced partial prohibition. Of late, a number of States have been giving various tax concessions to please powerful lobbies in the society. These populist measures competitively practiced by successive governments have created serious dents on the revenues of some of the States. Punjab needs special mention in this context where due to large number of tax concessions the tax-NSDP ratio has, indeed, come down over the last couple of years.

The experiences of various States clearly indicate that there is high positive correlation between tax efforts and tax revenues. A closer examination of the individual components of tax structure in different States brings out the fact that those States which have reached high tax-SDP ratios like Kerala, Tamil Nadu and Karnataka have tried to exploit the full potential of tax revenues by widening the coverage, rationalising the rates and streamlining the procedures to minimise tax evasion. The additional tax revenue potential of States like Uttar Pradesh, West Bengal and Punjab, where the tax NSDP ratios are exceptionally low, are substantive. The sales tax revenue collected in West Bengal is less than 50 per cent of that collected in Tamil Nadu, though the two State economies are of comparable size. It is noted that an appreciably higher rate of sales tax on motor spirits alone fetches an additional Rs.1000 crore in Tamil Nadu as compared to West Bengal. Similarly, Tamil Nadu collects almost three times the excise revenues collected in West Bengal though the former is under a regime of partial prohibition while the latter has no prohibition at all. While sales tax accounts for about 60 per cent or more of the tax revenues of most of the States, its share is as low as 40 per cent in Punjab. This, despite the fact that Punjab has one of the highest per capita consumption expenditure. Similarly, Uttar Pradesh collects less amount as motor vehicle tax than Haryana or Orissa, though it is well known that the potential tax revenue in Uttar Pradesh on this account could be much more than that of Haryana or Orissa.

Sharing of Central taxes with the States is a constitutionally ordained function and the principles for vertical division of the tax revenues between the Centre and the States and horizontal sharing of the States share by the various States are determined by the Finance Commissions. The currency of the Tenth Finance Commission award will continue till the end of 1999-2000. Presently, 77.5 per cent of personal income tax revenues and 47.5 per cent of the Union Excise revenues are distributed among the States. The formula used for horizontal allocation is fairly egalitarian which gives 60 per cent weight to per capita income and 20 per cent weight to population.

For the 15 major States as a whole, share of central taxes worked out to just about one-third of the total tax revenues. The State-wise amounts are presented in column 3 of table 2. For high income States, the share of Central taxes in total tax revenues varies from 16 per cent each for Gujarat, Maharashtra and Punjab to 23 per cent for Goa. In the case of middle income States the shares vary from 21 per cent for Tamil Nadu to 38 per cent for Andhra Pradesh. For low income States the corresponding shares vary from 39 per cent for Madhya Pradesh to as much as 64 per cent for Bihar. The egalitarian nature of Central tax devolution to the States is, thus, quite evident.

A major concern of the States of late, however, is the deceleration in the growth of Central tax revenues and hence the quantum of devolutions. The annual growth in the total revenues devolved to the States was between 12 to 20 per cent per year till 1996-97. In 1997-98, but for Voluntary Disclosure of Income Scheme (VDIS), there might have been an absolute decline in the devolved revenues. The amount devolved in 1998-99 was just at 1997-98 level. Further, due to recessionary conditions and low rate of industrial growth the union excise revenue may fall significantly short of the projected level and this is likely to reduce the overall devolution to the States below the budget estimates. If the current trend of decelerating growth in Central tax revenues continues, even the proposed implementation of alternative devolution scheme recommended by the Tenth Finance Commission may not bring any succor to the State governments.

Column 4 of Table 2 presents the total tax revenues of the States which consist of their own tax revenues and the devolved tax revenues from the Centre. Total tax revenues accounted for about 70 per cent of the total revenues of 15 major States in 1996-97.

The total non-tax revenues of the States consist of States own non-tax revenues and grants from the Centre. The principal components of States own non-tax revenues are interest receipts, dividends and profits, user charges for economic services, social services and other general services. Grants from the Centre comprise of the grant component of Central assistance for State plans and centrally sponsored schemes, grants under Finance Commission dispensation for meeting the special needs of the States, natural calamity and relief grants and other sundry grants. The total non-tax revenues of the 15 major States worked out to a little over 30 per cent of their total revenues in 1996-97. These were more or less equally shared by own non-tax revenues of the States and grants from the Centre.

Column 5 of Table 4 gives the State-wise own non-tax revenues of the States. They vary from Rs.347 crore in Goa to Rs.3755 crore in Maharashtra. There is wide variation in the amount of own non-tax revenues among States within each of the three groups. A significant share of non-tax revenues in some States like Goa, Gujarat, Andhra Pradesh, Bihar and Madhya Pradesh, is on account of mineral royalties which are accounted as part of the user charges for economic services. In States like Kerala, Karnataka and Madhya Pradesh revenues from forestry and wild life is important. States where public sector units are run efficiently and commercially profitably they are in a position to contribute significant amounts to the State public exchequer in the form of interests and dividends. Gujarat, Maharashtra, Karnataka and Tamil Nadu are in this category. Haryana’s exceptionally large non-tax revenue is on account of a large amount of gross receipts from the State lotteries which accounts for almost half of the amount. By and large, those States which recover a reasonable fraction of the cost of economic and social services which do not belong to the category of merit goods, collect a fair share of their own non-tax revenues from this source. Those States which have exceptionally low own non-tax revenues, which include Kerala, West Bengal and Orissa, do not have any of the above mentioned sources as a major revenue earner.

State-wise grants from the Centre are presented in column 6 of Table 2. On the whole the Central grants have an egalitarian bias. This arises from the fact that the grants under plan based on Gadgil Formula, the Finance Commission formula and the criteria for allocation of the principal poverty alleviation programmes under Centrally Sponsored Schemes, all have an egalitarian bias.

IV. Total Expenditure of Major States

Apart from meeting the unavoidable expenditure on account of maintenance of the various organs of the State and general administration, the State governments incur considerable expenditure in providing various social and economic services. Part of these, are in the form of revenue expenditure and the remaining in the form of capital expenditure. Indeed these expenditures are important instruments of economic and social transformation of the society and as such they constitute what is known as development expenditure.

Table 3: Total Expenditure of the States in 1996-97

States

Revenue Expenditure Capital expenditure Total Expenditure % share of development expenditure in total expenditure Interest payment as a % of revenue expenditure

(1)

(2)

(3)

(4)

(5)

(6)

High Income States

1. Goa

789

125

914

63.3

12.8

2. Gujarat

10259

1767

12026

73.2

15.7

3. Haryana

6767

381

7148

54.4

10.6

4. Maharashtra

20846

3363

24209

72.8

11.7

5. Punjab

6926

107

7033

58.1

23.6

Middle Income States

1. Andhra Pradesh

14392

-387

14005

79.5

12.8

2. Karnataka

10201

1365

11566

72.6

11.8

3. Kerala

6788

900

7688

64.7

16.2

4. Tamil Nadu

13065

1341

14406

73.3

11.3

5. West Bengal

10362

1262

11624

72.9

18.7

Low Income States

1. Bihar

8254

675

8929

61.2

17.2

2. Madhya Pradesh

11462

479

11941

76.2

12.0

3. Orissa

5117

965

6082

67.4

21.1

4. Rajasthan

8226

1840

10066

71.8

18.9

5. Uttar Pradesh

19208

2777

21985

61.3

21.1

 

All India/All States

168950

21331

190281

69.5

15.1

Source: Based on Central and State budgets as reported in the Supplement to RBI Bulletin, February, 1999.

In the previous section, we have examined the details of revenue receipts of the States. Besides revenue receipts the States receive non-debt capital receipts on account of recovery of loans and other miscellaneous capital receipts. Almost invariably all the States incur expenditure which outstrip the total receipts. The gap is filled by borrowings. The repayment liabilities on account of borrowings, especially the interest liability, is a fast growing item of expenditure for all the States.

