The Third State Finance Commission Report ( 2005) , Kerala

THIRD STATE FINANCE COMMISION KERALA

REPORT WITH ACTION TAKEN REPORT

NOVEMBER 2005

1

Action Taken Report on the Recommendations of the 3rd Kerala State Finance Commission Devolution of State Tax Revenues to LSGs (Chapter 6)

Recommendation - 14. 1 During the financial year 2006-2007, an amount of Rs. 2050 crore may be transferred to Local Self Governments, as their share of State tax revenues. Out of this amount, Rs. 300 crore will be for expenditure on their traditional functions, Rs. 350 crore for expenditure on maintenance of assets and Rs. 1400 crore for expenditure on developing and expanding services and institutions transferred to them by the State Government. During each of the four subsequent years, amounts derived by applying annual growth of ten percent may be so transferred. The total amount to be so transferred during the five years 2006-07 to 2010-1] will be Rs. 12515 cr.

Action Taken The recommendation is accepted. Any NABARD allocation will be over and above this allocation. As to whether the amounts to be devolved will include the Local Bodies Grant received by the Govt of Kerala from Govt of India under the XII Finance Commission Recommendations, till a directive to the contrary is received from the Ministry of Finance, Govt of India, the amount being devolved will be considered as inclusive of the XII FC grants (which is the practice being followed for the past 5 years). In case there is a serious resources problem, the procedure suggested by the 3rd SFC vide their recommendation at Para 9.14 will be followed.

Recommendation - 14. 2 Funds meant for expenditure on traditional functions and maintenance (eg. Rs. 300 crore and Rs. 350 crore respectively in 2006-07) will be distributed among the LSGs following the same ratios as applied to the distribution of 3.5% and 5.5 % of State tax revenue (final audited figures) recommended by the Second State Finance Commission. The funds meant for expenditure on development (eg. Rs.1400 crore in 2006-07) will be distributed among the LSGs following the ratio applied for distributing plan funds. The amounts to be transferred to each LSGfor each of the five years for the three different types of expenditure are given in Appendix I (not enclosed).

Action Taken This recommendation is accepted as far as funds for traditional functions (eg. Rs 300 cr. in 2006-07) and funds for expenditure on development (eg. Rs 1400 cr. in 2006-07) are concerned. However, in respect of funds for expenditure on development in 2006-07 (i.e.Rs 1400 cr.), the LSGI wise allocation will be as proposed by the State Planning Board. As far as funds for maintenance (eg. Rs. 350 cr. in 2006-07) are concerned, the recommendation is accepted for the first 4 months of 2006-07. For the remaining 4 years and 8 months, while keeping the total at levels recommended by the 3r SFC, the horizontal distribution of funds among the LSGIs will be based on the value of the actual assets transferred and the need for maintaining such assets, for which a separate formula is being evolved by the Government. The formula will be finalized by June 2006 and the actual amount due to each LSGI for the remaining 4 years & 8 months will be announced by July, 2006. The share of new LSGIs will be calculated as per formula by reducing the share of the "parent" LSGIs.

Recommendation - 14. 3 The entire amount will be provided in the State Government budget of the relevant years as 'Compensation and assignment to Local Self Governments' in Non-Plan revenue account under the major head of account 3604.

Action Taken Accepted. However, Funds for Road Maintenance will be provided under an appropriate PWD head of account, because the 12th Finance Commission and the Government of India have linked XII FC Road Maintenance Grants (which will cover roads transferred to LSGIs as well) to the State Government making certain minimum provisions and incurring certain actual expenditure under the PWD Maintenance head of account. The manner of release of such road maintenance funds to the LSGIs will be the same as suggested by the 3rd SFC for Maintenance Funds. The controlling officer for the funds set apart under the PWD head of account will be an officer of the Local Self Government Department.

Recommendation - 14. 4 Additional resources of three types can be raised by LSGs, (i) increase in tax and non tax revenues (ii) Public contribution (Hi) borrowing. Additional revenue receipts should be raised through systemic improvement in administration of tax and non tax revenue items.

Action Taken Accepted. However, in line with the recommendation in para 12.13, the borrowal in a year will be limited to 5% of the total own revenue receipts anticipated in the year in the case of Grama Panchayats and 5% of the funds for development allocated in the year, in respect of Block Panchayats and District Panchayats. The limit of 5% will not apply in respect of purely commercial projects, the cash flows from which will, on their own, repay the loan. Also, the borrowal will have to conform to the requirements of the Kerala Local Authorities Loans Act, 1963.

Recommendation - 14. 5 Increasing rates may be done only after examining all the implications and not merely on the ground that there will be consequent increase in revenue receipts. Public contribution should be raised as cash contributions. Borrowing should be done only to a limited extent and there should be a dear schedule for repayment of outstanding debt, Action Taken

Accepted. Also, as recommended in Para 8.14, a Commission will be set up to review the tax structure in the State (both at the State and the local Self Government level), keeping in view the incidence of Central taxes also. Recommendation -14. 6 For systemic improvement, specific steps listed in para 8. 21 may be implemented. Action Taken

Accepted Release of Funds (Chapter 9) Recommendation - 14. 7 Release of the share of tax revenue recommended in chapter 6 should be as per a

schedule known to LSGs, so that they can plan their expenditure accordingly. Funds meant for traditional functions expenditure (eg. Rs. 300 crore in 2006-07) should be released in twelve equal monthly installments from April to March. Funds meant for maintenance expenditure (eg. Rs. 350 crore in 2006-07) should be released in ten equal monthly installments from April to January. Funds meant for development expenditure (Rs. 1400 crore in 2006-07) should be released in ten equal monthly installments from May to February (As illustration, for release of funds in 2006-07, a Table is given in para 9. 10).

Action Taken Accepted Recommendation - 14. 8 Problems arising in the smooth release of funds should be resolved through joint consultations, in a sprit of co-operation and mutual understanding, outlined in

paras 9. J 3

and 9. 14. Action Taken

Accepted Drawal of Funds (Chapter 10) Recommendation - 14. 9 Funds released as per the schedule specified in chapter 9 should be transfer credited from head of account 3604 to Public Account (major head of account 8448) before the 5th of every month. There will be three Deposit Accounts under 8448. Account I will be for funds for traditional expenditure (eg. Rs. 300 crore in 2006-07). Account II will be for funds for maintenance (eg. Rs. 350 crore in 2006-07). Account III will be for development expenditure (eg. Rs. 1400 crore in 2006-07). The officers authorised to do the transfer credit are indicated in para 10.11. Action Taken

Accepted

Recommendation -14. 10 From head of account 8448, LSGs will draw funds for maintenance and development expenditure through Bills presented in the treasury, supported by all necessary documents

based on actual requirement and for immediate disbursement. Funds for traditional functions (eg. Rs. 300 crore in 2006-07) can be drawn by cheques as is the practice now. Details of accounting procedure may be finalised in consultation with the Accountant General. Action Taken

Accepted. Penalization of the accounting procedure will be done by the Local Self Govt Dept. in consultation with the Accountant General and Finance Dept. Recommendation -14.11 If the amounts (for maintenance and development) remaining in the Public Account to the credit of individual LSGs on 31st March closing, is more than 10 (ten) percent of the total amount released (deposited in the Public Account to the credit of that LSG) during that financial year, the excess over ten (10) per cent will be reduced from the budget provision for that LSGfor next year, as illustrated in para JO. 15. Action Taken Accepted Recommendation 14. 12 For bills presented for drawal from Public Account within the limits of monthly release credited to the account of the LSG, there should not be any treasury restrictions or need for ways and means clearance from Finance Department. However for utilising that part of the fund, if any, carried over from the previous month's release, special authorisation from Finance Department will be required. Action Taken Treasury restrictions are imposed only when the State is on overdraft or is likely to get into overdraft. There could be very serious situations when no payment at all, not even salary, can be authorized from the Treasury (although this has not happened in the last 5 years or so). Subject to such emergency situations, Government supports the recommendation that there shall not be any treasury' restriction for bills presented for drawal from public account. Government will ensure that every month there will be at least 10 working days during which the LSGs can present bills and get payment without any Treasury restriction. The recommendation that there shall not be any need for ways and means clearance for bills is also acceptable within the 10-day period. The recommendation that for utilizing that part of the funds, if any, carried over from the previous months release, special authorization from Finance Department will be required, is also acceptable to Government.

Fiscal Freedom of LSGs (Chapter 11) Recommendation - 14. 13 Procedure specified in chapter 10 will be an interim arrangement till a system of full fiscal freedom is put in place. Under that system, funds released by Government from head of account 3604 should be allowed to be held by LSGs in Government controlled banks. LSGs should draw funds from bank, by cheques. Such drawal should be preceded by a procedure of financial scrutiny.

Action Taken Accepted, This will be implemented after the full fiscal freedom regime is in place (i.e. 2008-09, as recommended in para 14.21 below). Recommendation - 14. 14 There should be four bank accounts for each LSG (1) for traditional functions expenditure, (ii)for maintenance expenditure (Hi) for expenditure on development of services and institutions (now known as decentralised plan) (iv) for agency functions like State sponsored schemes, centrally .sponsored schemes, welfare pensions etc. Action Taken

Accepted. This will be implemented after the full fiscal freedom regime is in place (ie. 2008-09, as recommended in para 14.21 below). Recommendation -14. 15 Own tax and non-tax receipts and tax share for traditional functions (eg. Rs. 300 crore in 2006-07), will be the inflow in the first account. Tax share from State Government, for maintenance (eg.Rs.350 crore in 2006-07) will be the inflow in the second account. Tax share for development (eg. Rs. 1400 crore in 2006-07) will be the inflow in the third account. Funds received from State and Central agencies should be the inflow in the fourth account. There should be a separate stream of inflow and outflow for borrowed funds, their repayment and for the public contribution. The details of these accounts will have to be worked out in consultation with the Accountant General and Director of Local Fund Audit. Action Taken

Accepted. This will be implemented after the full fiscal freedom regime is in place (ie. 2008-09, as recommended in para 14.21 below). Recommendation - 14. 16 It is essential to have a Finance and Accounts Wing even in Grama Panchayats. At

least one person competent to handle these functions should be made available to each LSG. That could be on deputation to the maximum extent possible and unavoidable minimum number by fresh recruitment through Public Service Commission. The staff of the Performance audit can also be used to strengthen this structure. The personnel so appointed will be the nucleus of a Finance Wing in LSGs.

Action Taken This is agreed to in principle. Since creation of additional staff cannot be readily agreed to, emphasis will be on developing a computer based system of accounting and giving the necessary training to the staff of LSGIs to handle this. The details will be worked out separately by the LSG Department, in consultation with Finance Dept. Posts will be created only if it is absolutely necessary. Recommendation - 14. 17 Major expenditure proposals (over a limit laid down depending on the volume of financial transactions of each LSG) should be seen by that unit, before the Secretary of the LSG clears it. After the Secretary clears the proposal it should be seen by the Chairperson of the respective standing Committee and the Chairperson of the Finance Standing Committee before approval by Chairman/Council After the proposal is so approved, cheques will have to be prepared for drawal of funds. Such cheques should be signed both by the Secretary and the Chairperson of the Finance Standing committee. Action Taken

Accepted. This will be implemented after the full fiscal freedom regime is in place (ie. 2008-09, as recommended in para 14.21 below).

Recommendation - 14. 18 It will be the duty of the Finance Wing and the Secretary to point out the pros and cons of a decision proposed to be taken. If higher authorities (Chairpersons of Standing Committees, Deputy Chairperson, Chairperson) overrule them, they will have to own the responsibility for that decision.

Action Taken

Accepted. This will be implemented after the full fiscal freedom regime is in place (i.e. 2008-09, as recommended in para 14.21 below). Recommendation - 14. 19 There should be a clear system to discourage delayed use of funds. The system will be as specified in para 11.15. Action Taken

Accepted Recommendation - 14. 20 There should also be a system for monitoring performance, as specified in para 11. 16.

Action Taken Accepted Structure of Developmental Financing (Chapter 12) Recommendation -14. 21 The new system of fiscal freedom can be put in position only after necessary staff are deployed, accounting details worked out and monitoring agencies formed. The new system should come into force in 2008-09.

