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Report of the Twelfth - Finance Commission (2005-2010) : A Summary
Date : Mar 21, 2005

 

INTRODUCTION

APPOINTMENT OF THE TWELFTH FINANCE COMMISSION

The appointment of a finance commission by the President is provided for under article 280 of the Constitution of India. The first such commission was constituted on November 19, 1951. The eleven finance commissions, which have preceded the present one, have, through their recommendations, given a definitive shape to fiscal federalism in our country. The present finance commission, which is the twelfth, was appointed by the President of India on 1st November, 2002 under the chairmanship of Dr. C. Rangarajan, the then Governor of Andhra Pradesh. The President also appointed two full-time members, namely, Shri T. R. Prasad, IAS (retd.), former Cabinet Secretary, Government of India and Prof. D. K. Srivastava of National Institute of Public Finance & Policy (NIPFP) and one part-time member, namely, Shri Som Pal, Member, Planning Commission. Dr. G.C. Srivastava, IAS was appointed as the Secretary to the Commission. Later on, he was appointed as Member Secretary, against the vacancy of the fourth Member with effect from July

1, 2003. Consequent upon the resignation of Shri Som Pal from the Commission, Dr. Shankar N. Acharya was appointed as a part-time member with effect from 1st July 2004.

The Commission was originally asked to make its report available by the 31st July 2004 covering a period of five years commencing on the 1st April 2005. Subsequently, due to disruption of normal activities on account of preponement of parliamentary election, the President, through his order dated 1st July 2004, extended the tenure of the Commission up to 31st December 2004, but required the report to be made available by 30th November 2004.

TERMS OF REFERENCE (TOR)

The President vide the notification dated 1st November, 2002 mandated the Commission to do the following: "4. The Commission shall make recommendations as to the following matters:-

(i) the distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them under Chapter I Part XII of the Constitution and the allocation between the States of the respective shares of such proceeds;

(ii) the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India and the sums to be paid to the States which are in need of assistance by way of grants-in-aid of their revenues under article 275 of the Constitution for purposes other than those specified in the provisions to clause (1) of that article; and

(iii) the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State.

5. The Commission shall review the state of the finances of the Union and the States and suggest a plan by which the governments, collectively and severally, may bring about a restructuring of the public finances restoring budgetary balance, achieving macro-economic stability and debt reduction along with equitable growth.

* This Article presents excerpts from the Report of the Twelfth Finance Commission which was presented to the Parliament on February 26, 2005. Excerpts from Chapter 1 (Introduction), Chapter 15 (Concluding Observations) and Chapter 16 (Summary of Recommendations) as well as select tables in the Report have been reproduced in this article. The Action Taken Report of the Government of India has also been reproduced in full.

6. In making its recommendations, the Commission shall have regard, among other considerations, to:-

(i) the resources, of the Central Government for five years commencing on 1st April 2005, on the basis of levels of taxation and non-tax revenues likely to be reached at the end of 2003- 04;

(ii) the demands on the resources of the Central Government, in particular, on account of expenditure on civil administration, defence, internal and border security, debt-servicing and other committed expenditure and liabilities;

(iii) the resources of the State Governments, for the five years commencing on 1st April 2005, on the basis of levels of taxation and non-tax revenues likely to be reached at the end of 2003- 04;

(iv) the objective of not only balancing the receipts and expenditure on revenue account of all the States and the Centre, but also generating surpluses for capital investment and reducing fiscal deficit;

(v) taxation efforts of the Central Government and each State Government as against targets, if any, and the potential for additional resource mobilization in order to improve the tax-Gross Domestic Product (GDP) and tax-Gross State Domestic Product (GSDP) ratio, as the case may be;

(vi) the expenditure on the non-salary component of maintenance and upkeep of capital assets and the non-wage related maintenance expenditure on plan schemes to be completed by the 31st March 2005 and the norms on the basis of which specific amounts are recommended for the maintenance of the capital assets and the manner of monitoring such expenditure;

(vii)the need for ensuring the commercial viability of irrigation projects, power projects, departmental undertakings, public sector enterprises etc. in the States through various means including adjustment of user charges and relinquishing of non-priority enterprises through privatisation or disinvestment.

7. In making its recommendations on various matters, the Commission will take the base of population figures as of 1971, in all such cases where population is a factor for determination of devolution of taxes and duties and grants-in-aid.

8. The Commission shall review the Fiscal Reform Facility introduced by the Central Government on the basis of the recommendations of the Eleventh Finance Commission, and suggest measures for effective achievement of its objectives.

9. The Commission may, after making an assessment of the debt position of the States as on the 31st March 2004, suggest such corrective measures, as are deemed necessary, consistent with macro-economic stability and debt sustainability. Such measures recommended will give weightage to the performance of the States in the fields of human development and investment climate.

10. The Commission may review the present arrangements as regards financing of Disaster Management with reference to the National Calamity Contingency Fund and the Calamity Relief Fund and make appropriate recommendations thereon.

11. The Commission shall indicate the basis on which it has arrived at its findings and make available the State-wise estimates of receipts and expenditure." In addition to the above, through a subsequent notification dated 31st October, 2003, the Commission was asked to make recommendations on the following matters: "(i) whether non-tax income of profit petroleum to the Union, arising out of contractual provisions, should be shared with the States from where the mineral oils are produced; and (ii) if so, to what extent."

CONCLUDING OBSERVATIONS

The Commission has recommended a scheme of fiscal transfers that can serve the objectives of equity and efficiency within a framework of fiscal consolidation. The effort needed to achieve fiscal consolidation should be seen as the joint responsibility of the central and state governments. For achieving vertical and horizontal balance, consistent with the responsibilities of the two levels of governments in respect of providing public and merit goods and services, both the centre and the states need to raise the levels of revenues relative to their respective revenue bases, and exercise restraint in undertaking unwarranted expenditure commitments.