A summary picture of State-wise expenditure is presented in Table 3. The total expenditure and its components viz., revenue and capital expenditure can be seen in columns 2 to 4. In column 5, the share of development expenditure as a percentage of total expenditure is given. Column 6 presents interest payment as a percentage of revenue expenditure.

Revenue and capital expenditure incurred by the 15 major States in 1996-97 are presented in columns 2 and 3 respectively of Table 3. It is clear that revenue expenditure, by far, accounts for the lion’s share of expenditure of the States. For all States taken together, revenue expenditure accounts for 89 per cent of the total expenditure. The share of revenue expenditure varied from 82 per cent in Rajasthan to over 100 per cent in Andhra Pradesh. The share of revenue expenditure does not appear to be related to the level of income of the State as no pattern can be discerned from the structure of expenditure of the three groups of States.

It is important to mention in this context that there has been a steady increase in the share of revenue in total expenditure of States over the years. The revenue expenditure as a percentage of total expenditure of all States was 65 per cent in 1980-81 which increased to 78 per cent in 1990-91 and further to 89 per cent in 1996-97. During this period the revenue expenditure of all States as a percentage of GDP increased from 10.89 per cent in 1980-81 to 13.40 per cent in 1990-91 and further to about 14 per cent in 1996-97. On the other hand the capital expenditure of the States as a share of GDP has been steadily coming down from 5.8 per cent in 1980-81 to 3.6 per cent in 1990-91 and further to 1.51 per cent in 1996-97.

The expenditure of the States can be broadly classified into development and non-development expenditure. Items of expenditure on various social and economic services, both on revenue and capital account can be classified as development expenditure. For all States taken together, development expenditure accounted for about 70 per cent of the total expenditure in 1996-97. Almost 80 per cent of the capital expenditure and a little less than two-thirds of the revenue expenditure can be classified as development expenditure. While social services accounted for the major share of revenue-development expenditure, economic services accounted for the major share of capital development expenditure.

Non-development expenditure account for about 30 per cent of the total expenditure of the State. This is comprised of over one-third of revenue expenditure and a little over 20 per cent of the capital expenditure. The principal non-development expenditure components of revenue expenditure are interest payments, administrative services and pensions. On the capital expenditure side the major items of non-development expenditure are repayment of loans to the Centre and discharge of other debts.

Percentage share of development expenditure in total expenditure for the 15 major States are presented in column 5 of Table 3. They vary from as low as 54 per cent in Haryana to as high as about 80 per cent in Andhra Pradesh. The fact that expenditure incurred on account of State lotteries in Haryana is a substantial non-development revenue expenditure in that State explains the very low share of development expenditure there. Similarly, the low development expenditure share of 58 per cent in Punjab is partly because of the very large interest burden on account of expenditure incurred on fighting terrorism in the State. The share of development expenditure was higher among the middle income States on the average, where four out of the five States had their share of development expenditure higher than the all States average. Only two States each in the case of high income and low income States had their share of development expenditure higher than the all States average.

As noted earlier, one of the major concerns about the State finances in recent years has been the increasing burden of interest payments. As a result of widening revenue gap, while capital investment has been coming down, borrowing of the States have been going up. Further, in the wake of financial sector deregulation, State governments have to pay market related interest rates which are significantly higher than the earlier fixed rates in a regulated money market. The combined effect of these- increased borrowings and higher interest rates - has been soaring interest burden on the States. Interest on State debt as a percentage of GDP which was as low as 0.90 in 1980-81 increased to 1.72 in 1990-91 and further to 2.12 in 1995-96.

Interest payment as a percentage of revenue expenditure for the 15 major States along with the all State average is presented in column 6 of Table 3. Two States in the high income group, two States in the middle income group and four States among the low income group have interest burden higher than the all States average of 15.1 per cent. Punjab had the highest interest burden at 23.6 per cent of the revenue expenditure in 1996-97. However, it may be mentioned that after the loan write off for Punjab announced by the Centre in 1998, the interest burden of Punjab has come down significantly.

V. Special Problems of Finances of Special Category States

Ten out of 25 States in the Indian Union are categorised as Special Category States and given favoured treatment in respect of plan financing and financial devolutions. They are the seven States in the North East - viz. Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland and Tripura - Himachal Pradesh, Jammu and Kashmir and Sikkim. A number of them were created for considerations other than financial viability. Some of them formed parts of former Assam as just one or two districts. All of them have the common characteristics of hilly and difficult terrain and very low level of infrastructural development. Most of them have significant tribal population. Almost all of them are border States with considerable international borders.

The ten Special Category States together accounts for just over 5 per cent of the population of the country. However, according to the Gadgil formula for devolution of Central assistance for States plan as approved by the National Development Council, 30 per cent of the total funds is earmarked for Special Category States. Further, as against the composition of Central assistance of 30 per cent grant and 70 per cent loan for major States (characterised as non-special category States), special category States receive 90 per cent plan assistance as grant and just 10 per cent as loan. Similar favoured treatment is received by the special category States in the hands of the Finance Commission in respect of devolution of Central tax revenues. High levels of devolution by the Planning Commission and the Finance Commission compensate for the very fragile own revenue basis of these States.

Table 4 presents the important financial indicators of special category Sates. As a reference point the all States average of each of the indicator is also included in the table. Column 2 presents the per capita net domestic products of the States at current prices for 1995-96, the year for which latest data are available. It is clear that special category States are, by and large, poor States with relatively low per capita incomes. Only Arunachal Pradesh and Nagaland have average NSDP higher than all States average, that too only marginally higher. Tripura is the second poorest State in the country, after Bihar, in terms of per capita income.

The various revenue receipts of the Special Category States are presented in columns 3 to 7 of Table 4. Column 3 presents the per capita own tax revenues. They vary from as low as Rs.77 in Mizoram to Rs.620 in Himachal Pradesh. All of them are below the all-States average of Rs.686, though Himachal Pradesh comes quite close. Some of these States do not even impose sales tax which is the principal source of own tax revenues in other States. Their logic is that due to transport and communication bottlenecks the prices are generally 25 to 50 per cent higher there as compared to the rest of the country and they do not want to overburden the consumers by further raising the prices by imposing sales tax.  

Table 4: Finances of Special Category States

State

Per capita net dome-stic prod-uct at curre-nt prices for 1995-96 (in Rs)

Revenue receipts per capita in 1995-96 (in Rs)

Devel-opme-ntal exp. as a % of reve-nue exp. in 1995-96 Capital exp. as a % of total exp. In 1995-96 Per capita outlay realised in the Eighth Plan at 1991-92 prices
Own tax reve-nues Own non-tax reve-nues Tax devo-lution Cent-ral Gran-ts Total
(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(10)

1.

Arunachal Pradesh

10205

82

866

1331

5774

8053

72.1

36.2

14936

2. Assam

6288

291

139

378

590

1398

65.6

11.4

836

3. Himachal Pradesh

8747

620

213

726

1624

3183

67.1

17.2

4408

4. Jammu and Kashmir

6181

347

192

783

2644

3966

62.2

23.3

2959

5. Manipur

6914

140

229

835

2278

3483

66.1

22.4

4476

6. Meghalaya

7862

345

349

832

2038

3564

67.9

21.6

3960

7. Mizoram

9570

77

614

1656

6052

8399

70.8

19.5

9518

8. Nagaland

9758

158

260

1511

4020

5949

60.0

17.1

4692

9. Sikkim

9472

471

789

1174

5502

7936

74.5

26.1

10932

10 Tripura

5083

161

129

766

2088

3144

67.9

19.1

3183

 
All States

9725

686

254

323

232

1494

61.5

15.2

1619

Source:Derived from data available in the Planning Commission, Government of India

Own non-tax revenues given in column 4 indicate that they vary from as low as Rs.129 per capita in Tripura to as much as Rs.866 in Arunachal Pradesh. The high level of non-tax revenues in States like Arunachal Pradesh, Mizoram and Meghalaya are on account of sizeable revenues from forestry. However, the recent Supreme Court mediated regulation of felling trees has created sizeable dent into this source of non-tax revenues. The high level of per capita non-tax revenue of Sikkim is partly explained in terms of the sizeable net revenue from lottery accruing to that State. With restrictions on lottery sales, this amount is likely to come down. On the whole own non-tax revenues of special category States are comparable to those of the major States.