Action Taken Accepted Recommendation - 14. 22 There should be a structure, of developmental financing in which both the Government and the LSGs participate. Funds assessed as available for developmental expenditure in the financial profiles in Appendix II. enhanced by further mobilisation of resources from revenue receipts, borrowing and public contribution should be taken as LSGs' contribution in the Plan Financing Table. What Government gives as share of State taxes to LSGs should reflect in the item 'Balance from Revenues' in the Plan financing Table. In the Plan outlay, the contribution from LSGs should be the outlay for decentralised Plan. Action Taken

Accepted

Recommendation - 14. 23 If however the Government want that LSGs should have a higher share of State Plan (depending on Government policy) the difference between funds available with LSGs and that share of outlay should be given as grant by Government to LSGs. Detailed Tables given in chapter 12 illustrate the position regarding availability of funds with LSGs. Action Taken

Accepted. The actual higher share of State Plan that the Government want LSGs to have, will be decided every year, while finalizing the annual plan. Recommendation - 14. 24

In respect of a very small number of LSGs their total availability of funds for development expenditure

is

less than

what

Government gives as share of taxes for

development expenditure. In such cases, gap grants may be given as indicated in Appendix \U (of 3" SFC Recommendation). Action Taken

Accepted, subject to the condition that if the figures of revenue vary after detailed audit, suitable downward modifications will be made. Recommendation - 14, 25 To update the financial profiles in Appendix JI from time to time, make a resources assessment of LSGs each year before finalising the size of the decentralised plan to be implemented by LSGs and also to make other studies relevant in this area, a 'Board of Fiscal Research' headed by the Chief Secretary may be constituted. The details are in Para 12.21. Action Taken

Accepted. As suggested by the 3rd SFC, only 2 or 3 additional posts of financial experts will be created. The rest of the staff will be found by redeployment from Finance and LSG Departments as well as the Directorates of Panchayat and Urban Affairs. Other Issues (Chapter 13) Recommendation - 14. 26 Regarding transfer of budget for payment of salary of employees institutions transferred to Panchayats and Municipalities, continue.

working in

the existing arrangement may

Action Taken

Accepted. Recommendation - 14. 27 For settlement of dues and claims between LSGs and Government agencies, there should a system of continual dialogue. The details are in para 13.6. Action Taken

The recommendation regarding continual dialogue is accepted. The recommendation in para 13.6 of the report that for 50% of the arrears from LSGIs to KWA and KSEB, the State Government may provide a block grant will be examined in detail and a separate decision taken. For resolution of disputes between the LSGIs on the one hand and KSEB/KWA on the other, an appropriate mechanism will be built in separately in consultation with the Power and Water Resources Departments. Recommendation - 14. 28 Work of disbursement (not the selection of beneficiaries) of welfare pensions may be transferred to the concerned Departments. Action Taken

Accepted. However, instead of transferring this to individual Departments, this may be centralized at the level of the Finance Department or the Directorate of Treasuries. A system for constant flow of information between the centralized agency and the LSGIs will have to be put in place. The details will be worked out by Fin. Dept. in consultation with the concerned Depts. Recommendation - 14. 29 Some addition to staff strength of Grama Panchayats may be unavoidable. Action Taken

This will have to be found mostly by redeployment.

Specific details will be

worked out by the LSG Rural and Urban Departments and the matter taken up with Finance Department for a separate decision. Posts will be created only if it is absolutely necessary. Recommendation is accepted with the above conditions. Recommendation - 14. 30 In consultation with Accountant General and Director of Local Fund Audit, a limit should be fixed on the number of days (in a month) when audit panics of any organisation would visit LSGs.

Action Taken

Accepted. This will be fixed by the concerned officers of the Dept of Local Fund Audit for every LSGI, in consultation with them. In exceptional situations, however, the audit parties may visit LSGI on other days as well. The number of such exceptional visits will not exceed 15 in a year. Recommendation - 14. 31 Levy of audit fees may be dispensed with. Action Taken The rate of fees which was 1% of the income has recently been reduced to 0.5% with retrospective effect. The recommendation to dispense with audit fees altogether for LSGIs will be considered separately, after its impact on other local bodies (who also have to pay audit fees @0.5% to the Local Fund Audit Department) is properly assessed. Recommendation -14. 32 Before ordering any exemption/reduction in taxation which would adversely affect LSGs, Government should obtain the recommendation of the LSGs. Action Taken Accepted.

CHAPTER 1 INTRODUCTION 1. 1 The Third State Finance Commission Kerala was constituted in September 2004. Annexure 1.1 of this report is a copy of the notification appointing the Commission and specifying the terms of reference. 1. 2 Commission commenced work within a few days. Though it took some time to organise the office and get the staff in position, the work of collection of data was initiated in early October 2004. To guide the work, Commission sittings were held frequently. During the first few months, almost every week one sitting was held so that close attention could be paid at the Commission level to the work of collection and processing of data. Later on also, Commission made it a point to meet as frequently as possible. 1.3 The scope of the work undertaken by the Commission was quite extensive. In spite of the Commission's best efforts, the work could not be completed within one year. A short extension of two months and eleven days (till 30th November 2005) was sought. A copy of the notification authorising the extension is given as Annexure 1. 2 1.4 In all, the Commission held 42 sittings. Besides, a number of other meetings and discussions were held by the Commission to ensure that the work was taken forward at a fast pace. We are glad to record that we received co-operation from all departments, other organisations and officials. 1. 5 In chapter 2 and 3 of this report, we have given a narration of the work done for data collection, processing and analysis. In the normal course, these two chapters may not appear very essential in the report. But the Commission is particular about transparency in the work done. We feel that the public have a right to know, not only the views and recommendations of the Commission, but also how the Commission proceeded to formulate those views and recommendations.

1.6 When we started work, the total number of Local Self Governments in the State was 1215 (991 Grama Panchayats, 152 Block Panchayats, 14 District Panchayats, 53 Municipalities and 5 Corporations). Recently, Government formed eight more Grama Panchayats realigning some of the LSGs. Commission could not take this into consideration in formulating recommendations, particularly in fixing the amounts of devolution of share of taxes to each LSG. Government may make suitable reallocation of funds indicated in Appendix I, among the new Panchayats by corresponding adjustment from the erstwhile LSGs from which the new ones were carved out. 1. 7 A massive volume of data was collected and processed by the Commission. We have formulated our recommendations based on that study and interaction during meetings, discussions and correspondence. We feel that it will be appropriate it, after Government places the Action Taken Report in the State Legislative Assembly, the Commission report is discussed in council meetings of all the LSGs Feedback from such a discussion, both favourable and critical, will be of great value for the work of the next State Finance Commission. 1. 8 Just to give an idea about the dimension of the data processing work done, we are giving here a chart showing the progress of that work from a base of seven million numbers to a pinnacle of thirty numbers. The chart will be repeated later in chapter 12, with appropriate explanatory narration and supporting Tables.

STRUCTURE OF DATA COLLECTION, ANALYSIS AND COMPILATION WORK DONE BY THIRD STATE FINANCE COMMISSION GRANT TOTAL FUNDS (1 TABLE) (30 NUMBERS)

ADDITIONAL RESOURCES (7 TABLES) (210 NUMBERS)

OVERALL SUMMARY (1 TABLE) (102 NUMBERS)

SECTORAL SUMMARY RURAL AND URBAN (2 TABLES) 204 NUMBERS

GROUP SUMMARY (5 TABLES) 510 NUMBERS

FINANCIAL PROFILES (1215 TABLES) (ABOUT 1.25 LAKH NUMBERS)

MINI STATEMENTS (1215 X 3 TABLES) (ABOUR 6 LAKH NUMBERS)

PERFORMANCE and D.C.B (ABOUT 7 MILLION NUMBERS)

CHAPTER 2 COLLECTION AND PROCESSING OF DATA 2. 1 The terms of reference of the Third State Finance Commission cover a wide range of issues. They touch virtually all aspects of the financial management of local, selfgovernments. To do justice to such terms of reference, it was essential to prepare a solid and extensive database, process the data in a well focused manner, analyse the data deeply and diversely and draw logically sound inferences from that analysis. The Commission therefore gave serious attention to the matter of data collection, from the very beginning of its working. 2. 2 The data collected and presented by the two previous Commissions were found to be quite helpful in determining the direction of data collection by this Commission. Instructions were given to the Commission Secretariat to immediately take up the work of updating the Tables and charts prepared by the two Commissions. Some data collection had been done by the State Finance Cell of the Finance Department of the State Government. This was also looked into by the Commission. 2.3 Having thus initiated the work of data collection, the Commission turned its attention to see what new initiative is required in this matter. That search led the Commission to a new area, which could, if successfully handled, make the Commission's recommendations to be of a pioneering nature. A good part of the time and energy of this Commission was spent on this new initiative. In retrospect, the Commission feels an enormous degree of satisfaction that we embarked on this massive data hunt which gave rare insight into what has been happening at the grassroot level of financial management of local self governments. This work took the Commission through a massive web of intricate and interrelated financial transactions - big, small and medium. We let ourselves be led entirely by the logic and inferences which emerged from the data - totally uninhibited by earlier impressions or commonly held notions. And we walked into the bright light of a new awareness of local self-government finances. Here we arc recording briefly the trail of that data expedition. Its contents and revelations, we will narrate later.

2. 4 Article 243 (I) and 243 (Y) of the Constitution direct State Finance Commissions to "review the financial position" of the Panchayats and Municipalities and then make their recommendations. There are different ways to carry out this mandate. Usually the financial position of LSGs is put within the normal framework of budgeting and accounting and on that basis, an overall assessment is made. While this may be a technically correct accounting way of assessing their finances, it might leave out the soul of the massive changes that took place in the very concept of LSGs' functioning which, in turn, reflect in their financial transactions. In order to avoid such a 'fatal flaw' in reviewing LSG finances, the Commission decided to look into the history of those changes and follow them in respect of each one of the LSGs, with a data design capable of capturing the nuances of that process of transformation. Hence the Commission decided to collect financial data in three parts, reflecting the three major stages in that transformation. LSGs before the 73rd and 74th Constitutional amendments LSGs during and after substantial shift of services and institutions that took place in accordance with Article 243 (G) and 243 (W). LSGs as instruments of economic development resulting from Kerala's widely acclaimed experiment of decentralised planning. 2. 5 The next step was to decide how the information format should be prepared. After considerable deliberation, Commission decided to follow a simple format. We had more than one reason to do this. First of all we wanted to move away from the notion that work of the type done by Finance Commission should impress everyone as highly technical and resoundingly erudite. Secondly, we wanted to arrive at a financial assessment about each of the three stages mentioned above. Thirdly we wanted to initiate a process by which LSGs and their staff would familiarise themselves to a system which would help them in making a self assessment of the extent and quality of service they render to people in the three areas traditional functions of a civic body, delegated authority and responsibility of the State Government and their role as instruments of economic growth. Keeping these aspects in view, we prepared five proformae. The numbers to be entered in them were only of two type

receipts and expenditure. No adjustments, share debits, capital revenue distinction, notional credits or debits - none of the complexities of budgeting and accounting presentation - only simple numbers of inflow and outflow of funds. The five proformae are listed below: 1. Proforma 1: - Receipts and Expenditure of Local Self Governments - Abstract ii. Proforma 2: - Statement showing Receipts under own funds, Expenditure for Traditional Functions met from own funds and projections iii. Proforma 3: - Statement showing Receipt and Expenditure under transferred functions/Assets and Projections iv. Proforma 4: - Statement showing Receipts, Expenditure and Projections under Plan Schemes v. Proforma 5: - Statement showing details of Receipts and Expenditure under Eleventh Finance Commission Award. Along with the proformae, a set of guidelines was also prepared in order to help the LSG staff fill them. 2. 6 Here the Commission would like to record the help received from sources outside the Commission, in finalising the proformae.

We contacted some of the officials who have

had long association with LSG administration as well as the developments since the Constitutional amendment of 1992. A list of the officials is given as Annexure 2. 1 2. 7 The next area of concern was how to reach out to all the one thousand two hundred and fifteen LSGs and ensure timely return of the proformae duly filled in. Here the Departments of Panchayats, Municipalities and Rural Development helped the Commission. At Commission's request, they appointed nodal officers in all districts who would co-ordinate the work of data collection and give guidance to the staff actually handling the work.

A list of the nodal officers is at Annexure 2. 2 In addition, we sent around the staff members of the Commission Secretariat to different districts. This was done with a view to seeing that even at the initial stage of filling the proformae, clarifications could be given to the extent necessary and feasible. Commission felt that such an arrangement would reduce the quantum of corrections to be attempted after the Commission Secretariat received the filled in proformae. All this was followed up with regular enquiries about the progress of work over phone. 2. 8 At this stage, the Commission felt the need for opening up another channel of data flow. When the proformae are received back, the data in them would have to be assessed. This would require information on various aspects. Following the pattern adopted by Central Finance Commissions, we evolved the concept of 'Subsidiary Points'. Each of these points would yield basic data about the important items included in the proformae. For instance, the format for such basic data on Property Tax / Building Tax would seek information on the demand for each year, arrears outstanding, collection each year against current demand and arrears etc. It would also seek information on the number of licenses given, area for which licenses were given etc. 2. 9 To expedite the work and ensure its quality, the Commission had a meeting with all the nodal officers. This was held on 10 - 02 - 2005. It helped both sides to clarify any doubts that remained. Specific time limits were also fixed for receipt of data - particularly the five proforame. These were again followed up by the Commission Secretariat, contacting nodal officers and others over phone. 2. 10 The work entrusted with LSG staff in this context was of a different type from what they had been used to on similar occasions in the past. Commission would like to record here that the majority of LSGs and their staff rose to the occasion and made diligent attempt to give the data in time. In spite of this and in spite of the instructions and guidelines given by the district level officers of the departments of Panchayat, Municipality and Rural Development, Commission Secretariat found that many of the proformae received back required further checking. This problem was handled in two ways. Firstly, the method of getting the defects rectified by contacting the concerned functionaries in LSG was tried.