The finances of the central and state governments, individually and in the aggregate, have evinced large and persistent imbalances in the period preceding the Commission’s award period. Four factors have accounted for the continuing deterioration: fall in centre’s tax-GDP ratio compared to the peak levels achieved in the late eighties, substantial increase in the level of salary and pension payments, particularly for the states, in the wake of the recommendations of the Fifth Central Pay Commission, high levels of nominal interest rates in the late nineties combined with the subsequent fall in inflation rates, and the low growth rates in the first three years of the new decade. While these reasons account for the acuteness of the ailment, there are also underlying structural reasons for the persistence of fiscal deterioration because of the tax structure and expenditure pattern.

In the scheme of fiscal transfers, the correction of vertical imbalance is, to some extent, based on judgment. An assessment has to be made of the gap between resources and responsibilities at the two levels of government. Taking into account a variety of factors including the historical trends, we have recommended an increase in the share of states in the divisible pool of taxes to 30.5 per cent from the current level of 29.5 per cent. We believe that this increase can be accommodated by the central government by pruning their activities that fall in the domain of the states. We have raised the indicative limit of overall transfers out of the gross revenue receipts of the centre from 37.5 per cent to 38 per cent.

In the context of horizontal imbalance, we feel that the equalization approach to transfers is appropriate as it is consistent with both equity and efficiency. It has not, however, been possible to implement this approach fully, as the extent of disparities in the per capita fiscal capacities of the states is too large and some of the better-off states are also in serious fiscal imbalance. In the devolution scheme recommended by us, we have endeavored to strike a balance among different criteria reflecting deficiency in fiscal capacities, cost disabilities, and fiscal efficiency. Apart from following a normative approach in assessing own resources and expenditures of the states with a view to estimating the resource gap, we have focused on education and health as the two critical merit services, where highest priority must be accorded in reducing disparities in the level of service provision, and have recommended conditional grants, within the framework of the equalization approach. We have also increased the proportion of grants to tax-devolution in the scheme of transfers. It is therefore necessary that in judging the transfer to a state, both tax devolution and grants should be taken into account. The coefficient of correlation between comparable GSDP per capita (average of 1999-00 to 2001-02) and the recommended per capita transfers, comprising tax devolution and all the grants, among the general category states excluding Goa, is estimated at -0.89, which emphasises the redistributive character of the transfers.

We have laid emphasis on strengthening the local bodies in keeping with the constitutional mandate for effective and autonomous local self-governance, recognizing that local bodies must be supported by a scheme of transfers that encourages decentralization and own effort for raising revenues. The recommended transfers for the local bodies constitute about 1.24 per cent of the shareable taxes and 0.9 per cent of centre’s gross revenue receipts.

We have recognized that the debt burden of the states is currently heavy. We have provided a scheme of debt relief, which is in two parts. First, there is the relief that comes from consolidating the past debt and rescheduling it, along with interest rate reduction. The second part consists of a debt write-off, which is linked to the reduction in the absolute levels of revenue deficits. Both reliefs will be available, only if states enact appropriate legislations to bring down the revenue deficit to zero by 2008-09 and commit to reducing the fiscal deficit in a phased manner. With the relief that we have recommended, it should be possible for states to pursue their developmental goals with fiscal prudence.

We have argued that important institutional changes are required to tackle some of the structural problems in managing government finances. One central change relates to the regime of government borrowing. We have recommended that states, like the centre, must decide their annual borrowing programme, within the framework of their respective fiscal responsibility legislations. There is also a need to let the states access the market directly for their borrowing requirements. The overall limit to their annual borrowing from all sources should be supervised by an independent body like a Loan Council with representatives from the Ministry of Finance, Planning Commission, Reserve Bank of India, and the state governments. This Council may, at the beginning of each year, announce borrowing limits for each state, taking into account the sustainability considerations into account. Our suggestion for de-linking grants and loans in plan assistance, as these need to be determined on different principles, is part of the reform of the borrowing regime.

In our plan for restructuring government finances, we expect a positive growth dividend, as revenue deficits relative to GDP progressively fall, implying a fall in government dis-savings, and an increase in the overall savings relative to GDP. A higher tax-GDP ratio combined with higher growth on a sustained basis, and fall in interest payments, create the necessary space for increasing government capital expenditure, and productivity enhancing non-interest, non-salary revenue expenditure. The virtuous cycle of reforms, robust government finances, and an equalizing system of fiscal transfers, should help establish a sound federal fiscal system in India.

SUMMARY OF RECOMMENDATIONS

PLAN FOR RESTRUCTURING PUBLIC FINANCES

1. By 2009-10, the combined tax-GDP ratio of the centre and the states should be increased to 17.6 per cent, primary expenditure to a level of 23 per cent of GDP and capital expenditure to nearly 7 per cent of GDP.

2. The combined debt-GDP ratio with external debt measured at historical exchange rates should, at a minimum, be brought down to 75 per cent by the end of 2009-10.

3. The system of on-lending should be brought to an end over time and the long term goal for the centre and states for the debt-GDP ratio should be 28 per cent each.

4. The fiscal deficit to GDP ratio targets for the centre and the states may be fixed at 3 per cent of GDP each.

5. The centre’s interest payment relative to revenue receipts should reach about 28 per cent by 2009-10. In the case of states, the level of interest payments relative to revenue receipts should fall to about 15 per cent by 2009-10.