Finance Commission-mediated tax revenue devolution is given, State-wise, in column 5. They vary from Rs.378 per capita for Assam to Rs.1656 per capita for Mizoram. Obviously the per capita tax revenue devolution for all the special category States exceeds the all States average of Rs.323 per capita. Indeed, three of them viz., Arunachal Pradesh, Mizoram and Nagaland receive more than four times the per capita average for all States and Sikkim receives more than three times.

Per capita grants from the Centre is given in column 6. It is clear that these are far in excess of the all States average of Rs.232 per capita. The principal reason for the very high level of Central grants to special category States is the fact that 90 per cent of the Central assistance for their State plans are in the form of grants and they together receive 30 per cent of the Central assistance though their share of the total population is just about 5 per cent of the total. Even the lowest per capita grant for Assam of Rs.590 is more than double the all States average. Grants per capita of States like Mizoram, Arunachal Pradesh and Sikkim are more than 20 times the all States average.

The total per capita revenue receipts of special category States are presented in column 7. They vary from Rs.1398 for Assam to as much as Rs.8399 for Mizoram. All of them except that of Assam exceed significantly the all States average of Rs.1494. It is interesting to note that the revenue receipts per capita of a number of special category States like Arunachal Pradesh, Mizoram and Sikkim are close to their per capita NSDPs. This implies that the size of the Governments in these States in terms of the purchasing power is comparable to the private sector especially in view of the fact that there are not any major corporates in these States.

Developmental expenditure as a percentage of revenue expenditure for special category States is presented in column 8. The share of developmental expenditure varies from 74.5 per cent in Sikkim to 60.0 per cent in Nagaland. Indeed, the only State with the share of developmental expenditure less than the all States average among special category States is Nagaland. Considering the fact that large quantum of plan assistance flows from the Centre to these States, high share of developmental expenditure is not surprising. Lower shares in States like Nagaland and Jammu and Kashmir are on account of large scale diversion of plan funds for current non-developmental expenditure.

Capital expenditure as a share of total expenditure of special category States is given in column 9 for different special category States. It is noteworthy that the share of capital expenditure in all special category States except Assam, is higher than the all States average. The share of capital expenditure is exceptionally high in Arunachal Pradesh and comparatively high in Sikkim. Considering the very low level of infra- structural developments in these States, the high share of capital expenditure is indicative of the right priorities.

Per capita plan outlays realised by the special category States during the Eighth Plan are presented in column 10 of Table 4. They vary from the low figure of Rs.836 for Asssm to the very high figure of Rs.14936 in Arunachal Pradesh. Assam is the only State where the plan expenditure was less than the all States average and that too almost half that level. All other special category States had achieved significantly higher levels of outlay during the Eighth Five Year Plan. It is, however, important to note that Assam, which accounts for more than 50 per cent of the population of special category States had achieved very low level of plan outlay, pulling down the population weighted average plan outlay for special category States to a low level of Rs.2631 per capita.

VI. Summing up

To sum up,

  • there has been a steady increase in the share of revenue expenditure and a decline in the share of capital expenditure across the States over time;
  • the share of developmental expenditure in total expenditure vary considerably across the States and on the average this share is higher among the middle income States as compared to higher and lower income States;
  • as a result of widening revenue gap, borrowings have been going up resulting in increasing interest liability which has crossed 20 per cent of the revenue expenditure in the case of a few States;
  • while there has been an overall deterioration in the finances of almost all the major States, the fiscal deterioration has been exceptionally damaging in the case of a few low income States and Bihar stands apart even among them;
  • the discussions bring out the exceptionally fragile nature of the finances of the Special Category States.

It is apparent that the present fiscal situation in most States is unsustainable. There is an urgent need for restoring a semblance of balance between revenue receipts and revenue expenditure. A practical step is to ensure that revenue expenditure growth does not exceed revenue receipts growth. This can be achieved only if utmost restraint is practiced in containing government expenditure. Most of the States have considerable scope for raising additional tax revenues. The scope for raising non-tax revenues by cutting implicit subsidies on a variety of economic and social services of a non-merit nature through appropriate user charges are substantial.

Part 2: The reform agenda

VII. Governance and fiscal deficit

Behind the fiscal crisis, as argued above, is a combination of stagnant revenues and rapidly increasing current expenditures. This has several implications. First, declining capital investment has led to slow growth which in turn has made increasing the revenue yield more difficult. Second, financially weak infrastructure sectors have placed a massive burden on the state; problem has been accentuated by the deepening culture of non-payment by customers of public utilities. And third, governance problems have accelerated fiscal crisis both directly and indirectly as discussed below.

In almost all states people perceive bureaucracy as wooden, disinterested in public welfare, and extremely corrupt. Despite expansion in the role of government during 1970-90, not much improvement has taken place in the effectiveness of administration. On the other hand, increasing corruption, declining performance and lack of concern for public welfare has made the people think that government machinery exists only for government servants who not only pressurise the government to increase their salaries but also use their powers and positions for illegal gratification.

Honesty at lower levels was as rare in the colonial past as it is now. The British appeared to believe that as long as the man at the top was honest, corruption at lower levels would not really do much damage. However there are indications that corruption is on the increase even in higher echelons of bureaucracy. People in the past looked upon functionaries at the cutting edge levels as an organised band of exploiters. In the not so recent past, members of the all India services were not considered a part of this mafia. Rather they were looked upon by the people as saviours from the tyranny of lower level functionaries, and were never considered corrupt. But of late the distinction seems to have got blurred, if not totally eliminated. Corruption at the top has emboldened lower level officials who now openly exploit the masses with impugnity. One of the Prime Ministers in India described the nature of public mal-administration in the following words:-

  • ‘We have government servants who do not serve but oppress the poor and the helpless, who do not uphold the law but connive with those who cheat the state and whole legions whose only concern is their private welfare at the cost of society. They have no work ethic, no feeling for the public cause, no involvement in the future of the nation, no comprehension of national goals, no commitment to the values of modern India. They have only a grasping mercenary outlook, devoid of competence, integrity and commitment.’

An effective and responsive district level field machinery should have a high degree of commitment, motivation, professional competence, adequate knowledge of their job and, above all, integrity. Stated objectives should be internalised and widely shared by the members of bureaucracy starting from Collector down to the village level worker. There has to be strong and consistent flow of energy from all concerned for meeting these objectives. Discipline needs to be combined with a high degree of innovation. Hard work should lead to output and output should lead to reward. Does the Civil Service and the development machinery conform to these standards?

The Ninth Five Year Plan 1997-2002 has observed -

  • ‘Past experience has shown that many development projects and programmes, having laudable objectives, have failed to deliver the results because of the inadequacies in design and implementation. It is common knowledge that the benefits intended to be delivered to the people through development programmes in the social sectors have not fully reached the beneficiaries because of the weakness in administrative, planning and the delivery mechanism. Lack of accountability of the implementing agencies either to the Government or to the people has been the single major cause for diversion of funds in development programmes.
  • Evaluation studies conducted by the Planning Commission also suggest that adequate attention is seldom paid to the assessment of beneficiary needs, the fixation of criteria for selection of target groups, the choice of implementation methods and delivery system, the adequacy of physical and financial inputs, choice of indicators to be monitored and the sustainability of programme benefits. Rigid guidelines for the implementation of programmes, high operational costs, improper targeting leading to leakage of benefits to areas / people not covered nor targeted, extending the coverage of a programme to a larger (than desired) area / population to avoid the risk of exclusion, inadequacy of the delivery systems of most programmes etc. are all reflections of inadequate planning of programmes before implementation.
  • Several cases of improper use of funds meant for anti-poverty programmes have come to light. In one of the employment generating schemes, it was found that the muster rolls were not maintained at the grass-root level. A voluntary organisation has unearthed several cases of large scale misappropriation of funds in rural development programmes in four districts of one State. This happened primarily because of lack of people's participation in the implementation of programmes, lack of transparency in the operation of schemes and inadequacy of monitoring mechanism.’