This yielded good results. Secondly an exercise was undertaken to consolidate the main two proformae, proformae 2 and 3 into simple statements. This was done using the computer facility available in the Commission Secretariat. 2. 11 The choice of only two proformae - Proforma 2 an 3 - for this exercise was decided on by the Commission after serious consideration. The main reason which weighed with the Commission was that these two proformae represented the areas of activity which could be assessed by the Commission with the help of information on subsidiary points sought from LSGs. It was also clear that these two proformae related to financial transactions which are more relevant to the work of the Finance Commission. Proforma 2 related to the receipts and expenditure in relation to the traditional functions LSGs were carrying out even before the Constitutional amendment of 1992. It was to meet the liability on these functions that the LSGs have been receiving shares as well as assignment of State taxes. The Second State Finance Commission had brought in a fundamental change by introducing the concept of a fixed share of state taxes for non plan non-maintenance expenditure. This type of expenditure was reflected in proforma 2. So its detailed study is essential for the work of the Third State Finance Commission. Similarly proforma 3 related to the work on maintenance of transferred assets as well as disbursement of welfare pensions. In respect of maintenance, Second State Finance Commission had introduced a new concept of a share in state taxes, 5.5 %. So here also a study by Third State Finance Commission is essential. It was against this background that the Commission decided to propose computerised mini statements based on these two proformae and study them in detail in consultation with LSG officials and officers of the Panchayat, Municipality and Rural Development Departments. A major role in this context is discharged by the line Departments which have transferred institutions and responsibilities to LSGs. So their views were also sought about the work done for maintenance of these institutions. 2. 12 At this stage the Commission considered what processing should be done regarding proforma 4 on Plan expenditure. Obviously developmental expenditure is an item of great importance in the new role acquired by LSGs. In fact that is the area where Kerala has already been recognised as a pioneer state in the context of decentralised planning. However, the expertise available to a Finance commission is not adequate to judge the quality of performance

in this vital area. Nor would the time required for a serious study of this major aspect be available to a Finance Commission with a specified tenure. Apart from all this, the Commission noted that the work of decentralised planning is being guided and monitored by a permanent body eminently competent to do that work, the State Planning Board. Keeping these aspects in view, Commission decided that, as far as proforma 4 is concerned, our work will be confined to an assessment of the financial data. For this purpose, mini statements were prepared on proforma 4 also. 2. 13 When the computerised mini statements based on proformae 2 and 3 were ready, Commission noticed a number of issues that had to be clarified. In some cases, the numbers given by LSGs were obviously wrong. In some other cases, they might not be wrong, but showed some surprising element, which needed clarification. In yet other cases, the data showed up disappointing performance in crucial sectors like civic services or timely utilisation of funds given by Government. This necessitated a third round of consultation. There was no time to seek correction/clarification from the field by correspondence nor was it feasible to send our staff to various districts and get the corrections in time for the Commission to initiate the work of drawing inferences. In view of these difficulties, Commission decided on a new and different approach.

2. 14 The Commission, after preliminary study of the consolidated Tables on proformae 2 and 3 prepared a list of commonly noticed defects. A few specific cases of LSGs which had given proformae containing these defects were also taken out. Meetings were held in different places covering one or more districts. The Secretaries of all LSGs were invited to these meetings. Officers of the Departments of Panchayat, Municipality and Rural Development were also invited. Using visual projection with slides, each main defect was explained to the officials. Then it was explained to them how each of these would affect the projections to be made by the Commission. Based on these, LSG officers were requested to give their views, on the spot, to the extent possible. Then they were requested to go back to their offices, check the data given by them with reference to the points made in the meetings and send in corrections and clarifications within a period of fifteen days. In view of the importance of these meetings, each meeting was attended by at least one Member of the Commission. This helped the Commission to a great extent. The dates and other particulars of the meetings are in Annexure 2. 3

2. 15 Before winding up the work of collection of data, Commission took up one more exercise to clean up the data with particular reference to Corporations and Municipalities. Substantial part of the financial transactions of the LSGs takes place in Corporations and Municipalities. Each Corporation and Municipality was requested to send their officers to meet the Commission Secretary. A detailed discussion of the remaining points of doubts was held in these meetings. Dates and other particulars of those discussions are given in Annexure 2. 4 2.16 Commission Secretary had to hold one more discussion with the officials of Corporations and some of the Municipalities. Those discussions helped in clearing up some doubts that remained, in regard to the data given by those LSGs. 2. 17 In the matter of data collection and processing Finance Commissions do come across certain difficulties in respect of accuracy and clarity. Because of the initiative taken by this commission, as stated earlier, to assess the financial position of each LSG, the limitations faced by this Commission were more challenging. The sheer volume of data was itself a major challenge. The sources of data, 1215 LSGs, were not familiar with supply of such detailed data. The total time available for collection and processing of data was relatively short. However the close attention paid by the Commission at every stage and the strenuous work done by the Commission secretariat made it possible to overcome these limitations, to a very large extent. If any deficiency still remains, that will be insignificant and will not, in our judgement, affect the validity of inferences drawn from the data.

CHAPTER 3 ANALYSIS OF DATA 3. 1 As the type of data and the format were different from those handled on similar occasions in the past, it was to be expected that analysis of the data would pose some difficulties. The large number of LSGs also adds to this difficulty. Commission however made an earnest effort to analyse the available data, within these limitations. In some respects, drawal of reasonable inferences was not possible in view of the infirmities in the data. In other respects we could make robust analysis and draw useful and relevant inferences. 3. 2 In proforma 1, we faced the first real difficulty. In drawing up that proforma, Commission had aimed at assessing the liquidity position of LSGs, apart from their financial position. These are two different things, though people tend to confuse between the two while discussing government finances. In the ideal situation, the opening balance, enhanced or depleted by the net result of the particular year's transactions, should reflect in the closing balance. And it goes without saying that such closing balance of a particular year should be the opening balance of the next year. In many of the proformae, when we received them back, both these principles - particularly the latter- were not observed. In the case of some local bodies, these were observed. To correct the former group of proformae, very extensive research would be necessary. This was particularly difficult as the dimensions of the funds handled by LSGs increased greatly during their transformation from local bodies mostly handling civic functions into agencies and instruments of economic growth in the framework of planning. The time and manpower necessary for such research were not available to this Commission. Moreover, in this context, one has to be charitable in judging LSGs' efficiency as, even the State Government budgets show substantial variation between account balances as per Accountant General's figures and balances as per Reserve Bank of India figures. Keeping all relevant aspects in view, the Commission decided to limit its study to the financial position arising from the transactions for each year on the items included in the proformae.

3. 3 The second major difficulty we faced was about the numbers relating to estimates for 2004-05. Commission would have liked to make that the base year for making projections, as it is the year immediately preceding the year during which our report had to be submitted. As we had initiated data collection in October/November 2004, only budget estimates of that year were available. So we had added another column - Latest Estimates (L.E) - in the proformae. 3. 4 When the proformae were received back, Commission found that in a very large number of cases, budget estimates and latest estimates were vastly different. During our process of seeking clarifications, we found that, in some cases it happened because the LSG staff got the meaning of the term 'L.E' wrong and entered figures (of receipt or expenditure) up to that stage in the financial year. But in the majority of such cases the problem was more basic and rather disturbing. During free exchange of views, LSG staff admitted that budget estimates were often prepared unrealistically. One reason was that, statutorily, a certain surplus had to be shown in the budget. More importantly, unrealistic provisions for expenditure and corresponding levels of receipts (which would apparently justify such provisions) were made at the stage of budget formulation. By the time actuals are available, few people notice the vast differences and almost none would care. At that time, attention would be on that year's budget provision and the issues related to it. In this respect also, one cannot be too critical of LSGs as, lack of realism in budget formulation is, though in varying degrees, a common malady in management of public finances at all levels of governance in this country. A few examples of the huge variation between B.E and L.E 2004-05, as given by LSGs, are given at Annexure 3. 1 Here we hasten to add that, in this and subsequent instances where we give such lists; they are only illustrative, not exhaustive. Only some cases are shown and proformae of those LSGs are not in isolation in that particular defect - many others contain the same defects. In some cases, the defect was either properly explained or corrected after district level discussions. 3. 5 Having thus found difficulties in taking 2004-05 figures as the base, the quality of numbers regarding actuals of the earlier three years (2001-02, 2002-03, 2003-04) was examined. In many instances, actuals showed vast fluctuations. Though actuals normally

follow a trend, it is not uncommon that in some years, certain factors special to those years influence and distort that trend. However, a fluctuation of the order noticed is a good number of proformae received from LSGs are uncommon. During the process of meetings and other consultation narrated earlier, Commission could get clarification in some cases and corrections in other cases. However, the fluctuations that remained even after that were of a substantial degree. This would make reliance on any particular year's actuals as the base rather unwise. A few examples of the vast fluctuations are given at Annexure 3. 2 3. 6 Both in Proforma 2 and Proforma 3, LSGs had been asked to give projections for the years ending with 2010-11. In many cases these projections were not consistent with the latest estimates of 2004-05. In some of those cases, the projections were found to be consistent with the actuals of 2003-04, assuming a reasonable rate of growth for 2004-05 and 2005-06. The guidelines for making projections had been indicated in the set of instructions sent to the LSGs along with the proformae. While some LSGs had obviously followed that, many had not. The Commission's idea was to get projections which would strike a reasonable balance between a sense of realism and an awareness of the need for financial prudence. Commission did not want figures of receipts unrealistic ally exaggerated or figures of expenditure unduly depressed. Equally unacceptable is the other extreme of projecting numbers without any concern for the need to improve receipts and reduce avoidable expenditure. 3. 7 Apart from the above-mentioned general aspects, there were problems about specific items. Property Tax is the single biggest item of LSGs1 own revenue receipts. The proforma had asked for information on property tax and service tax separately. There were also different columns for the two. But in many (or most) cases, the numbers given as property tax included service tax. In spite of this, service tax numbers had been given in the respective columns also. Obviously this would mean double counting. During consultations, Commission Secretariat tried its best to ascertain what exactly is the position in each of the LSGs. To a great extent they succeeded. 3. 8 Another difficulty in respect of property tax was the glaring inconsistency between the figures given in Proforma 2 and the data given in the DCB statement on property

tax. DCB statement had split demand and collection into two sections - one against current demand and the other against arrears. Then the total collection also had to be given. In some cases, the total collection figures did not tally with the figures given in proforma 2. The substantial fluctuation in actuals of 2001-02,02-03 and 03-04 also indicated poor alignment with DCB data. Which was more reliable in respect of each such LSG, was an issue which the Commission Secretariat could not resolve entirely, in spite of their best efforts. 3. 9 Data regarding two major tax items - property tax and profession tax - given by LSGs generally showed poor performance compared to demand. This was rather difficult to understand as in respect of both these taxes, there is little justification for not collecting the demand. In respect of non-tax revenue, the genera! position showed rather poor performance in most of the LSGs. We will revert to these aspects later. 3. 10 The figures regarding expenditure also contained some points of doubt. In many cases, expenses under ' management and collection' showed steep increase. To some extent, this is understandable and is a common phenomenon of Government expenditure at all levels of governance. What was of particular concern here was that, at least in some cases, 'management and collection' was the only item in proforma 2 which showed such steep increase. This made the Commission look into the expenditure on civic services rather closely. 3. 11

Here the term 'civic services' is being used to cover the following items of

expenditure. Water supply Public Health Street Lighting Drainage Public Works 3.12 It is obvious that the basic need and justification for the existence of a local self government is its role in ensuring satisfactory service to the public in these areas of activity.