6. The revenue deficit relative to GDP for the centre and the states, for their combined as well as individual accounts should be brought down to zero by 2008-09.

7. States should follow a recruitment and wage policy, in a manner such that the total salary bill relative to revenue expenditure net of interest payments and pensions does not exceed 35 per cent.

8. Each state should enact a fiscal responsibility legislation, which should, at a minimum, provide for (a) eliminating revenue deficit by 2008-09; (b) reducing fiscal deficit to 3 per cent of GSDP or its equivalent, defined as the ratio of interest payment to revenue receipts; (c) bringing out annual reduction targets of revenue and fiscal deficits; (d) bringing out annual statement giving prospects for the state economy and related fiscal strategy; and (e) bringing out special statements along with the budget giving in detail the number of employees in government, public sector, and aided institutions and related salaries.

SHARING OF UNION TAX REVENUES

9. The share of the states in the net proceeds of shareable central taxes shall be 30.5 per cent. For this purpose, additional excise duties in lieu of sales tax are treated as a part of the general pool of central taxes. If the tax rental arrangement is terminated and the states are allowed to levy sales tax (or VAT) on these commodities without any prescribed limit, the share of the states in the net proceeds of shareable central taxes shall be reduced to 29.5 per cent.

10. If any legislation is enacted in respect of service tax after the eighty eighth Constitutional amendment is notified, it must be ensured that the revenue accruing to a state under the legislation should not be less than the share that would accrue to it, had the entire service tax proceeds been part of the shareable pool.

11. The indicative amount of over all transfers to states may be fixed at 38 per cent of the central gross revenue receipt.1 12. The states should be given a share as specified in Table 1 in the net proceeds of all the shareable Union taxes in each of the five financial years during the period 2005-06 to 2009-10.

1 Please see Annex Table 1 for Total Twelfth Finance Commission Transfers to States.

Table 1: Inter se Shares of States

State

Share (all

Share of

 

shareable taxes

Service Tax

 

excluding

 
 

service tax)

 
 

(per cent)

(per cent)

     

1

2

3

     

Andhra Pradesh

7.356

7.453

Arunachal Pradesh

0.288

0.292

Assam

3.235

3.277

Bihar

11.028

11.173

Chhattisgarh

2.654

2.689

Goa

0.259

0.262

Gujarat

3.569

3.616

Haryana

1.075

1.089

Himachal Pradesh

0.522

0.529

Jammu & Kashmir

1.297

nil

Jharkhand

3.361

3.405

Karnataka

4.459

4.518

Kerala

2.665

2.700

Madhya Pradesh

6.711

6.799

Maharashtra

4.997

5.063

Manipur

0.362

0.367

Meghalaya

0.371

0.376

Mizoram

0.239

0.242

Nagaland

0.263

0.266

Orissa

5.161

5.229

Punjab

1.299

1.316

Rajasthan

5.609

5.683

Sikkim

0.227

0.230

Tamil Nadu

5.305

5.374

Tripura

0.428

0.433

Uttar Pradesh

19.264

19.517

Uttaranchal

0.939

0.952

West Bengal

7.057

7.150

All states

100.000

100.000

     
   

LOCAL BODIES

13. A total grant of Rs.20,000 crore for the panchayati raj institutions and Rs.5,000 crore for the urban local bodies may be given to the states for the period 2005-10 with inter-se distribution as indicated in the Report (Table 8.1).

14. The PRIs should be encouraged to take over the assets relating to water supply and sanitation and utilize the grants for repairs/rejuvenation as also the O&M costs.

The PRIs should, however, recover at least 50 percent of the recurring costs in the form of user charges.

15. Out of the grants allocated for the panchayats, priority should be given to expenditure on the O&M costs of water supply and sanitation. This will facilitate panchayats to take over the schemes and operate them. 16. At least 50 per cent of the grants provided to each state for the urban local bodies should be earmarked for the scheme of solid waste management through public-private partnership. The municipalities should concentrate on collection, segregation and transportation of solid waste. The cost of these activities, whether carried out in house or out sourced, could be met from the grants.

17. Besides expenditure on the O&M costs of water supply and sanitation in rural areas and on the schemes of solid waste management in urban areas, PRIs and ULBs should, out of the grants allocated, give high priority to expenditure on creation of data base and maintenance of accounts through the use of modern technology and management systems, wherever possible. Some of the modern methods like GIS (Geographic Information Systems) for mapping of properties in urban areas and computerization for switching over to a modern system of financial management would go a long way in creating strong local governments, fulfilling the spirit of the 73rd and 74th Constitutional amendments.

18. The states may assess the requirement of each local body on the basis of the principles stated by us and earmark funds accordingly out of the total allocation recommended by us.

19. Grants have not been recommended separately for the normal and the excluded areas under the fifth and sixth schedule of the Constitution. The states having such areas may distribute the grants recommended by us to all local bodies, including those in the excluded areas, in a fair and just manner. 20. The central government should not impose any condition other than those prescribed by us, for release or utilization of these grants, which are largely in the nature of a correction of vertical imbalance between the centre and the states.

21. The normal practice of insisting on the utilization of amounts already released before further releases are considered, may continue and the grants may be released to a state only after it certifies that the previous releases have been passed on to the local bodies. The amounts due to the states in the first year of our award period i.e. 2005-06 may be released without such an insistence.

22. State governments should not take more than 15 days in transferring the grants to local bodies after these are released by the central government. The centre should take a serious view of any undue delay on the part of the state.

23. The central government should take note of our views on the issues listed in para 8.23 of the Report, while formulating or revising various policy measures. In particular, action may be taken to raise the ceiling on profession tax.