A note circulated by the Department of Administrative Reforms and Public Grievances vide its letter No. K-11022/23/96-P dated 6th November 1996 observed -

  • ‘The public administration and the civil services at all levels are passing through difficult times in terms of eroded credibility and effectiveness of the civil service, growing public perception of an unholy nexus between certain elements among politicians and civil servants and criminals and increasing criticism of the low level of honesty, transparency and accessibility to the political and bureaucratic elements in-charge of administration.
  • The present lack of transparency and the scope for manipulation of the system results in the criterion of merit being undermined by considerations of personal loyalty and complicity with unethical dealings. The absence of a well-defined structure for rewards and punishments, and the confusion regarding the desirable service norms for civil service has led to low morale and pursuit of career advancement at the expense of ethical values.’

A young IAS officer working in the field has described the predicament of honest officers in the following terms:-

  • ‘As Project Director I was handling RD funds and it was often a problem to release money to the Blocks and Panchayats. This was so because the BDO or the Mukhia would immediately take up 'n' number of schemes and distribute the total money as advance to either his own relatives who act as agents or Abhikartas in JRY schemes or the muscle men or petty contractors of the local MLA. If any action is proposed against the BDO or the Mukhia a report has to be sent to the Minister who often does not take any action. This further emboldens the BDO while the Collector/ PD gets demoralised. Upright officers have been systematically marginalised by the indulgent political masters who expect a committed bureaucracy. Committed officers enjoy outstanding CRs and foreign training, while upright officers are sidelined in Rajbhasha, Protocol etc. When they apply for GOI deputation, all kinds of hinderances are created. This is done to break the upright officer and make him submissive and more committed.’

Addressing the Chief Secretaries Conference on 20th November 1996, Cabinet Secretary observed -

  • ‘In recent times, the services have been facing a grave crisis of identity and role definition. The civil services which were known for their 'steel frame' and commitment to the values of nation-building, have today come under a great stress. Bureaucrats have been characterised as self-seekers, corrupt and mired in red-tape. People have come to believe that public service is meant to benefit the Government servants and politicians and not the public. There is also a growing feeling that many of the civil servants are involved in partisan politics and sectarianism. There is talk of a nexus between politicians, bureaucrats and criminals, and instances of senior bureaucrats as well as politicians being involved in specific cases of corruption now abound.
  • All these, unfortunately, have affected the very quality of governance in the country. There is, on the one hand, a downward slide in the general morale of the civil services which constitute the backbone of the administrative framework, on the other, increasing attempts are being made to encroach upon the domain and functions of the Executive as laid down in the Constitution.
  • However, the reforms carried out in the past have basically dealt with the procedural changes without taking into account their impact on the quality of service for the people. The reforms also failed to cover either the measures to make the administration more accountable, transparent and people oriented, or the steps to counter the growing demoralisation and corruption in the public services.
  • In many State Governments, civil servants at operational and decision-making levels, are vulnerable to sudden and rapid shifts on account of arbitrary, political or other considerations. In fact, the morale of the civil service to a large extent is influenced by the transparency in the process by which decisions are taken in regard to promotion and placement of individual office.
  • There can hardly be two opinions on the imperative need at this juncture to refurbish our image which is increasingly getting tarnished by corruption in high places. There should be no compromise on probity, and extreme deterrent action should be taken in exemplary cases.’

The collapse of ethical standards has a number of implications for fiscal discipline. In such a scenario of low institutional capability and poor performance of civil servants it is unfair to expect that the political processes would be totally free from populism. Politics is after all 'art of the possible', and if the civil service is no longer able to ensure good governance, politicians are forced to resort to populism in order to reach at least some benefits to the people to keep the faith of the voter alive in the political system. Subsidies on water, power and transport help in maintaining the credibility of the democratic system, since the voter does not seem to be getting any other benefit through the vast and ever growing bureaucratic machinery. Unless massive efforts are undertaken to improve governance and make the administrative apparatus perform for what it is paid, public may not take very kindly to withdrawal of subsidies. States’ reluctance to hit at the entrenched government servants, take action against the corrupt ones, or reduce their numbers or make changes in their service conditions further confirms the belief of the people that state apparatus exists only for government servants. The problems of security, the culture of harassment, long delays, administrative secrecy, and the seeming inability to check organised power theft - all discourage formal sector, large scale, law-abiding tax paying units from investing in some states. But it is the growth of the latter upon which prospects for future productivity and export growth and higher wage jobs will largely depend. These states will be neither able to end the fiscal crisis nor to restore growth unless they are able to address problems of governance. Whether the issue is tax compliance or the environment for the private sector or the state’s physical and social infrastructure, progress will be impossible without a significant redirection and improvement in the way these states run their administration.

Hence it is important that along with wiping out the revenue deficit simultaneous efforts are launched to improve governance and restore the confidence of the common man in the democratic processes. This will not only reduce government expenditure but will also make the common person accept lower subsidies. When he is convinced that the additional tax he pays is going to improve roads or increase the quality of power and water supply, and not merely be pocketed by the avaricious civil servant, he is more likely to respond to the national need for better fiscal health of public finances. A civil service renewal programme which improves public satisfaction therefore has to be an essential component of proper fiscal management.

VIII. Prime Minister’s directions

The extent of adjustment should not be under-estimated. In order to achieve a revenue surplus of 25% in five years some very tough decisions will have to be taken, such as freeze on new hiring, creating new jobs of primary school teachers only at the panchayat level, restructuring of power sector, increasing user charges at various levels, liquidation or privatisation of several public enterprises, tax reforms, and above all better governance. The adjustment process would be painful, but not adjusting will be more so. Without structural reform, per capita growth will stagnate and may turn negative, state finances will border on insolvency and thus not be able to attract private investment, and employment will fall and crime would increase. With a wide ranging reform programme, states will not only improve the quality of public services, stabilize its debt, but significantly raise per capita growth rate and make a dent on poverty and quality of life of the population.

The Deputy Chairman of the Planning Comnmission wrote to the Prime Minister in October, 1998 regarding problems and issues which arose during the finalisation of State’s Plan for 1998-99 and made certain suggestions for possible new directions of change. The Prime Minister, in response to this communication, gave the following directions:

  1. The Central Assistance to State Plans should increasingly take the form of project-specific assistance. The existing schemes based on this principle, like the Accelerated Irrigation Benefit Programme (AIBP) and Rural Infrastructure Development Fund (RIDF) administered by NABARD, may be made more effective. To enhance the scope of project-based assistance, another fund might be created for providing assistance for infrastructure other than irrigation, particularly roads, bridges and power projects.
  2. Allocation from non-lapsable funds for North-Eastern States should be accounted as part of the State Plans. This will give a boost to States’ Plan size to which they attach a lot of political importance.
  3. States should be encouraged to utilise more of the external assistance. A mechanism may be devised to help weaker States in preparation and implementation of externally-aided projects. In this context, a good chunk of SLR borrowings may be reserved for counterpart fundings which the States are expected to provide for such project. The remaining SLR borrowings may be allocated to the States on project-specific basis.

We would like to quote here from the address of the Prime Minister to the National Development Council meeting held on Feb. 19, 1999:-

  • The realisation of the social and economic objectives of the Ninth Plan depends critically on our being able to finance public investment in crucial areas of social and physical infrastructure. We will fail in our duty if we do not improve the Central and State finances. The Centre has started taking certain firm measures to fulfill our responsibility. I urge the State Governments, too, to put their finances in order.