In LSG administration these civic services are as basic as maintenance of law and order is in the case of the State Government. Any degree of diligence in other areas of activity even the crucial area of economic development - cannot be an acceptable alibi for poor delivery of civic services. Meticulous and committed application of time, money and energy of the LSG in these services may not receive high publicity and fanfare like the inauguration of a new project or building as part of plan activity. But that does not mean that these civic services should be of lesser concern. 3. 13 Proforma 3 also posed some difficulties. Non-Plan expenditure on services and institutions transferred by State Government to LSGs figured in the proforma. In many cases, expenditure in vital areas was found to be poor. Unfortunately, there is a general impression that non-plan expenditure is something to be constantly reduced. This is a wrong impression though it might have resulted from the well-intended desire to increase availability of funds for plan investment. Non-plan expenditure need not, and should not, be seen as the enemy of plan expenditure. This is particularly so in the case of LSGs as institutions and services so relevant to the common man's life have to be maintained at a reasonable level by well-applied funds of adequate quantum. 3. 14 Figures of maintenance expenditure showed a peculiar phenomenon. Generally speaking, they showed a reasonable trend during 2001-02,02-03 and 03-04. The order of expenditure was not very high though, by then, State Government had transferred many institutions and services. The grants received from State Government were also not very high, though there are cases where 'maintenance expenditure' fell short of the funds available even during that period. In 2004-05, this difference between funds received and funds spent on maintenance increased sharply. The obvious reason was that Government had accepted the recommendations of the Second Finance Commission to allocate 5.5 % of State's own tax receipts to LSGs for maintenance work. The resultant steep increase in availability of funds could not be matched by increase in expenditure. This is perhaps understandable as, in an item like this, some time will be taken in gearing up the machinery in order to utilise a rather sudden increase in fund availability. A few examples of the variation between fund availability and its use for maintenance are at Annexure 3. 3

3. 15 Before concluding the analysis of data, we have to refer to one more aspect, rather distressing to the Commission. The reference is to the figures regarding welfare pensions. These pensions constitute a source of sustenance for the weakest members of our society. Owing to ways and means difficulties of the State Government, release of funds for some of these pensions has been in arrears. This would make one expect that as soon as funds are allocated by Government, LSGs would hasten to pass these on to the beneficiaries who are, obviously, desperately waiting for that. But the data we received in proforma 3 tell a different story. In many cases, there are wide gaps between funds received by LSGs from Government and funds disbursed as welfare pensions. In some cases, the shortfall persists even if the totals of three years (2001-02,02-03,03-04) are taken. In some others, in some years disbursement is higher than receipts and in some other years less than receipts. A few examples are given in Annexure 3. 4 During discussions, Commission tried to understand the causes and implications of this phenomenon. Though we are not sure that we have understood them completely, we have some idea and what we learnt is a matter of concern. We will revert to this important issue later in this report, when we come to our approach and specific recommendations. 3. 16 In spite of the infirmities mentioned above. Commission is broadly satisfied about the response from LSGs in regard to data. What was attempted was not only new but also extensive in nature. Time given was short. The staff in LSGs are almost constantly busy; and many offices are undermanned. In such a situation, what Commission has received should be judged as positive response from LSGs.

CHAPTER 4 FORECAST OF RECEIPTS AND EXPENDITURE OF LOCAL SELF GOVERNMENTS FOR THE PERIOD 2006-07 TO 2010-11 4. 1 As narrated in the previous two chapters, the data collected from LSGs covered a period of ten years.- Out of this, half covers the five-year period which will be the period for implementation of our recommendations. This is the period between 1-4-2006 to 31-32011. The main objective of collecting data for the earlier five years - from 1-4-2001 to 313-2006 was to get a reliable base for making a reasonable projection of the various items of receipts and expenditure of LSGs for the period to be covered by the Commission's recommendations. In the ideal situation, projection of receipts and expenditure should be based on norms evolved independent of past performance, modulated to the extent necessary based on past experience and finalised as a set of projections which strike the golden mean between realism and financial prudence. This would however require detailed technical studies of various items of receipts and expenditure based on which norms could be evolved. The time and effort required for that were beyond the scope of this Commission's tenure and staff strength. In any case, as an exercise of a pioneering nature, a beginning towards the reassessment of major items of receipts and expenditure based on past figures - appropriately adjusted for accomplishment of well-known objectives - would by itself, be a significant step forward. This is what the Commission attempted. 4. 2 For this exercise, the first step was to identify the items to be projected individually and the remaining ones where items could be clubbed together. Commission evolved the following list of items accordingly. Receipt Property / Building tax Profession tax Entertainment tax Other taxes Non-tax revenues

Additional mobilisation of resources Expenditure Management and collection Civic Services

Other expenditure Expenditure on development and expansion of services and institutions Repayment of debt Maintenance Expenditure Expenditure on Welfare Pensions 4. 3 The single biggest item of revenue of LSGs is property/building tax. Actuals for three years, 2001-04, budget estimates and latest estimates for 2004-05 and projections for 2005-06 as given by LSGs were studied along with Demand Collection Balance (DCB) and other details given by them. In this item of revenue, in its very nature, collection should be very close to demand. But the actual position is, sadly, very different. Substantial arrears have accumulated over the years. We obtained figures of collection against current demand, and collection against arrears separately. This was to get an idea how much of a particular year's demand is collected the same year. Based on averages of three years, only 70 GPs collected 90 % (or above) of current demand. Only 163 GPs collected above 80 % and below 90 %. Collection between 70 % and 80 % was achieved by 243 GPs. Position in Corporations and Municipalities is not particularly better.

4. 4 Against this background Commission gave serious thought to the manner in which projection should be made. Once an assessment is made and legal objections, if any, are settled, there is no justification for collection below demand. In this view, collection should be 100 % or very near 100 % of demand. However, taking note of the past we decided to take 90 % of the demand of 2004-05, as given by each LSG, as the base. This was projected to grow by 10 % per annum from 2005-06 onwards to 2010-11. To this was added, each year from 2005-06, an amount equal to one by six (1/6) of the arrears outstanding in 2004-05. The assumption is that the arrears as in 2004-05 will be cleared in six years, of

which five years (2006-07 to 2010-11) will be years covered by the Commission's recommendations. 4. 5 In the case of profession tax, we assumed collection equal to demand. However arrears have piled up. Some of the reasons for such arrear accumulation may be beyond the control of LSGs; but most are within their control. A system of preparing DCB statements, spotting of default, action to ensure collection etc. are woefully lacking in many LSGs. Collection of arrears is not very easy in this tax. Further in cases where the institution concerned has stopped functioning it will be virtually impossible to collect arrears. Keeping these practical aspects in view, we have assumed collection of only half of the arrears as in 2004-05 during the six year period from 2005-06 onwards. With 10 % annual progression, figures for the five year period covered by the Commission recommendations (2006-11) have been fixed. 4. 6 In the case of entertainment tax there is a special problem. Owing to some Government decisions and other factors like development of television etc. the trend of actual collection in this item has been quite erratic. Therefore it will not be reasonable to take any one year's collection as the base year number. So we worked out the average collection of three years, 2001-02, 2002-03, 2003-04 as the base and attributed that average number to the middle year ie 2002-03. To this, annual progression of only 5 % was added to arrive at the projections. We have been somewhat extra liberal in reassessing this item of revenue as we find that in this item, LSGs are really the victims of certain aspects of Government policy. 4. 7 In proforma 2, there was a separate column for collection of service tax, which is levied as a percentage of property tax. Instructions had been given that this column should be filled separately so that performance in collecting service tax could be specifically assessed and a forecast made. But most of the LSGs, while giving the figures of service tax collection in the appropriate column, have also included that in the figures regarding property tax. Because of this, if we project service tax revenue in such cases, there will be double counting of that much revenue. In order to avoid this, we have omitted service tax from separate projections. Property tax has been projected, including service tax. While on this item, Commission has to refer to a disturbing fact. Many LSGs do not seem to be collecting any

service tax at all.

There is no justification for not collecting service tax after rendering

service, as LSGs cannot afford to lose revenue which is statutorily their right to collect. If however, no service tax is collected because those services are not rendered in those LSGs, that is even more disturbing. Providing such services is an essential function of a civic body and laxity on this account should be avoided. 4. 8 The next item is 'other own taxes'. Here average of actual collection for three years, 2001-02, 2002-03, 2003-04, was taken and fixed as the deemed collection of the middle year, 2002-03. On this number annual growth of 10 % was assumed and accordingly, the projections for 2006 to 2011 were fixed. 4. 9 All the items of non-tax revenue were taken together. In fact this is an area where there is considerable scope for improvement. We will revert to that aspect while dealing with the general issue of improving the resources of LSGs for purposes of reassessment in the present context. For the purpose of making projections for 2006 to 2011, we took as base the average of actual collections of 2001-02, 2002-03 and 2003-04. That number was assumed on the collection for 2002-03. To this annual progression of 10 % was applied for fixing the projection for each of the five years from 2006-07 to 2010-11. 4. 10 In the case of expenditure, management and collection was taken as one item as this seems to be an item of consistently heavy expenditure. Average actual expenditure of three years 2001 to 2004 was taken as the deemed expenditure of 2002-03. With 10 % progression it was projected up to 2010-11. 4. 11 Civic services expenditure is obviously the most important item in the traditional items of expenditure of a civic body. In many LSGs, the expenditure on Public Health, Water supply, Drainage, Lighting and Public Works is quite low. (There are, however, instances where some LSGs have included plan expenditure also under some of these items, particularly public works. We have tried to spot such cases and correct them to the extent possible). Poor expenditure in traditional civic functions, which were being attended to by LSGs even before the Constitutional amendment is a disturbing feature. It has to be corrected. A modest element of such a correction is built into the projections under this

item. The base year is fixed as 2002-03 and the deemed expenditure of that year is taken as the average of actuals of three years 2001-04. Usual annual progression of 10 % is given at the fist stage. Then a further step up of 20 % each year is given on the numbers so arrived. This is to indicate the need for giving better attention to this area. 4. 12 The issue of debt and its servicing has assumed serious dimensions. In our terms of reference, there is a specific item about the borrowing potential and programme of LSGs. We will deal with that separately. In the present context of making projections of repayment requirements for the period between 2006 and 2011, we faced special problems. The actuals often showed erratic trends. During discussions and consultations we found that this was because there is no well laid out scheme of repayment. Repayment is done on a purely adhoc basis by many LSGs. When they have some funds or when Government allows some diversion of other funds for this purpose, some repayment is made. How much arrears are building up, how long it will take to clear these etc. are not known even to the LSG staff. In projections, some LSGs have shown sharp increase on the plea of increasing its borrowing programme for development purposes. This is not backed up with specific data. In any case, fresh borrowing cannot significantly add to the repayment liability of the immediate future, though there will certainly be some increase. Keeping all this in view, for the purpose of making projections for 2006 to 2011, we took as base the average of actual repayment of 2001-02, 2002-03 and 2003-04. That number was assumed to be the figure for 2002-03. To this annual progression of 10 % was applied for fixing the projection for each of the five year from 2006-07 to 2010-11. However if the projection made by the LSG concerned is less than the amount derived as above, we have gone by the projection made by the LSG concerned. 4. 13 Earlier in the report, we have mentioned briefly about our limited approach to the issue of plan expenditure. As stated there, we are dealing only with the financial aspect of plan. But we are well aware of the importance of this item, particularly in the Kerala context of decentralised planning. This is reflected in our projections also. Actual expenditure of 2003-04, the last year for which actuals were available in the data given by LSGs, is taken as the base. We have used that year's expenditure as the base but with one modification. The general experience of the years after the advent of decentralised planning is that the State Government's resources difficulties as well as ways and means problems resulted in two types

of adverse impact. Whenever it was found that the financial resources estimated while finalising the State's Annual Plan were not actually available, cuts were made in State Plan outlay and such cuts applied to the provision for LSGs also. Apart from this, State Government's ways and means difficulties caused by mismatch of inward and outward flow of funds resulted in a situation where actual disbursements were delayed or staggered. This sometimes led to late or last minute receipt of plan funds by LSGs resulting in poor plan expenditure. To take care of this aspect, we have built in a step up of 15 % in the base year figure and then made the forecast at an annual growth rate of 10 %. 4. 14 Expenditure on maintenance is a major item, particularly after the transfer of a large volume of assets to LSGs. As mentioned earlier, Commission found it difficult to make a reasonable projection of this item of expenditure for the five-year period 2006 to 2011. The main reason is the drastic change in the position of funds availability for this item. Earlier, Government used to give some maintenance grant. With the approval of the recommendations of the Second State Finance Commission, the size of available funds increased substantially. The first year during which such funds were made available was 2004-05. Data collected by the Commission showed that the expenditure in 2004-05 would be far below the level of funds allotted by Government. Various reasons are cited for this shortfall. In an item like maintenance, it is not possible to use substantially higher funds received without reasonable advance information. Works have to be identified, estimates have to be prepared, tenders invited examined and work order given before starting a work. Even then expenditure (except some advances) will not be possible. Execution of works has to take place before regular payment is made. All this takes time. Another reason pointed out in discussions with LSG staff is the delayed release of funds by Government. Many LSGs pointed out that funds were made available near the close of the financial year. To some extent this also was a reason. The third reason attributed to the shortfall is the introduction of bill system for drawing funds from the treasury. 4. 15 In the first year of the new dispensation under the Second State Finance Commission scheme, it is therefore understandable that LSGs could not spend substantial part of the allotment of 5.5 % of State's own tax revenue for this purpose. Ironically, while this increase in funds allotment for maintaining assets was being made, Government allowed