24. The state should adopt the best practices listed in the Report (para 8.19) to improve the resources of the panchayats.

25. The suggestions made by us in respect of state finance commissions in the Report (paras 8.29 to 8.37 and 8.54) should be acted upon with a view to strengthening the institution of SFCs, so that it may play an effective role in the system of fiscal transfers to the third tier of government.

CALAMITY RELIEF

26. The scheme of CRF be continued in its present form with contributions from the centre and the states in the ratio of 75:25.

27. The size of the CRF for our award period is worked out at Rs.21,333.33 crore.

28. The scheme of NCCF may continue in its present form with core corpus of Rs.500 crore. The outgo from the fund may continue to be replenished by way of collection of National Calamity Contingent Duty and levy of special surcharges.

29. The definition of natural calamity, as applicable at present, may be expanded to cover landslides, avalanches, cloud burst and pest attacks.

30. The centre may continue to make allocation of foodgrains to the needy states as a relief measure, but a transparent policy in this regard is required to be put in place.

31. A committee consisting of scientists, flood control specialists and other experts be set up to study and map the hazards to which several states are subject to.

32. The provision for disaster preparedness and mitigation needs to be built into the state plans, and not as a part of calamity relief.

GRANTS-IN-AID TO STATES

33. The system of imposing a 70:30 ratio between loans and grants for extending plan assistance to non-special category states (10:90 in the case of special category states) should be done away with. Instead, the centre should confine itself to extending plan grants to the states, and leave it to the states to decide how much they wish to borrow and from whom.

34. A total non-plan revenue deficit grant of Rs.56,855.87 crore is recommended during the award period for fifteen states.

35. Eight states have been recommended for grants amounting to Rs.10,171.65 crore over the award period for the education sector, with a minimum of Rs.20 crore in a year for any eligible state.

36. Seven states have been recommended for grants amounting to Rs.5,887.08 crore over the award period for the health sector (major heads 2210 and 2211), with a minimum of Rs.10 crore a year for any eligible state.

37. The grants for the education and health sectors are an additionality, over and above the normal expenditure to be incurred by the states in these sectors. These grants should be utilised only for the respective sectors (non-plan), i.e., major head 2202 in the case of education and major heads 2210 and 2211 in the case of health. Conditionalities governing the releases and utilisation of these grants have been specified in the Report (annexures 10.1 to 10.3). No further conditionalities should be imposed by the central or the state government for the release or utilisation of these grants. Monitoring of the expenditure relating to these grants will rest with the state government concerned.

38. A grant of Rs.15,000 crore over the award period is recommended for maintenance of roads and bridges.This amount will be in addition to the normal expenditure which the states would be incurring on maintenance of roads and bridges. This amount will be provided in equal instalments over the last four years (i.e., 2006-07 to 2009-10) of the award period, so that the states get a year for making preparations to absorb these funds.

39. An amount of Rs.5,000 crore is recommended as grants for maintenance of public buildings.

40. The maintenance grants for roads and bridges, and for buildings, are an additionality, over and above the normal maintenance expenditure to be incurred by the states. These grants should be released and spent in accordance with the conditionalities indicated.

41. A grant of Rs. 1,000 crore spread over the award period 2005-10 is recommended for maintenance of forests. This would be an additionality over and above what the states would be spending through their forest departments. It should also result in increased expenditure to the extent of this grant, in addition to the normal expenditure of the forest department.

42. A grant of Rs.625 crore spread over the award period is recommended for heri-tage conservation. This grant will be used for preservation and protection of historical monuments, archaeological sites, public libraries, museums and archives, and also for improving the tourist infrastructure to facilitate visits to these sites.

43. An amount of Rs.7,100 crore has been recommended as grant for state specific needs. While these grants have been phased out equally over the last four years, this phasing should be taken as indicative in nature.The states may communicate the required phasing of grants to the central government.

FISCAL REFORM FACILITY

44. The scheme of Fiscal Reform Facility may not continue over the period 2005- 10, as the scheme of debt relief as described in the Report (Chapter 12), obviates the need for a separate Fiscal Reform Facility.

DEBT RELIEF AND CORRECTIVE MEASURES

45. Each state must enact a fiscal responsibility legislation prescribing specific annual targets with a view to eliminating the revenue deficit by 2008-09 and reducing fiscal deficits based on a path for reduction of borrowings and guarantees. Enacting the fiscal responsibility legislation on the lines indicated in the Report (Chapter 4) will be a necessary precondition for availing of debt relief.

46. Debt relief may not be linked with performance in human development or investment climate.

47. The central loans to states contracted till 31.3.04 and outstanding on 31.3.05 (amounting to Rs. 1,28,795 crore) may be consolidated and rescheduled for a fresh term of 20 years (resulting in repayment in 20 equal instalments), and an interest rate of 7.5 per cent be charged on them. This will be subject to the state enacting the fiscal responsibility legislation and will take effect prospectively from the year in which such legislation is enacted.

48. A debt write-off scheme linked to the reduction of revenue deficit of states may be introduced. Under the scheme, the repayments due from 2005-06 to 2009-10 on central loans contracted up to 31.3.04 and recommended to be consolidated will be eligible for write off. The quantum of write off of repayment will be linked to the absolute amount by which the revenue deficit is reduced in each successive year during the award period. The reduction in the revenue deficit must be cumulatively higher than the cumulative reduction attributable to the interest relief recommended by us. Also, the fiscal deficit of the state must be contained at least to the level of 2004-05. In effect, if the revenue deficit is brought down to zero, the entire repayments during the period will be written off. The enactment of the fiscal responsibility legislation would be a necessary pre-condition for availing the debt relief under this scheme also with the benefit accruing prospectively.