Dear Chief Ministers, recent trends in this regard are alarming. States’ own contribution to Plan financing has been almost non-existent. States are increasingly borrowing even to finance their current consumption. Reluctance to mobilise additional resources to meet increasing expenditure is the reason for this. There is a need for austerity all around to contain wasteful public expenditure. Revenue should be increased through a greater attention to efficiency and productivity of the enormous human and financial resources we invest in our various schemes. Can we accomplish this without a political consensus to end competitive populism? No.

Today there is both a need and scope to raise resources through levying reasonable electricity tariffs and irrigation charges. Untargeted and unintended subsidies often lead to distortions in resource allocation, besides failing to benefit the really poor. Reforms in the power sector, which we have been stressing at the Centre, must be quickly and effectively implemented by States.

We should also address the problem of implicit subsidies. For instance, take the subsidies for higher education. Is it not paradoxical that even rich students pay college fees that, in some States, are less than what they spend on cold drinks? No Government can afford to provide costly services, free of cost, universally. They must levy reasonable user charges wherever possible, particularly for non-merit goods and services.

What is required is a change in the mindset, in the fixed notions about subsidised public services. We should not be prisoners of the past. Subsidised services should be restricted to only those who cannot afford to pay.

There is tax competition among States to attract private investments. Such policies are harmful as States have lost tax revenue without much influencing investment decisions. This must stop. Better infrastructure, faster decision-making, and investor-friendly environment are more important in the decision matrix of the investor community.

A practice that is pushing States towards fiscal crisis is the ready extension of guarantees to the borrowings of State-level public enterprises. These guarantees may devolve on State Governments, as the financial health of many such enterprises is not sound. This practice will hurt States’ credibility and adversely influence their credit ratings.

The 73rd and 74th Amendments to our Constitution, five years ago, provide for a third tier of government. Still, several States have not yet imbibed the spirit of these Amendments. There is an urgent need for genuine devolution of political, administrative, and financial powers to the Panchayati Raj institutions. If democracy works at the national and State level, it will surely work at the village level also. Rather, democracy at the national and State levels will only be enriched by extending it to the grassroots.

People often perceive the bureaucracy as an agent of exploitation rather than a provider of service. Corruption has become a low risk and high reward activity. Frequent and arbitrary transfers combined with limited tenures, are harming the work ethic and lowering the morale of honest officers. While expecting discipline and diligence from the administration, the political executive should self-critically review its own performance. Unless we do this, we cannot regain credibility in the eyes of the people who have elected us to serve them.

A question that is often asked these days is: What is the role of Planning Commission in a liberalised economy? While detailed micro-economic planning may no longer be needed, the Commission still has a crucial role in long-term direction-setting. In my opinion, Planning Commission should emerge as a Think Tank for addressing the critical policy issues facing the economy, to formulate pro-people policies, and to improve the implementation of such policies through a better delivery system. I am directing the Planning Commission to pay greater attention to identifying policies that rejuvenate the economy and help the poor.

Friends, as I mentioned in the beginning, we are standing at the crossroads. We need greater fiscal discipline and responsibility, both at the Centre and in States, so that public sector investment is not jeopardised. It will also help the private sector to perform its due role in the many difficult tasks it has to perform to achieve our target of seven percent economic growth in the next three years. In addition, it will facilitate greater inflow of foreign direct investment, which we need in many critical areas. Scarcity of public resources means inadequate investment in roads, railways, power generation etc., which are vital for a strong economy. The biggest loser will be the poor, the weakest, the underprivileged, in whose name many of the existing populist policies are often justified.

Let us all resolve today to rise above partisan politics and work together to build a strong, prosperous, and modern India. Let today’s meeting of the NDC, the apex body of our Union of States, be long remembered for sending this message loud and clear. I am proud that the people have bestowed on us the opportunity at this critical stage to guide the destiny of India.’

Finance Minister’s meeting

In pursuance of the decision taken in the NDC meeting held on 19th February, 1999, Finance Minister held a meeting of a group of Chief Ministers on 20th March, 1999 to address the medium-term fiscal problems of the States. In his opening remarks, the Finance Minister said,

‘It is our considered view that the current Ways and Means imbalance faced by the States is not of a recent origin. It is true that salary hikes may have further worsened the situation in most cases, but the erosion in the health of our fiscal system began some time ago. If we look at the past trends, prevailing even prior to the pay hikes effected by the Centre, there has been a cause for concern. Revenue deficits of States have risen constantly since 1987-88, and reached in 1998-99 a whopping proportion of 44% of revenue expenditure. Borrowings and interest payment liabilities have grown unabated, creating a serious problem for the sustainability of our fiscal system. The current fiscal stress is only a manifestation of the structural imbalance, although it could have been accentuated by recent pay hikes.

The States like Kerala, Karnataka, Gujarat and Tamil Nadu have done distinctly better than other States. It is seen that because of the tax efforts of these States, their expenditure performance has also been better. On the other hand, there are States with poorer track record, showing coexistence of lower tax efforts and high establishment costs. Therefore, there is need to improve tax efforts and reduce revenue expenditure, with a view to increasing investment for development.

The 9th Plan, which we have already approved, also lays emphasis on the need for a fiscal correction. It describes the precarious condition of the States’ finances and recommends that "bold steps (should be) taken and taken expeditiously, to redress the situation. The time is for decisive action and not empty rhetoric. The situation needs to be addressed on a war footing". The 9th Plan enumerates a number of measures that the States can implement to improve their finances. Let me repeat some of them here.

  • States must augment their tax and non-tax revenues. The tax/SDP ratios must be raised through rationalisation of tax structure and improvement in tax administration.
  • Non-tax revenues can be substantially increased by revision of user charges on public services.
  • The growth of Non-Plan Revenue Expenditure needs to be arrested, and the efficiency and accountability of public expenditure needs to be enhanced.
  • In particular, there is an urgent need to control the fast-growing burden of subsidies by ensuring that these are transparent and closely targeted.
  • State level public enterprises must also make their due contribution to the resource mobilisation efforts of the States. Restoration of the financial health of SEBs, and improvement in the functioning of SRTCs are necessary.’

In the meeting it was decided that for the year 1999-2000 the Finance Ministry would provide immedite relief to those states which embark upon a path of fiscal reforms. Since then nine states, including the Punjab, Rajasthan, Mizoram, Orissa, Himachal Pradesh, Assam and Andhra Pradesh have entered into specific MOUs with the central governments.

The meeting also decided that from the year 2000-2001 state-specific medium-term fiscal strategies should be drawn up jointly by the Centre and the States. This would be monitored by a Committee chaired by the Secretary, Planning Commission with Secretary Expenditure as Member. Such a medium-term fiscal reforms programme would enable the States, on the one hand, to overcome the immediate fiscal problems facing them and, more important, put them on path of fiscal sustainability in the medium-term.

The medium-term fiscal strategy would include certain measures aimed at providing financial help to States to alleviate the fiscal stress facing them. However, the Strategy would have to incorporate certain conditionalities. These would focus on critical issues facing the States on the fiscal and governance front. Moreover, these conditionalities would be formulated with a view to accelerating the reform process at State level so that State finances are put on a sound footing in the medium term. In this context it is essential to point out that a holistic view of the fiscal problems facing the States must be taken. Changes are required not only in the policies being pursued but also in the way State Governments carry out their business. States fulfilling these conditionalities will be given significantly higher plan funds from the year 2000-2001 onwards, so that more money is available to the states for basic minimum services, roads, irrigation, power, and other capital and asset building projects.

An annual fund (the size is yet to be decided) would be created at the Planning Commission to augment plan resource of those states who agree to generate a revenue surplus of 25% in a period of five years and improve governance. For the states where the present deficit is more than 25% of revenue receipts, the target would only to move by +10% every year. The balance from current revenues of States for 1998-99 (latest estimates) are given in Table No. 5.

Table 5: Balance From Current Revenues 1998-99 (LE)

1

2

3

4

5

6

S No.