Public Works Department to resume authority over some of the roads, thereby taking up the responsibility for their maintenance. A peculiar situation has developed in this context. We will deal with that later in the report. 4. 16 What is important in the immediate context of this chapter is the difficulty in making projections for this item of expenditure. While the actuals up to 2003-04 reflect the position before 5.5 % was allotted, the figures of 2004-05 reflect the shortfall of expenditure caused by the different reasons explained above. Making projections for 2006-11 on the basis of such actuals will not be reasonable. 4. 17 Examples of the position of receipts and expenditure under this item for 200102,2002-03,2003-04 and 2004-05 (Latest Estimates given by LSGs in the Second half of 200405) may be seen at Annexure 4. 1

4. 18 One of the most important activities of the Government transferred to LSGs is the disbursement of welfare pensions. The Commission found that the financial data regarding this item of work brought out a baffling aspect. Mention of this has been made earlier in the report. Many LSGs do not seem to have spent the funds they receive from Government. In some cases there is underspending in one year and overspending another year. In some cases, there is underspending even if two or three years' position is taken together. All this in conflict with the common man's impression how the scheme of welfare pensions works. Owing to both resources and liquidity problems faced by State Government, these pension have been disbursed in a few instalments together, at short or long intervals. Beneficiaries who belong to the weakest sections of society are anxiously waiting for this money. The authority to whom the funds are given for disbursement is the LSG which is the Government institution closest to that weak section of society. So one would assume that funds released by Government would get disbursed in no time. This, obviously, has not been happening.

4. 19 There are different explanations for this; all or most of them are partly true. First of all, the staff position in LSGs. It is true that staff required for the work of pensions disbursement has not been fully or even substantially transferred to LSGs. Then there is the issue of treasury restrictions that come in the way of actual drawal of funds. Thirdly, instalments received close to the end of the financial year often lapse. Finally there is the common complaint regarding bill system. 4. 20 Whatever or whoever is at fault, this is an area which need immediate correction. In any case, it is not possible to make any projection in this regard, nor is it necessary for assessing the financial position of LSG for the five-year period 2006-07 to 2010-11. As in the case of maintenance expenditure, in this item also, Commission has to proceed on the basis that funds released by Government will be fully spent, effectively spent and spent without delay or causing any lapse of appropriation. Later in the report we will be dealing with this issue. 4.21 Commission had entrusted a study to the University of Kerala. The study was intended to cover certain major aspects in the services rendered by the LSGs, particularly maintenance, civic services expenditure and welfare pensions. We have received the report covering these areas and also making some observations regarding certain other areas also. Data and inferences in the report regarding areas relevant to our work have been used as inputs in our report. We should however make it clear that the views given in the university report are not necessarily endorsed by this Commission. As stated above we have used them as inputs but come to our own inferences taking all relevant factors into account. We are grateful to the University and their Department of Economics for the work done in making the study. Their report will be made available to the Government for any future reference required. 4. 22 For completing the work of projecting the financial position of LSGs during the five-year period 2006 to 2011, an assessment of the yield from additional resources mobilisation had to be done. Later in the report, ARM needs and potential will be dealt with in response to the specific mention in our terms of reference. For the immediate purpose of projections, the method adopted is given here. In the case of Property tax, an amount equal to

15 % of the amounts projected for each year is taken as the minimum possible additional resources mobilisation. The revision of Property tax consequent on the introduction of the new system of taxation based on plinth area and other relevant factors should bring in at least 15 % increase in collection. In addition to this item 10 % of the projections of nonlax revenue is also taken as minimum additional resources in drawing up the forecast of LSGs' financial position. The amount adding those two items (Property/Building tax and non tax revenue) together is taken as the projection of ARM for each of the five years 2006 to 2011. 4. 23 Block Panchayats (the intermediate level) and District Panchayats (the top level) in the LSG structure have no powers of taxation. They depend on devolution for their functions, These two levels have a small amount of non-tax collection and this has been taken into account. For the purpose of projection of receipts and expenditure we have applied the same norms and parameters us applied to other LSGs. 4. 24 The work of forecasting has been done applying some norms and also based on actual numbers of the past. (It may be noted here that even Central Finance Commissions, after evolving scientific norms, do rely substantially on actuals of the third of year of the previous Finance Commission award period). On some norms that are applied, in certain cases our estimation of receipts was less than the concerned LSG's own projections. In some other cases our projection of expenditure is more than their projections. While applying some principles, there is no escape from the logical and arithmetical results of those norms.

CHAPTER 5 OUR APPROACH 5. 1 In formulating our approach, we have kept in view the background against which this Commission has been constituted. The process of decentralisation has taken rapid snides forward, bringing out both its strong points and shades of weakness. The role of LSGs has increased dramatically during this period. Their presence in the vital area of economic planning has come to stay. The First State Finance Commission and the Second State Finance Commission did pioneering work seeking to establish a system of smooth and regular flow of funds to LSGs. The Second Commission's main recommendations have been in operation from the year 2004-05 onwards. 5. 2 During this period of fast expansion of the role of LSGs, both acclaim and criticism cropped up. There have been intense discussions both at the political and administrative levels. Systemic reforms have been attempted. Some have succeeded; some did not yield the expected results. Quite a lot of fault-finding has taken place. In response a lot of explanations arid alibis have also been aired. The common man seems to be a little confused in this jumble of voices, even while he accepts that overall, what has happened is certainly in public interest. 5. 3 To define our approach against this background, we felt we should listen to the voice of democracy, the guiding ethos of the change. So we decided to interact with the Chairpersons of the LSGs. Commission had enlightening discussions with representatives of the Chairpersons of all the five levels of Local Self Government as indicated in Annexure 5. 1. 5. 4 In the earlier chapters, we have referred to the discussions held with officials. On major issues we wanted to get the views of experts also. So Commission conducted a workshop attended by eminent economists who have specilised in public finance. Annexure 5. 2 gives a list of the participants.

5. 5 The most important work to be done by the Commission is the formulation of a scheme of devolution of taxes. Technically, a Finance Commission can bring in an entirely new scheme of devolution. In fact, the Second State Finance Commission did recommend such a change. They brought in the concept of a fixed percentages of State Taxes to be given as share of LSGs for general purposes and maintenance expenditure. They also recommended that statutory action should be taken to perpetuate the policy decision taken earlier by State Government that a fixed percentage of the State Plan outlay would also be given to LSGs. In theory the Third Commission could review all this. But our approach is that there is no sense in making changes merely for the sake of change. An existing system should be judged objectively before seeking to change it and bring in a new system. The Second Commission's initiative in fixing a percentage (3.5 %) of State Taxes as LSG share for meeting general purpose expenditure and another percentage (5.5 %) for meeting maintenance expenditure has been generally appreciated. It is easier to administer than the system of sharing of individual taxes. It is also consistent with the scheme now in vogue for devolution of Central tax shares to States. To change this new scheme (which has been in operation for only two years) and go back to sharing of individual taxes does not seem necessary or appropriate. 5. 6 At the same time, we do not wish to turn away from some modification to the scheme brought in by the Second Commission. Here the only consideration is improvement of the system, not its abandonment. Hence the Commission decided that our approach to devolution should be to keep the essence of the Second Commission's recommendations (approved by Government) regarding general purposes and maintenance grants but to consider whether any modifications are warranted in order to further improve on the scheme of devolution put in place in 2004-05. Similar would be our approach regarding development expenditure also. 5. 7 Having made this decision, we wanted to consider what kind of study is required to assess whether, and if so what, modifications are required in the scheme of devolution is vogue from 2004-05. In that context, we identified our important area where pioneering work was yet to be done. This is the work of assessing the financial position of each LSG. Articles 243 (I) and 243 (Y) clearly mention the review of the financial position of Panchayats and

Municipalities. Further, such a review will help the State Government to present before the I Central Finance Commission, the requirement of Central funds to strengthen the finances of LSG's. That would be helptul in seeking adequate additional devolution under| Article 280 (3) (bb). In this context it will be relent to recall the view of the Twelfth Central Finance Commission. Para 8.30 of their report is reproduced below. "If the SFCs follow the procedure adopted by the central finance commission for transfer of resources from the center to the states, their reports would contain an estimation and analysis of the finances of the state government as well as the local bodies at the pre and post transfer stages along with a quantification of the revenues that could be generated additionally by the local bodies by adopting the measures recommended therein. The gaps that may still remain would then constitute the basis for the measures to he recommended by the central finance commission". 5. 8 In earlier chapters we have narrated how we collected data from all the 1215 LSGs, how the massive data were processed and how forecasts were made on receipts and expenditure for the five-year period from 1-4-2006 to 31-3-2011. Commission decided that the work done in that context should be used to prepare a summary profile of the likely financial position of each LSG for that period. To the best of our information, such a set of profiles covering all LSGs is not available anywhere now. Consequently, it has not been possible to assess the exact requirement of funds of individual LSGs or the aggregate of such requirements to be presented to the Central Finance Commission. If the initiative this Commission has taken in making such assessments of the financial position of each LSG is refined and perfected over a period of time and made a standing feature of the financial management of the State, our case for assistance to LSGs can be forcefully presented before future Central Finance Commissions. 5. 9 There are other important advantages arising from this exercise. At present the State Government does not seem to have an idea of the overall financial strength and weakness of LSGs. Neither does any individual LSG know of its own overall financial position assessed in a well-structured manner. Consequently there is no clear idea, which LSGs are relatively well-off, which are just self-sufficient (after receiving due share of taxes

etc.) and which are in financial difficulties even for discharging their basic civic duties, not to speak of investment. This has crated an anomalous situation in plan funding, which we will explain later in the report. The initiative taken for preparing a financial profile of each LSG would be of longstanding benefit in this context also. As a beginning, we propose to identify the weakest among LSGs and provide some token relief to them so that, in future years, as the system is refined and perfected and adequate funds are received from Central Finance Commissions, the weaker LSGs can also go in for effective expansion and development of services and institutions. 5. 10 The next important element in our approach is the fair balance we would like to maintain in our recommendations, particularly those relating to devolution. There should be a balancing of the interests of the State Government, the LSGs and, most important, the people tor whose welfare both the State Government and the LSGs are committed. 5. 11 Any scheme of devolution which the State Government cannot afford will not he in the interest of the Government or LSGs. Firstly, The Government may not be able to accept such a scheme. Secondly, even if it is accepted, its implementations will pose difficulties and that will, in turn, cause erratic flow of funds to LSGs. This however does not mean that no effort is required from the side of the State Government to ensure adequate flow of funds to LSGs to help them discharge the enlarged area of functioning given to them by the state legislature. What we mean is that on the one side, there should be an earnest attempt in the State Government to improve their finances and. on the other side, the scheme of devolution should be realistic enough not to transgress the reasonable limits of State Government's potential. We propose to formulate our recommendation keeping this middle path in view. 5, 12 In fairness to the LSGs. a basic point has to be stressed in this context. Once the decentralisation process is put in place and more and more functions and instructions are transferred to LSGs, flow of adequate funds to LSGs should not be considered an act of charity or magnanimity on the part of the State Government. It is, really, the Government's duty to ensure adequate funds. State Government should not only commit such funds but also release these regularly as per a schedule known to LSGs so that LSGs can regulate their

expenditure properly. But, once this is assured, LSGs themselves have to rise to the occasion. They should not be found wanting in raising financial resources which they can form their own sources. In regard to expenditure, LSGs should be accountable in two ways. Firstly they should be able to utilise the funds in time and should be willing to face effective cuts in future entitlements if such timely expenditure is not ensured. Secondly all functionaries of LSGs who exercise power during the stages of processing or decision-making in expenditure should hold themselves accountable for ensuring correct use of funds. It is a basic principle in governance and administration that those with power should also be accountable. Power without responsibility and accountability is a dangerous phenomenon. Our recommendations will be designed keeping both the rights and the duties of LSGs and their functionaries. 5. 13 Now we come to the most important element which is the people's interest, In a democracy, this should be supreme. People have the inalienable right to be governed wisely, justly, efficiently and above all honestly. One area where this principle is crucial is the use of funds. When LSGs are assured adequate funds they should see that the services expected by the people are delivered. In any arrangement of transfer of funds from one level to the other, it is wise to have checks and correctives to ensure this. This is an important aspect we propose to keep in mind in giving shape to our recommendations. 5. 14 Terms of reference of the Commission include certain other important issues. Additional resources mobilisation, borrowing potential, budgeting and accounting etc. figure among them. In regard to each item we will be making specific recommendations wherever we feel the need for a particular course of action. But before shaping such recommendations, we propose to ask ourselves some basic questions instead of proceeding merely on commonly held assumptions. For instance, before recommending what should be done to raise additional resources, we would examine whether additional resources are necessary, whether there is capacity to usefully deploy such additional resources, how such resources be raised by rate revision or other means, etc. We do not propose to be guided by the assumption that additional resources generation is a virtue in itself or an end in itself. It is a means to an end and if the end cannot be achieved, there is no point in burdening people more and more. Similar would be our approach to borrowing. Basic questions have to be answered in this area also. What happened to the borrowings in the past? What can one see on the ground?