49. The central government should not act as an intermediary for future lending and allow the states to approach the market directly. If some fiscally weak states are unable to raise funds from the market, the centre could borrow for the purpose of on lending to such states, but the interest rates should remain aligned to the marginal cost of borrowing for the centre.

50. External assistance may be transferred to states on the same terms and conditions as attached to such assistance by external funding agencies, thereby making government of India a financial intermediary without any gain or loss. The external assistance passed through to states should be managed through a separate fund in the public account.

51. The moratorium on repayments and interest payments on the outstanding special term loan amounting to Rs. 3,772 crore as on 31.03.2000 given to Punjab may continue for another two years i.e. up to 2006-07, by which time the central government must finalize the quantum of debt relief to be allowed in terms of the recommendations of the EFC.

52. In respect of relief and rehabilitation loans given to Gujarat from ADB and World Bank through the central government, the central government may, if the government of Gujarat so desires, alter the terms and conditions of these loans, so that these are available to Gujarat on the same terms on which the external agencies have extended these loans.

53. All states should set up sinking funds for amortization of all loans including loans from banks, liabilities on account of NSSF etc. The fund should be maintained outside the consolidated fund of the states and the public account and should not be used for any other purpose, except for redemption of loans. 54. States should set up guarantee redemption funds through earmarked guarantee fees. This should be preceded by risk weighting of guarantees. The quantum of contribution to the fund should be decided accordingly.

PROFIT PETROLEUM

55. The Union should share the profit petroleum from NELP areas with the states from where the mineral oil and natural gas are produced. The share should be in the ratio of 50:50.

56. There need not be sharing of profits in respect of nomination fields and non-NELP blocks.

57. The revenues earned by the central government on contracts signed under the coal bed methane policy may be shared with the producing states in the same manner as profit petroleum.

58. In respect of any mineral, if a loss of revenue is anticipated for a state in the process of implementation of a policy, which involves production sharing, a similar compensation mechanism should be adopted by the central government.

A PERMANENT SECRETARIAT FOR THE FINANCE COMMISSION

59. The finance commission division of the Ministry of Finance should be converted into a full-fledged department, serving as the permanent secretariat for the finance commissions. This secretariat should be vested with the powers of a full-fledged department of the government, with Ministry of Finance only as its nodal ministry for the purpose of linkage with the Parliament.

60. The expenditure of finance commissions should be treated as expenditure "charged" on the consolidated fund of India.

61. A research committee should be set up with adequate funding to organize studies relevant to fiscal federalism. 62. The finance commissions should have a tenure of at least 3 years to enable them to do their work adequately.

63. The Thirteenth Finance Commission should be set up at the beginning of 2007 and appropriate and adequate arrangements for the office and residence of the chairman and members of the Commission must be made before the appointment of the Commission, so that Commission’s time is not wasted in routine administrative matters.

MONITORING MECHANISM

64. Every state should set up a high level monitoring committee headed by the Chief Secretary with the Finance Secretary and the Secretaries / heads of departments as members for monitoring proper utilization of finance commission grants.

65. The monitoring committee should meet at least once in every quarter to review the utilization of the grants and to issue directions for mid-course correction, if considered necessary.

66. The monitoring committee should be responsible for monitoring both financial and physical targets and for ensuring adherence to the specific conditionalities in respect of each grant, wherever applicable.

67. In the beginning of the year, the monitoring committee should approve finance commission assisted projects to be undertaken in each sector, quantify the targets, both in physical and financial terms and lay down the time period for achieving specific milestones.

ACCOUNTING PROCEDURE

68. Central government should gradually move towards accrual basis of accounting.

69. In the interim period, additional information in the form of statements should be appended to the present system of cash accounting to enable more informed decision making. The additional information may relate to subsidies, expenditure on salaries, expenditure on pensions, committed liabilities, maintenance expenditure, segregation of salary and non-salary portions and liabilities and repayment schedule on outstanding debts.

70. The definition of revenue and fiscal deficits be standardized and instructions for a uniform classification code down to the object head may be issued to all the states.

71. A National Institute of Public Financial Accountants be set up by the government of India and its charter be decided in consultation with the Comptroller and Auditor General.

Explanatory Memorandum as to the Action Taken on the Recommendations Made by the Twelfth Finance Commission

1. The Twelfth Finance Commission was constituted by the President on November 1, 2002 to give recommendations on specified aspects of Centre- State fiscal relations during 2005-10. The Commission submitted its Report covering all aspects of its mandate on December 17,2004.

2. The Finance Commissions are constituted by the President after every five years or earlier under Article 280 of the Constitution to give recommendations on specified aspects of Centre-State fiscal relations. The recommendations of these Commissions are based on a detailed assessment of the financial position of the Central and State Governments and wide consultations with stakeholders. The Commissions usually visit the States, sponsor studies, hold consultations with experts and their recommendations are backed up by detailed reasons disclosing the methodology adopted by them.

3. The Report of the Twelfth Finance Commission (herein after referred to as the Commission) covering the five years period commencing from April 1, 2005 together with the Explanatory Memorandum on the action taken on the recommendations of the Commission is being laid on the Table of the House, in pursuance of Article 281 of the Constitution. A summary of the Commission’s main recommendations relating devolution of taxes and duties to the States, grants-in-aid under article 275 of the Constitution, financing of relief expenditure and debt relief to the States and other matters is contained in Chapter 16 of the Report of the Commission.

4. The Government has carefully considered the main recommendations contained in the Report of the Commission and the action proposed to be taken on these recommendations is detailed below.