States

Revenue Receipts

NPRE

BCR

BCR as %

(Rs.Crore)

(Rs.Crore)

(3-4)

of Rev.Receipts

A. NON-SPECIAL CATEGORY

1

Andhra Pradesh

12371.46

12318.32

53.14

0.43

2

Bihar

8898.88

11833.20

-2934.32

-32.97

3

Goa

575.92

669.74

-93.82

-16.29

4

Gujarat

10683.11

10127.53

555.58

5.20

5

Haryana

5537.13

6655.85

-1118.72

-20.20

6

Karnataka

10456.62

10200.64

255.98

2.45

7

Kerala

7009.98

8429.65

-1419.67

-20.25

8

Madhya Pradesh

11297.72

13264.67

-1966.95

-17.41

9

Maharashtra

19675.91

20732.94

-1057.03

-5.37

10

Orissa

4136.56

5435.59

-1299.03

-31.40

11

Punjab

4974.15

7109.96

-2135.81

-42.94

12

Rajasthan

7593.55

9556.37

-1962.82

-25.85

13

Tamil Nadu

13122.79

14589.29

-1466.50

-11.18

14

Uttar Pradesh

14646.39

22318.70

-7672.31

-52.38

15

West Bengal

7999.65

14804.64

-6804.99

-85.07

Total (A)

B. SPECIAL CATEGORY

16

Arunachal Pradesh

352.19

447.74

- 95.55

-27.13

17

Assam

3126.52

4791.41

-1664.89

-53.25

18

Himachal Pradesh

1514.63

2349.99

- 835.36

- 55.15

19

Jammu and Kashmir

1992.14

3239.95

- 1247.81

- 62.64

20

Manipur

441.19

969.39

- 528.20

-119.72

21

Meghalya

495.51

739.84

- 244.33

- 49.31

22

Mizoram

295.29

485.93

- 190.64

- 64.56

23

Nagaland

484.39

714.99

- 230.60

- 47.61

24

Sikkim

181.10

388.00

- 206.90

- 114.25

25

Tripura

561.07

981.45

- 420.38

-74.92

Total (B)

Total (A) + (B)

To begin with, Planning Commission would earmark certain funds for each state out of the total kitty on the basis of Gadgil formula. The share of States in Normal Central Assistance for 1999-2000 according to Gadgil formula can be seen in Table 6. However, this fund would be available to the individual state only when it signs a MOU with the Planning Commission about the proposed reforms the state would undertake and the time period of completing various bench marks to be identified jointly by the Planning Commission and the state. The MOU would give equal weightage to fiscal discipline and good governance. Six-monthly meetings would be held with the participating states and the progress of implementation of various commitments made by the state governments would be reviewed. In addition, quarterly progress reports would be obtained from the state governments, on the basis of which monthly releases would be made to the states. In case the progress is not rated satisfactory, funds meant for the particular state would be transferred to other states in the same category.

Table 6: Distribution of Normal Central Assistance for 1999-2000

Sl.No.

State

% share in Gadgil Formula

% share in population (1971)

A. SPECIAL CATEGORY STATES    
1. Arunachal Pradesh

2.70

0.09

2. Assam

6.58

2.69

3. Himachal Pradesh

3.25

0.64

4. Jammu and Kashmir

6.45

0.85

5. Manipur

1.97

0.20

6. Meghalaya

1.63

0.19

7. Mizoram

1.79

0.06

8. Nagaland

1.90

0.10

9. Sikkim

1.23

0.04

10. Tripura

2.51

0.29

 
  Total

30.00

5.13

 
B. NON-SPECIAL CATEGORY STATES    
B.1 HIGHER INCOME STATES*    
1. Andhra Pradesh

4.19

8.01

2. Goa

0.38

0.15

3. Gujarat

2.54

4.92

4. Haryana

1.17

1.85

5. Karnataka

2.89

5.40

6. Maharashtra

4.50

9.28

7. Punjab

1.45

2.49

8. Tamil Nadu

3.91

7.59

 
  Total B1

21.03

39.68

 
B2 LOWER INCOME STATES#    
1. Bihar

8.59

10.38

2. Kerala

3.07

3.93

3. Madhya Pradesh

5.55

7.67

4. Orissa

3.16

4.04

5. Rajasthan

3.53

4.75

6. Uttar Pradesh

12.00

16.27

7. West Bengal

5.97

8.16

 
  Total B2

41.47

55.19

  Total (B1+B2)

62.50

94.87

C. SPECIAL PROBLEMS

7.50

--

  GRAND TOTAL (A+B+C)

100.00

100.00

* States having higher per capita income than the National Average.

# States having lower per capita income than the National Average

The basic aim of the Medium-term Fiscal Reforms Programme is, no doubt, to provide incentives, in the form of augmentation of plan funds, to those States which are taking measures to put their finances on sound footing and improve governance. However, considerations of equity have been fully taken into account while designing the reform programme. In order to achieve a balance between efficiency and equity, the annual corpus of the fund would be first divided into three broad categories of States on the basis of their Gadgil-formula based shares in the Normal Central Assistance as indicated in Table No. 6. Thus, 30 per cent of the annual corpus would be allocated to Special Category States , 21 per cent to those non-Special Category States whose per capita income is higher than the national average and 41.5 per cent to those non-Special Category States whose per capita income is less than the national average. The balance 7.5 per cent of the annual corpus of funds would be kept for meeting special problems of the States. Though the initial allocation would be formular based, the ultimate releases of funds to individual States within these three broad categories would, however, be done on the basis of their performance, as described in the previous paragraph.

Implementation of commitments for governance and revenue deficit as a proportion of revenue receipts would be closely monitored. Since the audited figures would be available only after sometime, quarterly monitoring would be done of those sectors and processes which have a bearing on revenue deficit and governance. Tentative funds would be allocated on the basis of performance in a number of sectors, described below.

IX. Measuring fiscal performance

a) Tax reforms

A tax reform programme which includes rationalisation of tax structure is an area of high priority. It is essential to restore the buoyancy of tax revenues and increase tax/SDP ratios.

b) Expenditure reform

States must initiate comprehensive expenditure reform programmes to reduce unproductive and wasteful expenditure on the one hand and improve the quality of expenditure on the other. Unwarranted rapid increases in salaries and subsidies of recent years must be curbed. On the other hand, capital expenditures and maintenance, which have been experiencing shortfalls, must be protected. Wage bill of the states would be closely monitored.

c) Improvement in fiscal administration and management

Strengthening, streamlining and simplification of the tax machinery is a must to check tax evasion and promote tax compliance. It will also help to improve business environment. Moreover improved management of expenditure will ensure more efficient use of scarce funds. This will entail reforms in budgeting, accounting, internal control and audit, cash and debt management and management information system. To begin with, states will be asked to set up Electricity Regulatory Authority and Public Service Tariff Commission.

d) Public sector enterprises reform including disinvestment

Public Sector enterprises, in particular the SEBs and the SRTCs, have proved to be a big drain on States’ resources. States must implement reforms to bring these enterprises under professional management and run them in a commercially viable manner. A disinvestment programme must be formulated in case of enterprises which cannot be revived. The tendency of State Governments to allow state owned enterprises to raise large amounts of state guaranteed off-budget loans without taking into account the financial health of these enterprises must be checked. This tendency is resulting in fast increase in contingent liabilities of State Governments which is impinging on their credit worthiness.

e) Power sector reforms

Power sector reforms are essential if States are to get back on the path of fiscal sustainability. SEBs are the single most important drain on States’ resources. Power tariffs must ensure cost-recovery and the culture of non-payment of dues by customers to public utilities must be curbed.

f) Improved infrastructure

The state of infrastructure, both physical and social, is acting as a drag on growth in most states. Infrastructure sector calls for urgent intervention if the growth process is to be accelerated and state finances are to benefit. More efficient management, higher investment and greater cost-recovery would, in general, be required in these areas.

g) User charges

User charges for water, transport and other services must be suitably enhanced.

