The Case of the Missing State Finance Commissions

State Finance Commissions have been largely absent from their role as mediator for fiscal devolution to municipalities and panchayats.

In the list of changes brought about by the 73rd and 74th amendments to local governance, one of the most resourceful changes was the idea of the State Finance Commission (SFC). Inspired by the Union Finance Commission (UFC), SFCs were created to “review the financial position of the panchayats and municipal corporations, and to make recommendations to the Governor.” However, unlike their counterparts at union level, SFCs have largely been missing from action.

The federal setup in India is structured such that there exists a vertical imbalance, in terms of service delivery and resources-raising-capacity among various tiers of the government. On one hand, the responsibility to provide services to the citizens was delegated to local bodies like municipal corporations and panchayats, owing to their proximity to the citizens. On the other hand, to ensure stable supply of money and appropriate distribution of resources, the revenue raising functions are largely left with central bodies. Hence, the local bodies are left with a large list of responsibilities but not enough resources to service them.

In order to minimise this imbalance, the Articles 243 (I) and 243 (Y) of the Indian Constitution prescribed that the Governors should create an SFC every five years. The primary role of the commission is to recommend the principles which would govern the distribution of revenue between state and municipalities/panchayats and help improve their financial position. The commission is also responsible for distributing net proceeds from all taxes, duties, tolls and fees between the state government, municipalities and panchayats. This gives the Commission the authority to review the financial position of zilla panchayats, taluk panchayats and gram panchayats, municipal corporations, city municipal councils, town municipal councils and town panchayats, and make recommendations to the Governor.

Even after being given significant mandates, these commissions have failed at making any significant impact on the financial distribution between states and local bodies. In the past two decades, most of the states have constituted only three to four SFCs keeping in line with the constitutional requirement. However, most of the recommendations by the commissions have only focused on the share of allocation rather than working on improving the current conditions. To add to it, most of the commissions focused more on allocation to rural regions. The ones that did focus on the dire state of urban regions continued to provide only marginal increases in the municipality’s share.

For instance, between the first Karnataka SFC and the second, the only significant recommendation was to increase the allocation from state to local bodies by mere 4%. Moreover, where the first SFC allocated ~30% to the panchayats and 5% to urban bodies, the second SFC raised the allocation merely to 32% to panchayats and 8% to urban bodies.

In his paper ‘Have the State Finance Commissions Fulfilled Their Constitutional Mandates?’, M A Oommen talks about how the first SFC to make local bodies more financially independent allotted 16% devolution of net state tax revenue as ‘untied entitlement’. However, the third SFC mentioned that the funds shown as passed to the the local governments were a part of the plan funds was allotted as lump sum grants-in-aid to local bodies from different departmental budgets.

A constant reminder of the terrible conditions of the SFC are the UFCs. UFCs, constituted by the President, recommend the basis for distribution of net proceeds between the union and state governments. In order to ensure that states have the capacity to devolve finances to the local bodies, UFCs have been asked to consider the recommendations of the SFCs. However,  as per the Fourteenth Finance Commission,

The previous Finance Commissions could not base their recommendations entirely on the SFC reports. These included variations in the approaches adopted by the SFCs, difference in the periods covered by individual SFCs, non-synchronisation of the SFC report periods with that of the Finance Commission report and the quality of SFC reports.

There are various reasons for this dire state of the SFCs but primary significant roadblocks include: lack of follow up from the local bodies, apathetic attitude of the states, lack of clarity about the role and functions of local bodies, and deplorable conditions of the finances at municipal and panchayat levels. With local bodies being majorly dependent on the state governments for their financial needs, they do not have the capacity to ensure hold states accountable for the lack of strong SFCs. On the other hand, state government with limited resources do not have any major incentive to follow the recommendations made by the commissions.

Hence, to make SFCs more impactful we need to take three steps:

First, we need to clearly define the roles and functions of local bodies so that the cost of service delivery can be appropriately estimated. Currently, the state legislature decides the responsibilities allotted to the local bodies. Hence, the responsibilities vary across states. In addition to this, the flow of funds into the cities have not been mapped clearly with state and union providing direct grants to the local bodies. With the information of responsibilities and funds being imprecise, its difficult for the SFCs to come up with a substantial recommendation.

Second, local bodies should be encouraged to hold the states accountable. Local bodies need to be financially independent to be able to hold the state government accountable to its demands. To achieve this goal, local bodies need to explore their own revenue sources better. For instance, municipalities can gain a higher revenue just by charging parking fees in the city.

Finally, it is up to the citizens and the local bodies to hold the ruling state government accountable. Most of the basic services are provided by the local government bodies like panchayats and municipal corporations. Therefore, its important that we ensure that the local bodies remain financially healthy.

About the author

Devika Kher

Devika Kher is the Programme Manager for the Takshashila Institution's Graduate Certificate of Public Policy. She is also a Policy Analyst at the Takshashila Institution and her areas of research focus are urban governance and public finance.