DEVOLUTION OF SHARE IN CENTRAL TAXES AND DUTIES TO STATES

5. Under Article 270 of the Constitution, as amended w.e.f. 1st April, 1996 by the Constitution (Eightieth Amendment) Act, 2000, a prescribed percentage of the net proceeds of all Central taxes (except Union surcharge, cess levied for specific purposes under any law made by Parliament and the duties and taxes referred to in Articles 268 and 269) is to be assigned to the States within which that tax is leviable in that year and distributed among those States in terms of Orders issued by the President on the recommendations of the Finance Commission.

For the period of five years commencing from April 1, 2005, the Commission has recommended that 30.5 per cent of the net proceeds of shareable Central taxes may be distributed amongst all such States where any such Central tax is leviable. If in any year during 2005-10, a particular Central tax is not leviable in a State, the share of that State in that tax should be put to zero and the entire proceeds be distributed among the remaining States by proportionately adjusting their shares. For this purpose, additional excise duties in lieu of sales tax on textiles, tobacco and sugar are treated as a part or the shareable pool of central taxes. If this tax rental arrangement is terminated and the States are allowed to levy sales tax (or VAT) on these commodities without any prescribed limit, the share of the States in the net proceeds of shareable central taxes shall be reduced to 29.5 per cent. If any legislation is enacted in respect of service tax after the Eighty Eighth Constitutional amendment is notified, it must be ensured that the revenue accruing to a State under the legislation should not be less than the share that would accrue to it, had the entire service tax proceeds been part of the shareable pool. The percentage share of each State in Union taxes and duties and the criteria for devolution and relating weights assigned to different factors is indicated in Chapter 7 of the Report.

The Government has accepted the above recommendations of the Commission.

GRANTS-IN-AID OF THE REVENUES O F STATES UNDER THE SUBSTANTIVE PROVISIONS OF ARTICLE 275 OF THE CONSTITUTION

NON-PLAN REVENUE DEFICIT GRANT

6. The Commission has recommended grants-in-aid to be given under Article 275(1) of the Constitution, other than those under the proviso to Article 275(1), equal to the amount of deficits assessed for each year during the period 2005-10. A total non-plan revenue deficit grant of Rs.56,855.87 crore is recommended during the award period for fifteen States, The amount of the grant for each State having non-plan deficits is indicated in Chapter 10 of the Report for each of the 5 years starting from the financial year 2005-06.

The Government has accepted this recommendation.

GRANT FOR EDUCATION

7. The Commission has recommended grants for eight States amounting to Rs.10,171.65 crore over the award period for the education sector, with a minimum of Rs.20 crore in a year for any eligible State. The year wise allocation for each State is given in Chapter 10 of the Report. The grant for the education sector is an additionality, over and above the normal expenditure to be incurred by the States in this sector. Conditionalities governing the release and utilisation of this grant have been specified in Annexures 10.1 to 10.3 of the Commission’s Report.

The Government has accepted this recommendation of the Commission.

GRANT FOR HEALTH

8. The Commission has recommended grants for seven States amounting to Rs.5,887.08 crore over the award period for the health sector, with a minimum of Rs.10 crore in a year for any eligible State. The year-wise allocation for each State is given in Chapter 10 of the Report. The grant for the health sector is an additionality, over and above normal expenditure to be incurred by the States in this sector. Conditionalities governing the release and utilisation of this grant have been specified in Annexures 10.1 to 10.3 of the Commission’s Report.

The Government has accepted this recommendation of the Commission.

GRANTS FOR MAINTENANCE OF ROADS AND BRIDGES AND PUBLIC BUILDINGS

9. The Commission has recommended grants amounting to Rs.15,000 crore for maintenance of roads and bridges and Rs. 5,000 crore for maintenance of public buildings over the award period. The State-wise, year-wise allocations are given in Chapter 10 of the Report. These grants are an additionality, over and above the normal expenditure to be incurred by the States. Conditionalities governing the release and utilisation of these grants have been specified in Annexure 10.4 to 10.6 of the Commission’s Report.

The Government has accepted the above recommendations of the Commission.

GRANT FOR MAINTENANCE OF FORESTS

10. The Commission has recommended grants amounting to Rs.1,000 crore over the award period for maintenance of forests. The State-wise, year-wise allocation is given in Chapter 10 of the Report. This grant is an additionality, over and above the normal expenditure to be incurred by the States for this purpose .

The Government has accepted this recommendation of the Commission.

GRANT FOR HERITAGE CONSERVATION

11. The Commission has recommended grants amounting to Rs.625 crore over the award period for heritage conservation. This grant is to be used for preservation and protection of historical monuments, archaeological sites, public libraries, museums and archives, and for improving the tourist infrastructure to facilitate visits to these sites. The State-wise, year-wise allocation is given in Chapter 10 of the Report. This grant is an additionality, over and above the normal expenditure to be incurred by the State for this purpose.

The Government has accepted this recommendation of the Commission.

GRANT FOR STATE SPECIFIC NEEDS

12. The Commission has recommended grants amounting to Rs.7,100 crore over the award period for State specific needs. The State-wise, purpose-wise details of these grants are given in Chapter 10 of the Report.

The Government has accepted this recommendation of the Commission subject to the condition that the grants would be released based on the level of preparedness of the States to utilize the grants for the specific purpose for which they have been recommended.