Are old loans being repaid as per schedule? Any LSG (or for that matter, any level of government) who does not have positive answers to these questions will not be right candidate for more and more funds from the debt market. They should first set right the present chaos before grabbing fresh loans from wherever available. 5. 15 Another area of concern on which Commission would like to indicate an approach is the utilisation of funds (other than State sponsored or Centrally sponsored plan programmes), which LSGs spend on behalf of Government. Here - mainly welfare pensionsCommission would like to take a look at the present arrangements, which seem to have resulted in a disturbing situation. However, we would not like to move to extremes - either changing the entire set up or just passively glossing over the present situation. 5. 16 Put in a nutshell, our overall approach will be one of consolidation and stabilisation. The last decade found rapid changes and real progress in decentralisation. That is, no doubt, commendable. In any such fast change, some mistakes and consequent confusion in certain respects are unavoidable. That is no reason for condemning the change that has taken place. But now, this historic transformation needs some time for consolidating its gains and structuring itself in a systemic arrangement that effectively corrects the aberrations of the past. We propose to keep in view the need for such consolidation arid stabilisation while formulating our recommendations in the coming chapters.

CHAPTER 6 DEVOLUTION OF STATE TAXES TO LOCAL SELF GOVERNMENTS 6. 1 As indicated in the previous Chapter, Commission would like to assess die capacity of the State Government before formulating recommendations about devolution of share of State Taxes 10 LSGs. Commission does not have an assessment from the Slate Government. However we made an assessment of the situation from available records of the Government, 6. 2 This Commission's recommendations cover the five-year period 2006-2011. Of these five years, tour are years during which Stale Government receives share of Central laxes based on the lecommendations of the Twelfth Central Finance Commission. These me the four years from 20U6 to 2010. So it will be appropriate to assume thai what the State Government hud sought from the Genual Finance Commission for the five year period 2005-2010 and what the Central Finance Commission allowed for thai period is u good pointer to the financial position the State Government is likely to have during the period covered by our recommendations. 6, 3 In the forecast submitted by the State Government to the Central Finance Commission, the pre - devolution non plan deficit in revenue account tor the live year period 2005-2010 was projected as Ks. 33267 crore. Plan deficit in the revenue account was projected as Ks. 15658 crore. However when the Central Finance Commission reassessed State Government's forecast, they did riot cover Plan revenue account at all On the noa-plua side, the total pie-devolution deficit lor trie five years 2005-2010, as reassessed by the Central Finance Commission was only Rs. 12468 crore, as against the state Government's projection ot" Rs. 33267 crore. 6. 4 Based on the norms adopted by Uie Twelfth Central Finance Commission, Kerala's entitlement of share of central taxes was tixca as 2.b65 % as against 3.057 % that Had been fixed by the Hleventn Central Finance Commission. This was a seiiuus setback to Stale

Government. The adverse impact of this would have been neutralised fully or partly had the Twelfth Central Commission made a higher assessment of State Government's non-plan revenue deficit. Their assessment of Rs. 12468 crore as non-plan revenue deficit ruled out such a neutralisation as the receipt of tax share even at the low level of 2.665 % would be higher than Rs. 12468 crore, making Kerala ineligible for any grant (except for the year 2005 - 06) under Article 275 for covering non-plan revenue account deficit. This means that Kerala was hit hard both ways. 6. 5 While it will not be appropriate for this Commission to comment on the devolution package recommended by the Twelfth Central Finance Commissions, we have to take note of the factual position that a serious initial disability was built into State finances for 2005-2010, on account of this aspect of the recommendations of the Central Commission. 6. 6 This is not the only aspect where, in an area relevant to the work of this Commission, there has been an adverse impact resulting from the Central Finance Commission's recommendations. In assessing the flow of iunds from State Government to Local Self Governments also, Kerala suffered a serious setback. The total amount that the Central Finance Commission assessed as Kerala Government's payment as compensation and assignment of State Taxes to LSGs for five years 2005-2010 was only Rs. 576 crore. If calculated on the basis of the Second State Finance Commission's recommendations (3.5 % general purpose grant and 5.5 % maintenance grant), the five year commitment would be around Rs. 4154 crore. The difference between this amount of Rs. 4154 crore and the relatively small amount of Rs. 576 crore is the second major adverse impact of the Twelfth Central Finance Commission recommendations on Kerala State finances in areas relevant to this Commission's work. 6. 7 The third area where Kerala was hit hard is the total avoidance of any consideration for Plan revenue deficit by the Twelfth Central Finance Commission. That was the Central Commission's approach applicable to all States. But, unlike other States, Kerala had decided on the allocation of one third of State Plan outlay as plan grant to LSGs and this also added to the revenue deficit of Kerala Government. Therefore, non-consideration of plan revenue deficit hit Kerala more hard than it affected other States. We will revert to this aspect

later. Here it is mentioned to give an idea of the dimensions of the adversity faced by Kerala Government consequent on the recommendations of the Twelfth Central Finance Commission. 6. 8 Apart from this, there are two other aspects that adversely affect the State Government's ability to move funds to LSGs. One is the target of revenue deficit elimination. What we understand is that, under Fiscal Responsibility Act, Government has to strive towards a zero revenue deficit. That would naturally affect all items of outflow and expenditure, though in varying degrees. The second such aspect is the impending pay revision. Going by past experience that will make a substantial addition to State Government's expenditure commitment, again adversely affecting their ability to provide funds for other purposes. 6. 9 Overall, the State Government's financial position during the period relevant to our report does not seem to be very heartening, to say the least. Therefore we have to be extremely cautious in framing our recommendations on devolution. 6. 10 However that caution cannot be carried beyond a point. As pointed out in the previous chapter, flow of adequate funds from State to LSGs is a right of the latter, as the State Legislature has entrusted a wide area of responsibility to LSGs. It is the duty of the State Government to ensure adequate flow of funds. This right of the LSGs is something which this Commission would like to firmly assert and fully accept, despite our understanding of the weak financial position of the State Government. 6. 11 After considering all aspects, this Commission feels that we have to maintain broadly the same level (dimensionally) of devolution as recommended by the Second State Finance Commission. But on a basic conceptual aspect we would like to make a deviation, which, we feel, is crucial to the concept of decentralisation. Before the advent of the new *

role, erstwhile local bodies were receiving funds by way of assignment and compensation. The proportions of those funds were obviously designed to meet the limited functions of the local bodies which were mainly of civic nature. The Constitutional amendment changed that limited role as well as the status of local bodies drastically. More services and institutions

were transferred, making them another level of governance, taking over the load of a part of the functions of State Government. This should, even simply extending the logic of tax assignments of the previous period, entitle LSGs to higher proportion of State taxes. Then came the historic move by Kerala Government, making LSGs their active partner in the endeavour of economic development. This means LSGs cannot be content merely maintaining the services and functions transferred to them but should invest in the expansion of those services and the development of those institutions. So, extending the logic of the erstwhile local bodies' financial relations with State Government, a further step-up in the proportion of State Taxes devolving to LSGs seems justified and unavoidable. In short, LSGs in Kerala are now entitled to receive a share of State Government taxes for three purposes, (i) to augment their own resources to meet their traditional functions, (ii) to maintain the services and institutions transferred to them, (iii) to extend and develop those services and institutions 6. 12 Now we come to the point what is the appropriate proportion of State's own tax revenue to be moved to LSGs for all these purposes together. Fixing it as a percentage is commendable, no doubt. But it has one disadvantage. LSGs will come to know their entitlement each year only when Government issue an order for that year. They cannot by themselves easily come to know what was the total State Tax revenue for the year for which final audited figures are available, what is the share (quantum) of each of the five levels of LSGs and then what is the quantum each of these would get each year. This is one factor adversely affecting proper financial planning even by those LSGs who are competent and willing to do that. Therefore, we propose to shift to a system by which the total proportion of the share of taxes to be moved to LSGs in the first year (2006-07) is fixed as a quantum equal to a reasonable percentage of State's own taxes (of two years previous) and then to fix similar quantum for each of the four years applying an annual rate of progression. 6. 13 We are deliberately avoiding the concept of grant in recommending devolution. The term 'grant' indicates a superior-inferior relationship between the two parties involved. Such a relationship is inconsistent with the spirit of the Constitutional amendment making Panchayats and Municipalities another level of governance. Disbursal of grants may mean that one is the 'seeker', other the 'giver'. Or that one is the beneficiary and the other is the

benefactor. Neither is the case. State Government and LSGs are partners, teammates. State Government is certainly the senior team member. But the seniority should reflect in the responsibility to give guidance and advice, not in condescendingly granting money or in nonchalantly withholding money. Though in dimension there is no substantial difference between the arrangement recommended by the Second Commission and what we are recommending, we make this conceptual change to assert the partnership of the two levels of governance in achieving the ultimate goal, which is the welfare of those governed. 6. 14 Taking all relevant factors into consideration, we recommend that an amount coming to around 25 (Twenty five) per cent of the total State Tax revenue of the year 2003*04 may be transferred to LSGs during the year 2006-07. During each of the four subsequent years amounts derived by applying annual growth of 10 (ten) percent (which would accommodate reasonable rates of inflation and real growth) may be so transferred. Though a fixed growth rate may, in some years, marginally cause loss to LSGs (compared to a system of fixing a percentage), it has the advantage that LSGs would know, as soon as the Finance Commission report is available, how much amount would be transferred to them in each of the five years. We therefore fix the total share of State Taxes to be transferred to LSGs for 2006-07 as Rs. 2050 (Two thousand and fifty) crore. Applying 10 % annual growth rate the total share of taxes transferred to LSGs in the five years 2006-2011 will be Rs. 12515 (Twelve thousand five hundred and fifteen) crore.

6. 15 Now we came to the distribution of these amounts among the five levels of LSGs and, further, among each of the LSGs at each level. Here also we do not want to drastically change the existing proportions, which came into operation in 2004-05. The amount will be split into three parts, (i) for traditional functions expenditure (for which Second Commission recommended 3.5 %) (ii) for maintenance (for which Second Commission recommended 5.5 %) and (iii) for expanding and developing services and institutions transferred to LSGs. Consistent with our approach here also we fix amounts. The amounts for each item for each year and the totals are given in the table below.

Table 6. 1 Share of State taxes to be transferred to the LSGs during 2006 - 2011 (Rs. in crore) No Item

2006-07 2007-08

2008-09

2009-10

2010-11

2006- 11

1

Traditional functions

300

330

363

399

439

1831

2

Maintenance

350

385

424

466

512

2137

3

Expansion, Development

1400

1540

1694

1863

2050

8547

4

Total

2050

2255

2481

2728

3001

12515

In fixing the amounts for maintenance, we have kept in view the low levels of expenditure in 2004-05 and the fact that some roads earlier handed over to LSGs were taken back by the PWD. (We hope the latter does not become a continuing feature as it clearly goes against the concept of decentralisation) 6. 16 The amount for traditional functions and the amount for maintenance will be distributed among individual levels of LSGs as well as individual LSGs following the same ratios as applied to the distribution of 3.5 % and 5.5 % respectively during 2004-05. In the case of the third item the ratios will be the same as applied by the Planning Board and Government for distributing the Plan grant for decentralised planning. 6. 17 In order to make the entire exercise transparent, we have prepared a Table specifying the amounts every LSG will get under each item for each of the five years, 2006-11. (If any arithmetical error in calculating the amounts as per the ratios indicated above is detected during implementation, that may be corrected). The table is given as Appendix I (One). The split of funds for road and non-road maintenance is done following the pattern adopted by Government in 200405, which we feel is a good refinement. 6. 18 So, in conclusion, we recommend that shares of State's own tax receipts may be transferred to LSGs as indicated in paragraphs 6. 14 to 6. 17 above. The entire amount may be provided in the State Government budgets of the relevant years as 'Compensation and Assignment to LSGs' under Non-Plan (title used by Twelfth Central Finance Commission in

Annexure 6.12 reassessing State Government forecasts). For this purpose the amouni we recommend for devolution should be deemed to be compensation for LSGs' due share in State I taxation and provided under major head of account 3604. Going by the experience in the past I such a presentation would make State Government's non plan revenue account forecasts I before future Central Finance Commissions more realistic and beneficial to the State, If however it is necessary (for any accounting purpose) to determine the incidence of this amount on each item of State tax revenue, it may be done based on the percentage of each tax

to the total State's tax

revenue. A hypothetical illustration is given below. Suppose A is one item of State's own tax. Suppose Rs.3000 crore is the collection estimated in the relevant year's State budget, from that tax.