X. Good governance

There cannot be two opinions that the quality of governance must be improved. Focus must be shifted from maximising the quantity of development funding to maximising of development outcomes and effectiveness of public service delivery. This will help in improving the perception of investors and donor agencies about the investment climate in the States. It will also contribute to increasing the revenue collecting ability of States. Redefining the role of the Government and improving its performance is crucial for the success of a fiscal consolidation programme. This will involve reducing government intervention in the economy through deregulation and disinvestment. Removing unnecessary controls (linked with statutory provisions for compulsory disclosure of data by business houses for public scrutiny) would substantially reduce the possibility of arbitrary executive discretion and thus opportunities for corrupt behaviour. Transparency must be built into all official procedures and systems. The right of the ordinary citizen to information should be recognised by law which will enable citizens to understand and challenge corruption and the arbitrary exercise of state power, as well as corruption by government authorities and dishonest practices by trade and business.

States would be judged on the basis of broadly the following policies and programmes.

a. Stability of tenure

A malaise afflicting the civil service generally is the instability of tenures, leading not only to a lack of sense of involvement but also to the inability to contribute effectively to amelioration of the system. In a north Indian state, the average tenure of an IAS officer in the last five years is said to be as low as six months. In the IPS it is even lower, leading to a wisecrack that 'if we are posted for weeks (Haftas) all we can do is to collect our weekly bribes (Haftas). Transfers have been used as instruments of reward and punishment, there is no transparency, and in the public mind transfer after a short stay is categorised as a stigma.

Frequent transfers and limited tenures are playing havoc with public organisations. With every quick change in the head of the office, a funereal air is noticeable and down the line the respect for authority is whittled away. Rapid changes erode the mandate of the Department or Organisation. It leads to lack of confidence to act firmly and equitably for the public good. There are two other consequences. Since the incumbent himself is not sure of how long he will stay it affects his attention to detail, the capacity to master the situation and begin thinking, even incrementally, about how to change things and improve them. Since he is not too sure of what has to be done, the preference is to opt for whatever was tried out in the past and seemed to have sufficed. In the process, changes which may have been initiated by the predecessor are either disregarded or thought of as being disruptionist. Most public organisations do not possess the 'memory' which will absorb change and continue it even under adverse circumstances. Second, there are even more deleterious consequences down the line. Other staff in the organisation do not extend the commitment so necessary for change to be institutionalised. Their assessment is that everything new being temporary administrative improvement and practice, different from the ordinary way of doing things, represent the foibles or prejudices (at worst) of the incumbent, to be sent packing immediately on the departure of the officer. An attenuated hierarchy, which distorts intent and initiative, further impels the status quo.

It is in this context that it is crucial and critical to remove uncertainty and imbue the officers with a certain security of tenure in every post, barring cases of promotion.

To begin with, the Planning Commission would calculate for each state the average tenure of collectors, SPs, Project Officers., and other such category of officers mutually identified. There should be adequate publicity about who can transfer officials at various levels in government. This power should not be exercised by an authority higher than the appointing or punishing authority. This will ensure that government does not meddle with the transfers of low level officials.

Stability index should be calculated for the above posts, and a norm of at least two years be fixed, so that although government would be free to transfer an officer before two years without calling for his explanation, the average must be maintained above two years. This would mean that for every short tenure some one else must have a sufficiently long tenure to maintain the average. Just as every government order carrying financial implications has to quote the authority of the Finance Department, every transfer order must indicate in arithmetical terms how the average has been affected by the transfer in question. States where this average is less than two years will be given two years of time to bring it above two years.

At least for higher ranks of the civil services e.g. Chief Secretaries, Secretaries of Government and DGPs, postings may be made contractual for a fixed period, and suitable systems may be evolved to ensure that they are rarely removed before the period of the contract without their consent or explanation.

The Transfer Allowance of each department may be so fixed that no transferring authority can transfer more than one-third of that cadre in a year.

It is not correct to assume that there would be political resistance to the idea of stability of tenure. Many Chief Ministers would welcome this proposal, as they are often pressurised by their political circumstances to resort to frequent transfers, and with a change in law, they would be able to resist the pressure in a better manner. It may also be mentioned here that many transfers are initiated at the request of the officer himself, and this tendency will also get curbed with new norms.

b. Transparency and corruption

Most manipulations succeed because of the environment of secrecy which pervades government functioning. There is no early check because decisions are taken behind closed doors. The sharing of information and making the entire system more transparent would certainly reduce the danger of the system being hijacked by crooks. Transparency builds external demand for reform and makes administration more responsive and performance oriented. Each state should therefore pass a Right to Information Act. If the right of the ordinary citizen to information is recognised, it will dramatically increase the strength of the citizen to understand and challenge corruption and the arbitrary exercise of state power. It should be the duty of each officer to pro-actively attempt to increase the power of the citizen in his or her relation with the state, through building in transparency into all official procedures and systems, and suo-motu making available all relevant information to the people. In the context of development workers, for instance, this would mean enforcing the rule that all muster rolls and bills are regularly read out and explained to the people in gram sabhas.

To do this, no radical change in official rules is required. On the contrary, existing rules already provide for such sharing of vital relevant information with the public and gram Sabhas. However, such rules are mostly observed in the breach, because it suits those exercising state power to sustain or even enhance the capacity of its functioning to enable its arbitrary malafide, nepotistic and corrupt exercise of power. It is therefore necessary that the state government should issue clear guidelines on the subject.

Nothing would send a stronger and more positive signal to the private sector than the announcement and implementation by government of a comprehensive anti-corruption strategy, which should include:

  • Immediate compulsory retirement of those whose record and reputation is tainted
  • Strengthening of powers of the state Vigilance Departments, Lok Ayukt and the Anti-Corruption branch of the state police enabling them to effectively initiate and pursue investigations independently of government direction
  • Immediate prosecution of officials against whom there is evidence of corruption
  • Guaranteed protection of civil servants who expose corrupt practices
  • Passing a law which would make all oral orders regarding transfer and other administrative matters illegal which interfere with delegated powers

In particular, property and tax returns of all senior officers should be available for scrutiny by the public. These could be put on a 'home page' of the government on the internet, so that anyone having access to internet could access such information and get in touch with government if the stated facts are contrary to his knowledge.

In addition, each state would be asked to pass the Corrupt Public Servants (Forfeiture of Property) Act, already drafted by the Law Commission. This will ensure that the illegally wealth of the corrupt is confiscated and is not enjoyed by them. There is already a law called The Benami Transaction Prohibition Act 1988. Under this Act benami properties can be confiscated. The states will be asked to frame rules and procedure for this law. The number of cases prosecuted under this law would be monitored.

c. Reduction in size

Steps need to be taken to drastically reduce the number of meaningless posts in each cadre. Some specific suggestions are:

  • The already existing provision of reviewing the work of those above 50 years and retire them if not found suitable should be stringently followed.
  • Encourage officers to join voluntary organisations of repute, educational and research institutes during mid-career. For new recruits to government service it should be a compulsory condition in their rules of recruitment that they would be asked to take leave without pay for 5 years at a stretch after they have put in 10 years of service.
  • Those government servants who have only 4 years left for retrirement should be given a choice of taking retirement on full salary or retain the government house for the remaining period of their service, provided their post is abolished. This will be the cheapest means of introducing VRS in government.

d. Professionalism

All talk of excellent or brilliant performance is meaningless unless a bottom line of minimum acceptable standard of performance is stipulated. This has to be at two levels viz. organisational and individual. It is imperative that each Ministry/ Department of the state government and all departments and agencies under the district administration, have a well defined and spelt out criteria by which performance of their functionaries can be evaluated. Non-adherence to this should entail adequate compensation to people and punishment to government servants for non-delivery of promised service. In consonance with the organisational performance standards, each individual's performance standard needs to be spelt out. Such a measure will perforce compel imbibing of professionalism and performance norms will shift from platitudes and aspirations to concrete output.

e. Effective implementation of development programmes

The implementation of the development programmes by the State Governments must be more effective. Close monitoring can be organised in selected areas such as implementation of schemes relating to primary health, primary education, watershed development, empowerment of the local people to discharge their responsibilities effectively at the local level, as evidenced by the implementation of poverty alleviation programmes etc. The monitoring can be on the basis of questionnaire designed by selected public institutions in consultation with the Planning Commission.