GRANTS FOR LOCAL BODIES

13. The Commission has recommended grants amounting to Rs.25,000 crore over the award period for local bodies. Of this, Rs.20,000 crore is for Panchayats and Rs.5,000 crore is for urban local bodies. The inter-State distribution and the criterion adopted in arriving at the proposed distribution are given in Chapter 8 of the Report. The Commission has emphasized that of the grants allocated to panchayats, priority should be given to expenditure on the O&M costs of water supply and sanitation and that at least 50% of the grants provided to each State for the urban local bodies should be earmarked for the scheme of solid waste management. Besides expenditure on the O&M costs of water supply and sanitation in rural areas and on the schemes of solid waste management in urban areas, panchayats and urban local bodies should, out of the grants allocated, give high priority to expenditure on creation of data base and maintenance of accounts.

The Government has accepted this recommendation of the Commission as per the provisos to recommendations summarized in paras 8.52 to 8.55 of the Report.

FINANCING OF CALAMITY RELIEF EXPENDITURE

14. The Commission has recommended the continuance of the scheme of Calamity Relief Fund in its present form with contributions from the Centre and the States in the ratio of 75:25. The size of the CRF for the period 2005-10 is worked out at Rs.21,333.33 crore. This includes the Centre’s share of Rs 16,000 crore, and the States’ share of Rs.5,333.33 crore. The State-wise distribution of CRF giving the Centre and State’s share is indicated at Annexure 9.1 to 9.3 of the Report. The Commission has also recommended continuance or the scheme of NCCF in its present form with core corpus of Rs.500 crore. The outgo from the fund may continue to be replenished by way of collection of National Calamity Contingent Duty and levy of special surcharges.

The Government has accepted the above recommendations of the Commission.

SHARING OF PROFIT PETROLEUM

15. The Commission has recommended the sharing of the non-tax revenue of ‘Profit Petroleum’ arising out of contractual provisions under NELP with the States from where the mineral oil and natural gas are produced in the ratio of 50:50. The details are given in Chapter 13 of the Report.

The Government has accepted the above recommendations of the Commission subject to the condition that this should be within the overall ceiling of transfers recommended by the Commission (38% of gross revenues). This would imply that once the total transfers cross 38% of gross revenues of the Centre sharing of non-tax revenue of Profit Petroleum would not accrue in that year. Further, this should not be considered by the States as establishing a general principle of sharing of the Centre’s non-tax revenues.

DEBT RELIEF TO STATES

16. The Commission has recommended that the scheme of Fiscal Reform facility may be replaced by a scheme of Debt Relief over the period 2005-10. The scheme of Debt Relief recommended by the Commission envisages:-(i) The rescheduling of all Central Loans contracted till 31.3.2004 and outstanding as on 31.3.2005 into fresh loans for 20 years carrying 7.5% interest w.e.f. the year a State enacts the Fiscal Responsibility Legislation.

Details of the scheme are given in Chapter 12 of the Report.

The Government has accepted the above recommendations of the Commission subject to the condition laid down by the Twelfth Finance Commission that the debt relief (re-scheduling and consolidation and lowering of interest rate) would be admissible on the State enacting the Fiscal Responsibility legislation and would take effect prospectively from the year in which such legislation is enacted. It is also expected that the States would comply with the obligations regarding reduction of Fiscal Deficit and Revenue Deficit imposed by the Fiscal Responsibility Legislation. The Centre would request the next Finance commission to make appropriate adjustment in case the State availing of the debt relief is not able to comply with the Fiscal Responsibility Legislation.

(ii) A debt write-off linked to reduction in revenue deficit by a State. The quantum of write-off of repayment would be linked to the absolute amount by which the revenue deficit is reduced in each successive year during the award period. In accordance with the recommendation of the Twelfth Finance Commission, the benefit of write-off would be available only if the fiscal deficit of the State is contained to the level of 2004-2005. If in any year, the fiscal deficit exceeds this level, the benefit of write-off, even if eligible otherwise, would not be given. The details of the scheme are given in Chapter 12 of the Report.

The Government has accepted the above recommendations of the Commission.

CENTRAL ASSISTANCE FOR STATE PLANS

17. The Commission has recommended that the Centre should release only the grant portion of Central Assistance for State Plan (CPA) and leave it to the State to raise loan portion from any source. For States unable to raise loans from market, the Centre may act as a financial intermediary but without any subsidisation of cost. The details are given in Chapter 10 of the Report.

This approach has been accepted by the Government, in principle, to be implemented in phases, in consultation with RBI. From 2005-06, the States would be allowed at their discretion, not to draw the loan portion of the CPA.

EXTERNAL ASSISTANCE LOANS

18. The Commission has recommended that the Centre should pass on external assistance on back-to-back basis to States and manage it through separate Fund in the Public Account. The details are given in Chapter 12 of the Report.

The Government has accepted the recommendation to pass on external assistance on the same terms and conditions on which it was received subject to the condition that the service cost and exchange rate fluctuations would also be passed on to the States under this arrangement.

ACCOUNTING PROCEDURE

19. The Commission has recommended a move by the Centre towards introduction of accrual accounting and standardisation of accounting classification down to the object head for all States to improve fiscal management. The details are given in Chapter 14 of the Report.

The Government has accepted this recommendation in principle . The Government Accounting Standards Board in the office of the Comptroller and Auditor General of India would be asked to draw a detailed road map and operational frame work for its implementation.

MISCELLANEOUS

20. The Commission has recommended that the total transfers (tax devolution and Plan/non-Plan grants) from the Centre to the States should not exceed 38% of gross revenue receipts of the Centre (both tax and non-tax). The details are given in Chapter 7 of the Report.

The Government has accepted this ceiling on total Revenue account transfers, from the Centre to the States subject to the condition that the acceptance does not imply the establishment of a principle of mandatory sharing of a fixed percentage of Centre’s revenue receipts with the States.

IMPLEMENTATION

21. The Commission’s recommendations fall in the following categories:

(i) Those to be implemented by an Order of the President.