Suppose the total State Tax revenue estimated in the budget for the relevant year is Rs. 10000 crore. So, collection from tax A is 30 % of total State Tax revenue. In this case, an amount equal to 30 % of the total share of State Taxes should be deemed to be the incidence on revenue from tax A.

CHAPTER 7 FINANCIAL PROFILE OF LOCAL SELF GOVERNMENTS 7.1 Having formulated the recommendations regarding devolution of taxes, Commission proceeded to prepare a summary financial profile for each of the LSGs. In the chapter dealing with forecasts of receipts and expenditure, principles based on which the forecasts were made have been explained. Using those forecasts and the figures given in Appendix I, it is possible to draw up the profiles. 7. 2 Commission gave considerable thought to the question what should be the product of the profile. The expenditure of LSGs has to serve mainly two purposes. One is to efficiently discharge the civic services functions which were being carried out even before the Constitutional amendment. The second is to develop and expand the services and institutions transferred to them in pursuance of the 73rd and 74th amendment to the Constitution. Keeping this in view, the Commission decided that the summary financial profile should derive the amount likely to be available with each LSG for developing and expanding services and institutions during 2006-2011, after making adequate provision for civic services functions. 7. 3 In the chapter on collection and processing of data, we have narrated the extensive nature of the data collected and the different stages of processing done. All that data and analysis will be made available to Government for future reference and use. Obviously all that cannot be given as part of the report. Even the limited endeavour of preparing one summary profile for each of the 1215 LSGs involves massive effort and would make the report unprecedentedly voluminous. So for that work, we selected (for inclusion in the proforma for the profile) items of receipts and expenditure in relevant groupings. Some items were omitted from inclusion in the proforma. 7. 4 One major item omitted is the forecast of plan expenditure. The main reason was that the product of the profile itself is the availability of funds for expenditure on development. So any projection based on the past or even on independent norms would not be relevant in that context. (That position will be made clearer later in the report) Another

item omitted is the expenditure on maintenance. Forecasting this item of expenditure is difficult as pointed out in the forecast chapter. The new arrangement of 5.5 % of tax revenue (of two years previous) given for maintenance came into force only in 2004-05. LSGs could not spend that amount, as they obviously needed time to prepare themselves for such increase in maintenance expenditure. Any forecast based partly or entirely on 2004-05 expenditure would mean acceptance of such low maintenance expenditure. That will certainly not be in public interest. So Commission decided to proceed on the basis that in the forecast years expenditure on maintenance will be (or should be) the same as the share of taxes received for that purpose. Based on this inference, the summary financial profile excludes both the expenditure on maintenance and the share of State taxes meant for maintenance. As the two would neutralize each other, our method will not create any difficulty in arriving at the final product of the profile. 7. 5 LSGs have an agency function in respect of welfare pensions. In this case also, there is difficulty in making forecasts as explained earlier. The problem of mismatch of funds received from government and funds actually disbursed by LSGs has to be handled separately - which we will do later in the report. For preparing the summary profile we avoided this item also. We did this on the assumption that, in this item, receipts and expenditure should match causing no net improvement or deterioration in the financial position of LSGs arrived at excluding this item. 7. 6 After the exclusion of some items as explained above, we prepared a proforma grouping receipts and expenditure and net position in 17 (seventeen) columns. The biggest three own items of taxes were shown separately. Other items of taxes were clubbed together. Non-tax revenue was shown as one item. Expenditure was grouped into three- Management, Civic services and other expenditure. Repayment of debt is a separate item. Share of tax recommended by us in the last chapter (after excluding the provision for maintenance) is also given a separate column. ARM at a normal level, as explained in the forecast chapter, is another separate column. 7. 7 Based on the projection of these items of receipts and expenditure, the summary profile arrives at the assessment of funds available for developing and expanding services and

institutions transferred to LSGs. This is the product of the profile exercise which we mentioned earlier. These profiles are given in Appendix II (Two) of the report. We may mention here that in the additions in the Tables, there is occasional discrepancy to the extent of one to three thousand rupees (too small to be of any significance). This is because, in the different stages of computer calculations, decimals were retained till the last stage and omitted only at the stage when the summary profile was drawn up. As the profile is meant to give an idea about the LSG's financial position and not for any accounts reconciliation work, it was not considered essential to spend further time in curing this minor discrepancy. 7. 8 As we explained earlier in the report, financial assessment of each of the 1215 LSGs, to the best of our information, has never been attempted before in this State. Commission has had to do this in relatively short time. Though all attempts have been made to clean the data and do reasonable projections, we are not in a position to claim perfection. If this initiative is followed up and there is an institution which will function permanently updating the data and doing continuous analysis, it will be of great advantage to both Stat Government, LSGs and academic institutions doing research in this area. 7. 9 The last column in the Table is the availability of funds for development. The projections of revenue receipts we have made are on the conservative side. So actual availability of funds can be more, if the LSGs can pay serious attention to their own resources generation. In the Tables, we have not provided for receipts from borrowing or from public contribution. When these two are also assumed at reasonable levels, availability of funds will go up even further. The final position of availability of funds for development after taking in to account all such sources will be presented later in the chapter on structure and scope of development expenditure.

CHAPTER 8 MOBILISATION OF ADDITIONAL RESOURCES 8. 1 In the Indian context of governance and economic development, perhaps no other term has been so overused as this one - additional resources mobilization. Faced with a mounting pile of demands from the people and weighed down with a basic inability to curb avoidable, unnecessary and wasteful expenditure, planners and administrators brought up the term 'ARM' (the popular shortened form) as a remedy for many of the inadequacies in administration and economic planning. Gradually, additional resources mobilization became an accounting concept. The question was how much more money Government can take from the people by inventing new taxes even overstretching the Seventh Schedule, by raising rates of existing taxes, by increasing charges for services and utilities delivered by Government ' agencies with decreasing levels of efficiency. The underlying simple principle appeared to be 'the more, the merrier'. 8. 2 In our humble view, there has to be a break with this past. As we indicated in the chapter on our approach, we would like to start from basics. Firstly, we would like to include within the scope of ARM not only additional yield from new or existing revenue sources, but also borrowing and public contribution of financial and human resources. We do not want to treat these three as separate subjects, in separate chapters. After having defined the scope of the term as we use it here, we would proceed to list the factors to be examined before making our recommendations. Need for additional resources Potential for raising additional resources

Capacity to tap the potential to the optimum Capacity to deploy the additional resources to the optimum

8. 3 Before proceeding to analyze each, we would make one clarification. In the summary financial profiles in Appendix II there is a column ARM. We have explained in the chapter on forecast how we have arrived at the numbers in that column. There, we admit,

we have gone by the usual method. The amounts are relatively small; and it was included for the purpose of drawing up the profiles consistent with the sequence mentioned by the Twelfth Central Finance Commission. 8. 4 Now we come to the aspect of need for additional resources. The Tables in Appendix II bring out the position of funds availability with the 1215 Local Self Governments. They show how much money each Local Self Government can generate for expanding and developing services and institutions transferred to them. And that is after reasonable provisions are made for expenditure on civic services, which is the first duty of Local Self Governments. In the case of many Local Self Governments, the funds available for development are higher than what they get for that purpose in the shares of taxes we have recommended in Appendix I. This means that the difference between the two would be the investable funds with Local Self Governments for development (including general purpose share from Government). Overall there is no great problem of lack of financial resources for development endeavor. Certainly ARM efforts, (taken up after careful consideration) can be of help in that endeavor. We will go into the specifics of this position later in the report. 8. 5 Next aspect to be considered is the potential for raising additional resources. There is no doubt Local Self Governments can raise a much higher order of own resources than they have been doing so far. This was evident during the discussions Commission had with officials of Local Self Governments. Before thinking of new sources of revenue, Local Self Governments should look into the potential for additional revenue from existing sources. The study made by the Commission revealed some disturbing facts about the way revenue is collected from existing sources. Building tax/property Tax is the biggest item of revenue receipt. In the chapter on forecast, we have assumed collection equal to 90 % of demand. This is certainly not an unreasonable assumption. But to achieve this, Local Self Governments have to make a real effort. At present most of them do not have a clear idea of the demand for each year and the arrear position. We gathered some data on demand with great difficulty and compared that with figures of collection. The picture is dismal. The total collection of property tax in Municipalities during the three years 2001-02, 02-03, 03-04 ranges between 62 % and 71 %. The average for the three years is only 70 %. In the Corporations, the total

collection ranges between 55 % and 74 %, the average bring 66 %. In most of the Grama Panchayats, the position is equally bad or worse. 8. 6 In the case of profession tax, the second biggest item of revenue, the position is not much better. In the Municipalities the total collection (average of three years) is only 81 %. In Corporations also, this is the average percentage. 8. 7 The position regarding other taxes or items of non-tax revenue is not much different. So the greatest potential for additional tax revenue and non tax revenue lies in collecting a higher percentage of the demand of the taxes and charges. For that, a series of systematic steps have to be taken starting with the preparation of a correct and uptodate Demand register, quick disposal of complaints / appeals, finalising the demand without delay, reviewing the collection regularly and taking appropriate steps to identify defaulters and ensuring collection of tax due from them. Increasing the rates, wherever justified, can be considered after that. 8. 8 In that context, it is necessary to examine how to tap the potential to the optimum. When there is a substantial percentage of default in one item of tax, if rates are raised, the chances are that the increased rates will also be paid by the same tax payers who now pay their taxes. Those who default (and do not face any coercive action, perhaps because Local Self Governments have plenty of funds these days) are likely to continue that practice. From this angle also, first priority should be to improve collection with existing rates of tax and non tax revenue rather than raising rates. 8. 9 This certainly does not mean that rates should not be raised at all. Whenever necessary and justified, that should be done. But in that context, Commission would like to strike a note of caution. The approach should not be 'the more, the merrier'. Before raising any rate of tax or introducing new items of revenue, there should be a study about its implications, its impact on the tax payer and economy and the cost of collection. Just because Local Self Government (or any other level of Government) would get more money, it will not be wise to go in for tax increase.

8. 10 It is often argued these days that the limit (of Rs. 25007- per annum) on profession tax should go. Profession tax rates are usually fixed according to slabs of income levels. So, in effect, it becomes an additional tax on income. If there is no limit, there could ultimately be wide variations in the effective tax incidence on income among different States. If that is permissible, why not make income tax itself a State tax? Obviously there were reasons why it was not made a state Tax. If those reasons are valid even now, is it desirable to neutralize that position by giving States powers to impose unlimited rates of tax on income - though under another name viz. profession tax? 8. 11 This is not to argue that maximum limit of profession tax rates should always be the same as now. The point is that all the implications and the likely impact should be studied and a view should be arrived at, instead of resorting to removal of limit just because that will give additional revenue. This is particularly relevant in situations where the present collection leaves big gaps compared to demand. 8. 12 Another area where the point of optimum tapping of potential is relevant is the charging of various fees by Local Self Governments. Some of them have maximum limits and some have minimum limits and some both. Before suggesting the removal of the limits, one should examine why such limits were fixed, whether the considerations by which limits were fixed earlier have become irrelevant or have they been overtaken by more valid considerations that arose subsequently. For instance, if maximum limit for license fees of petty shops is taken away, it could happen that a small Tettikkata" on the southern side of a road falling in one Panchayat may end up paying double the fee paid by its counterpart on the northern side of the road falling in another Panchayat which does not increase the fees. In a system where there is an upper limit, there will still be variation but that cannot go beyond a point. In any case, should a country trying to move towards a unified national tax on goods and services simultaneously move in the opposite direction of giving each Panchayat unlimited freedom to charge any fees on small business and industry? Again we are not suggesting that License fees should not be raised or that there should be a maximum limit. The point is that all relevant aspects should be carefully considered before such decisions are taken. This is very essential to ensure that the tax regime (and non tax revenue structure) does not become whimsical and adhoc, designed only with the aim to gather more money.