Through a process of stratified random sampling five to ten villages can be identified in every state for impact studies and obtaining progress report in these sectors. This work can be given either to the academic institutes or consultants approved by the Planning Commission or to the Programme Evaluation Unit wherever possible. The allocation of additional funds to the States can be made in such a manner that the States which perform better get a corresponding weightage over the States which do not implement these programmes effectively.

f. Accountability to the people

At present the system of government is such that it is difficult for an average citizen to have access to information about schemes and programmes that affect him, and even about his rights and records. The complicated procedures not only distance government from the very people that are sought to be provided with services but also create possible sources of corruption. Therefore the stress needs to be on developing computer based information systems so that discretion and delay can be reduced. For instance, why can't in the revenue tahsils we instal a computer where you insert a ten rupee note and get land ownership record of the entire village? Each department should develop citizen’s charter establishing clearly enforceable norms.

Departments such as the Police and Revenue, which have more dealings with the people, should be assessed once in three years by an independent professional organisation, consisting of journalists, retired judges or members of the armed forces, academicians, activists, NGOs, and even retired government servants. These should look at their policies and performance, and suggest constructive steps for their improvement. At present the systems of inspection are elaborate but often preclude the possibility of a 'fresh look' as they are totally governmental and rigid. The system should be made more open so that the civil service can gain from the expertise of outsiders in the mode of donor agency evaluations of projects and there is a feeling of greater accountability. The teams should consist, in addition to government servants, of development practitioners from other fields, independent social research institutes, academicians and even members of the public. The teams would undertake surveys of quality of service delivery in key areas, scrutinise policies programmes and delivery mechanisms. Civil servant’s views on work constraints and reporting fraud and corruption should be elicited. The reviews conducted should also form the basis of time bound changes and improvements which should be monitored.

Action against corrupt officers cannot be initiated in many states as the power to sanction prosecution is vested in state governments. This should be declared a semi-judicial process, and the powers to sanction prosecution should be vested with a designated authority, who should pass a speaking order on receipt of complaint from CBI or other agencies.

g. Improving quality of life through greater attention to environment

In the last thirty years however there is enough empirical evidence to establish that environmental conservation must go hand in hand with economic development because any economic development which destroys the environment will create more poverty, unemployment and diseases and thus cannot be called even economic development. It may just be transfer of resources from the poor to the rich. This is because the poor depend on nature for their daily survival – for them the Gross Nature Product is more important than the Gross National Product. Environmentally destructive economic development will impoverish the poor even further and destroy their livelihood resource base. In the absence of clean air and clean water not only is the productivity of the poor going down but their expenses on medical care is shooting up resulting in their further misery. Denuded hills and barren pastures have resulted in falling groundwater levels, reduced availability of organic manure, and loss of soil and moisture for crops, thus affecting the productivity of rainfed agriculture and income through cattle. Therefore the environmental concern in India must go "beyond pretty trees and tigers" and must link it with peoples’ lives and concerns.

Investment in better environment and forests however requires taking unpopular decisions (closing down of polluting industries, controlling vehicular pollution, reducing subsidy on forest raw material, etc.). It also needs greater investment the benefit from which is not easily discernible or immediate. When states are starved of funds cuts are imposed on the budgets of these departments and activities, and money is diverted to paying salaries or contractor driven programmes. Therefore improving governance must mean better policies and more funds for improving the quality of life through greater attention to environmental concerns. A certain part of the additionality of funds would be reserved for forestry and related activities and would be available when the states change their policies in favour of greater peoples’ involvement. A note on suggested policies in the forestry sector is enclosed. A similar note on other environmental issues would follow. The follow up on these policies by the state governments would be monitored when allocating more funds for such programmes.

h. Decentralisation and redefining the role of government

The 73rd Amendment envisages a polity where more and more powers are decentralised to the third stratum, but ironically in many of the States administrative and financial powers have been heavily concentrated in the Secretariats and Directorates. This process of centralisation of authority has specially been going on in the last thirty years. This concentration, in addition to facilitating political corruption, results in making decisions the outcome of a long and tedious process that inconveniences the public.

Every organisation/department/Ministry needs to clearly work out a plan for devolution of powers. This decentralisation would naturally devolve greater responsibility down the line as well, and would have to be accompanied by delegation of powers, both administrative and financial. Devolution of spending responsibilities and revenue raising powers to the elected local bodies can ensure significant gains in service quality and accountability. Local Government finances must be strengthened. Along with this the capacity of rural elected bodies to make efficient use of devolved resources must also be reinforced. The system of inspections and summary recording of observations and work done should be revived.

De-regulation has made almost no impact at the state level. The systems of buying and selling land, issue of a ration card or refund of security, and Rent Control Acts, all need a thorough revision. One can set up an industry worth billions of Rupees in India without any license today, but a farmer can neither set up a brick kiln unit, nor a rice shelling plant, nor a cold storage, and not even cut a tree standing on his own private field without bribing several officials. A simple operation of converting prosopis (a shrub occurring everywhere in states like Gujarat and Tamil Nadu, the more you cut it the more it grows) into charcoal, which can give employment to thousands of people requires four different permissions! One to cut the tree, the other to transport it, the third to set up the kiln which costs only a few thousand Rupees, and the fourth one to transport charcoal which is also a forest product. In another state, tribal women are prohibited from doing value addition to gathered products, such as brooms, they must sell it to the designated contractor who thus enjoys a monopoly and pays pittance to the tribals. Almost all occupations in the urban informal sector, such as hawking, small manufacturing in residential areas are illegal! It is a sad commentary on our laws that the informal sector that provides maximum employment is mostly declared as illegal and subject to the whims of law enforcing agencies. No wonder, opening up of the economy has not been seen as a political asset by the political parties. A Committee should be set up to identify specific laws and rules that hamper entrepreneurship. A systematic review needs to be undertaken to review the areas in which government must withdraw, albeit in a phased manner, and departments that need to be wound up should be defined. It is also suggested that officers should be encouraged to take mid-career sabbatical, and live in the rural areas, so that they can see for themselves how the various organs of administration exploit the common man.

With the changing role of government the size and scale of the civil services no longer relate to the nature of functions that government can or should undertake. One should identify surplus staff, set up an effective redeployment plan, and a liberal system for exit. For the time being recruitment should only take place for functional posts, and vacant posts of secretarial and clerical posts should not be allowed to be filled. One should study China, which in a span of three years reduced its bureaucracy by 25%.

It is clear that reducing the size of government, ensuring more goal orientation, and stability of tenure leading to specialisation is likely to be a time consuming process. But if the process is initiated immediately and in right earnest, the country should be able to enter the 21st century with a vision of the future.

XI. Summing up

To sum up, the existing fiscal situation in States does not admit of easy responses. Innovative and bold decisions which mark a complete break with the existing mind set and present way of doing things are required. The medium-term reform programme outlined in this paper springs from this perception.

It is for the first time that such a wide-ranging reform programme, worked out jointly by the Centre and the States, is being attempted in the country. The endeavour is to strike at the very roots of the malaise affecting the State finances. In the process we would not only restore the financing health of States but also bring about a fundamental transformation in the way the country is governed. A responsive and accountable administration which was the ideal our founding fathers worked for would at last become a reality. Indeed, it is only when the Centre and the States are willing to act jointly, in a responsible and disciplined manner, can such basic changes be brought about in the economy and polity of the country and a way out of the present crisis situation found. The successful implementation of the medium-term reform programme by the States would, therefore, put the country firmly on the path of sustained and equitable growth and enable it to march confidently into the next millennium.