(ii) Those to be implemented by executive orders. (iii)Those to be examined further.

22. The recommendations under Articles 270 and 275(1) of the Constitution relating to share in Union taxes and duties and grants-in-aid, respectively, fall in the first category and the necessary orders will be submitted to the President for approval.

23. The recommendations relating to sharing of Profit Petroleum, Debt Relief, Central Assistance for State Plans and External Assistance Loans will be implemented by executive orders.

24. Other recommendations of the Commission will be considered in due course.

Annex Table 1 : Total Twelfth Finance Commission Transfers to States

                         

(Rs.in crore)

             

Grants-in-aid

         
 

Share in

                     

Total

States

Central

Non-Plan

Health

Educa-

Mainte-

Mainte-

Mainte-

Heritage

State

Local

Calamity

Total

Transfers

 

Taxes &

Revenue

Sector

tion

nance of

nance of

nance of

Conser-

Specific

Bodies

Relief

(Col. 3 to

(Col. 2 +

 

Duties

Deficit

(2005-10)

(2005-10)

Roads &

Buildings

Forests

vation

Needs

(2005-10)

(2005-10)

Col. 12)

Col. 13)

 

(2005-10)

(2005-10)

   

Bridges

(2006-10)

(2005-10)

(2006-10)

(2006-10)

       
         

(2006-10)

               

1

2

3

4

5

6

7

8

9

10

11

12

13

14

Andhra Pradesh

45138.68

     

980.12

242.53

65.00

40.00

500.00

1961.00

1425.93

5214.58

50353.26

Arunachal Pradesh

1767.34

1357.88

   

44.36

57.42

100.00

5.00

10.00

71.00

112.56

1758.22

3525.56

Assam

19850.69

305.67

966.02

1107.37

330.12

230.64

40.00

20.00

130.00

581.00

767.89

4478.71

24329.40

Bihar

67671.04

 

1819.69

2683.76

309.36

359.61

5.00

40.00

400.00

1766.00

592.37

7975.79

75646.83

Chhattisgarh

16285.76

     

262.40

183.09

85.00

10.00

300.00

703.00

444.45

1987.94

18273.70

Goa

1589.14

     

39.48

24.18

3.00

20.00

10.00

30.00

8.73

135.39

1724.53

Gujarat

21900.47

     

895.20

203.61

20.00

25.00

200.00

1345.00

1019.47

3708.28

25608.75

Haryana

6596.46

     

182.72

151.80

2.00

15.00

100.00

479.00

515.46

1445.98

8042.44

Himachal Pradesh

3203.22

10202.38

   

261.64

147.60

20.00

10.00

50.00

155.00

400.52

11247.14

14450.36

Jammu & Kashmir

7441.71

12353.46

   

117.68

164.54

30.00

10.00

100.00

319.00

343.89

13438.57

20880.28

Jharkhand

20624.02

 

360.98

651.73

409.04

159.61

30.00

10.00

330.00

580.00

501.46

3032.82

23656.84

Karnataka

27361.88

     

1458.12

205.12

55.00

50.00

600.00

1211.00

475.16

4054.40

31416.28

Kerala

16353.21

470.37

   

642.32

103.50

25.00

25.00

500.00

1134.00

354.32

3254.51

19607.72

Madhya Pradesh

41180.59

 

181.64

459.56

586.88

443.02

115.00

20.00

300.00

2024.00

1011.27

5141.37

46321.96

Maharashtra

30663.19

     

1189.68

223.61

70.00

50.00

300.00

2774.00

923.77

5531.06

36194.25

Manipur

2221.44

4391.98

   

76.96

37.71

30.00

5.00

30.00

55.00

22.11

4648.76

6870.20

Meghalaya

2276.61

1796.86

   

86.40

35.02

30.00

5.00

35.00

58.00

44.88

2091.16

4367.77

Mizoram

1466.52

2977.79

   

42.12

23.29

25.00

5.00

65.00

30.00

26.19

3194.39

4660.91

Nagaland

1613.67

5536.50

   

120.88

46.17

25.00

5.00

45.00

46.00

15.19

5839.74

7453.41

Orissa

31669.47

488.04

196.37

323.30

1475.08

389.14

75.00

50.00

170.00

907.00

1199.37

5273.30

36942.77

Punjab

7971.00

3132.67

   

420.96

151.80

2.00

10.00

96.00

495.00

605.16

4913.59

12884.59

Rajasthan

34418.56

   

100.00

633.32

213.09

25.00

50.00

450.00

1450.00

1722.50

4643.91

39062.47

Sikkim

1392.94

188.67

   

18.64

32.15

8.00

5.00

100.00

14.00

69.74

436.20

1829.14

Tamil Nadu

32552.74

     

1214.40

242.53

30.00

40.00

300.00

1442.00

866.46

4135.39

36688.13

Tripura

2626.09

5494.20

   

61.48

50.11

15.00

5.00

49.00

65.00

51.12

5790.91

8417.00

Uttar Pradesh

118209.45

 

2312.38

4454.07

2403.16

600.28

20.00

50.00

800.00

3445.00

1177.11

15262.00

133471.45

Uttaranchal

5762.22

5114.68

50.00

 

324.56

97.60

35.00

5.00

240.00

196.00

369.28

6432.12

12194.34

West Bengal

43303.91

3044.72

 

391.86

412.92

181.23

15.00

40.00

890.00

1664.00

933.64

7573.37

50877.28

Total States

613112.02

56855.87

5887.08

10171.65

15000.00

5000.00

1000.00

625.00

7100.00

25000.00

16000.00

142639.60

755751.62



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