8. 13 Even after keeping all such aspects in view, there is possibility for additional revenue from tax and non tax items, over the levels indicated in the Tables in Appendix II. We will come to the specific levels of such further 'ARM' later in the report while tying up the position regarding funds for development expenditure. 8. 14 Before leaving this aspect of the subject, we do wish that the Kerala Government appoints a Commission to review the tax structure in the state (both at the State and Local Self Government level) keeping in view the incidence of Central taxes also. A Commission consisting of eminent and erudite experts could be asked to look at taxation not only from the point of view of those who govern, impose and collect taxes but also those who are governed and have to pay these taxes - particularly those who do not evade taxes either because they do not want to evade taxes or because they cannot, even if they want to. 8. 15 Next we move to the fourth aspect- deployment of the additional resources. But before that, we would touch upon two other sources of additional resources. The first is borrowing. We would begin with looking into the appropriate context for borrowed funds in the functioning of Local Self Governments. Local Self Governments are firstly civic service providers. Now they are also agents of development in primary areas of economy like agricultural promotion, primary health care, basic education etc. Apart from this they also have to exercise statutory and regulatory roles as in matters like giving license for building. Which of these areas call for massive investment of borrowed funds? Normally such funds (of large size) are invested in major infrastructure projects or industrial enterprises. Of course, these days large funds from international aid agencies are used in areas of social services with a good part of them being loan. But that is usually done through the agency of Central and State Governments. So the scope for freelance borrowing by Local Self Governments, particularly Grama Panchayats, is rather limited. 8. 16 Then comes the experience of the past. Many Local Self Governments, mostly Corporations and Municipalities, had borrowed funds for various purposes. Commission made an earnest effort to assess the liabilities in this regard. In spite of a series of discussions and correspondence not much useful data could be gathered. In most cases, there is no clear

idea which are the loans outstanding, what is the schedule of remaining repayment, what arrangement have been made for repayment etc. Whatever repayment takes place is mostly of an adhoc nature. Sometimes, Local Self Governments had to use part of plan funds for such repayments - a basically unsound practice in development financing. Unable to think of any better option, the State Government even allowed this. Proper loan registers, repayment profiles or even a Demand Collection Balance (DCB) statement is not available in most cases. As for the assets created by investing the borrowed funds, the less said the better. Even an attempt to get a list of assets and their value has not succeeded in spite of efforts by previous Finance Commissions and even by the Accountant General. Our efforts in this direction too failed. 8. 17 Against this background, Commission is of the definite view that, at this stage, the priority is not to access more borrowing. Creation of accurate loan data base and servicing the loans in time should be the first priority. Having said that, we are not ruling out fresh borrowing. We will revert to that and indicate the reasonable level of borrowing later in the report when we tie up our scheme of financing expenditure on expansion and development of services and institutions transferred to Local Self Governments. 8. 18 The third type of additional resources Local Self Governments can generate is from public contribution. If the performance of Local Self Government is really beneficial to the community, it should be possible for them to attract positive response from the people by way of public contribution. Local Self Governments have to give effective leadership in spreading the idea that local self governance does not simply mean using funds received from tax and other government sources. There should be a meaningful and effective participation by the public - those among them who can afford to make such contributions. This is particularly relevant as most of the works undertaken by Local Self Governments directly and immediately benefit the local people. 8, 19 But here a word of caution is called for. In Kerala, there is little purpose in seeking public contribution as labour, giving minimum wages or asking for work for food etc. To be realistic, public contribution in Kerala for development work should be hard cash. Money is available in our villages and towns as one can see walking into any consumer and

luxury items shop or entertainment centres. LSGs should have the stature to attract a small part of such funds for the common benefit of the community. 8. 20 Now we come to the most important aspect, deployment of the funds generated though additional resources mobilization. Every paisa of those funds is the product of some (small or big) self-deprivation for the citizen. Governmental agencies that use the funds have the sacred duty to deploy them effectively. In the case of developmental investment by LSGs the picture, which emerge from the past experience, is not heartening. There has been mutual recrimination between State government departments and LSGs. LSGs complain that funds are not released in time and Government functionaries would say that funds are not used in time. As usual on such occasions, perhaps fault lies on both sides. But the relevant point is that the citizen should not be the victim of this war of words. Carried over any longer, this argument between LSGs and Government departments will give the citizen the impression that it is deliberately meant to divert attention from the fact that both are failing in their common commitment to invest funds available in the total system with efficiency and speed. 8. 21 The gist of the discussion in the foregoing paragraphs of the chapter is that additional resources should rather be generated from existing sources. A specific quantification is attempted later in the report. Here we recommend some measures to ensure, eventually, better yield from available sources of revenue generation. (a) Demand register for the biggest three taxes (at least) should be prepared by all LSGs, before the end of the current financial year. (b) A register indicating the arrears, the period to which they relate should also be prepared. (c) A Demand Collection Balance (DCB) statement of all revenue receipts should be prepared and placed before the meetings of the LSG once in a quarter (at least) and that should be discussed by the council and appropriate direction given to officials. (d) Review of tax collection and realization of non tax revenue should be discussed in Grama Sabhas and Ward meetings opce in a quarter.

(e) A statement on revenue collection and arrear position of LSGs (one statement for Grama Panchayats, one for Municipalities and one for Corporations) should be placed by Government in the State Assembly every year for a one day discussion. As the revenue collection done by LSGs is from statutes passed by the legislature, all shares of state taxes given to them by the state government are also from statutes passed by legislature and all the services and institutions newly transferred to LSGs were transferred on the decision of the state legislature, a discussion in the state Assembly cannot, by any stretch of logic, be considered an inappropriate interference in the powers of LSGs. In fact, such a discussion is necessary for the state legislature to know whether funds from sources authorized by them are dutifully collected. (If the initiative taken by the Commission in drawing up financial profile of each LSG is carried forward, it should not be difficult to prepare a detailed statement for submission in the Assembly.) (f) For debt position, DCB Statement should be prepared and reviewed in council meetings as well as in Grama Sabhas and Ward Committees. (g) A list of major defaulters of property tax (above a certain limit depending on the situation in each LSG) should be put up on the notice boards in each Panchayat, Municipality and Corporation. This should be put on their websites also, wherever available.

CHAPTER 9 RELEASE OF FUNDS 9. 1 When a substantial amount of money has to be transferred from State Government to Local Self Governments, there are bound to be ways and men implications for the Government. Consequently there has been mutual accusations by LSGl and Government about release of funds. Local Self Governments raise the complaint ttul erratic and irregular flow of funds mar efficient implementation of their schemes. GovernmeM feel that even when funds are released, LSGs' inability in utilising them in time creates problem. 9. 2

Commission does not want to arbitrate on this issue. In our view no amount on

faultfinding is relevant because irrespective of who is at fault (rather who is more at fault), the real sufferer is the public who should benefit from the timely implementation of schemes and projects. So, in fairness to the people, Commission recommends that a system of hands release should be developed to ensure three things. Timely release of funds Timely expenditure If timely expenditure does not take place in spite of timely release of funds, and effective cut of corresponding amounts from future entitlements 9. 3 Government's difficulties arise from Two basic factors. The first is that state budgets are not always based on a realistic assessment of availability of resources. In the desire to increase plan outlays from year to year, Governments often resort to over optimist estimates of receipts. In addition, in response to situations that arise in the course of the year, they make provisions for fresh items of expenditure. All these add up to serious resources deficiency for meeting the expenditure commitments undertaken in budget estimates and supplementary demands. Usual response of Governments to this phenomenon is to order cuts in plan. This affects all sectors adversely, LSG's finances being one such sector.

9. 4 The second basic factor adversely affecting Government's financial management is the mismatch between the flow of receipts and expenditure. There are humps in expenditure on certain occasions. But receipts do not show corresponding increase at such times. So on such occasions Governments run into ways and means difficulties. This situation is often tackled by Governments by a series of measures as part of ways and means management, starting with letter of credit system and treasury payments control system. Its most severe manifestation is the practice of ways and means clearance of individual bills, which, during normal times, is not need not be taken up by the Finance Department in the Government Secretariat.

9. 5 The real solution lies in the Government formulating realistic plan and on that basis, realistic budgets and then refraining from adding to expenditure in the course of the year except in extreme contingencies to meet which further resources should be raised or relatively lower priority expenditure should be pruned. Though in theory every one would agree with this, in practice, it is seldom done anywhere.

9. 6 So, with the ills of the budgeting system as it is today, a way has to be found to release funds to LSGs ensuring reasonably smooth receipt of funds by them without causing unpredictable burden on Government's financial management. Commission would like to draw up a clear schedule of release of funds for this purpose.

9. 7 We therefore recommend that the share of taxes payable to LSGs as recommended by the Commission in chapter 6 should be released as per the following schedule. The first part meant for meeting expenditure on traditional functions and general purpose (eg. Rs. 300 crore in 2006-07) should be released in 12 (twelve) equal monthly instalments from April to March).

9. 8 The second part meant for maintenance works (eg. Rs. 350 crore in 2006-07) should be released in ten (10) equal monthly instalments from April to January.

9. 9 Funds for the third part, which is meant for expenditure on extension and development (eg. Rs. 1400 crore in 2006-07) may be released in ten equal monthly instalments from May to February. 9. 10 A Table indicating the cash flow from Government to LSGs during 2006-07 on the basis suggested above is given below. Government can manage their ways and means planning taking into account these disbursements - just as they take into account outgo of cash on account of salary disbursement. Table 9. 1 Schedule of release of funds to LSGs during 2006-07

(Rs. in lakh) Funds for Traditional functions

Funds for Maintenance

Funds for Development

April

2500

3500

Nil

6000

May

2500

3500

14000

20000

June

2500

3500

14000

20000

July

2500

3500

14000

20000

August

2500

3500

14000

20000

September

2500

3500

14000

20000

October

2500

3500

14000

20000

November

2500

3500

14000

20000

December

2500

3500

14000

20000

January

2500

3500

14000

20000

February

2500

Nil

14000

16500

March

2500

Nil

Nil

2500

Total

30000

35000

140000

205000

Month

Total

9. 11 In spite of such an arrangement, difficulties could still arise in smooth release of funds. Here Commission would like to stress two major points. First is the experience of the State Government in regard to the relevant recommendation of the Twelfth Central Finance Commission. As was pointed out earlier, Kerala's expenditure for the entire five year

period 2005-10 on assignment and compensation to LSGs was assessed by the Twelfth Central finance Commission at a very low level, Rs. 576 crore. One reason for this was the low actual expenditure (partly caused by extreme financial difficulties which were being faced by the Government) in 2002-03. So low release of funds to LSGs does not ultimately help the State Government. This has to be borne in mind by Government. If the next (Thirteenth) Central Finance Commission follows the same pattern as almost all Central Finance Commissions have so far followed, they would base their non plan revenue account projection on the actuals of 2007-08. If State Government postpones or reduces non plan revenue expenditure including release of funds to LSGs in 2007- 08, the state Government's non plan revenue expenditure projection which will be done by the Thirteenth Central Finance Commission may again be a low figure - as it happened in the Twelfth Central Finance Commission. So restricting flow of funds to LSGs may help the State Government's ways and means (and resources) management of those respective years, but that may ultimately lead to loss for the State.

9. 12. The second aspect is what we mentioned in the chapter on our approach. The relation between the State Government and LSGs is one of partnership. This should reflect in the manner of resolving problems in the matter of fund releases. On the one hand, the State Government has to be as anxious as the LSGs themselves that adequate funds flow to LSGs. On the other hand, LSGs should be ready to accept their fair share of the genuine difficulties of the state Government. This is the real meaning of a true partnership. Commission therefore recommends a scheme of joint consultation.

9. 13. In the second month of every quarter, Principal Secretary, Finance should convene a meeting attended by Secretaries in LSG Department and representatives of the Associations of Chairpersons of the LSGs. Bottlenecks in the funds flow, if any, could be discussed in such meetings. The aim should be to develop the practice of sorting out the problem in a friendly spirit of give and take. If both sides take such meetings seriously, difficulties arising out of the ways and means compulsions of the State Government can be tackled in a manner without causing real hurt to either side.

9. 14. But in some years, the problem could be deeper than ways and means issues. State Government may have a real resources problem or commitment for an unforeseen inevitable expenditure necessitated by situations indicated in the Fiscal Responsibility Act. LSGs should show the right team spirit and be ready to accept their share of the State Government's genuine difficulty. State Government should be ready to take LSGs into confidence. In such an eventuality Commission recommends that a meeting of the Finance Minister and the Minister in charge of Local Self Governments should be held to ensure the genuine expenditure commitments of the LSGs during the year are not affected or compromised beyond a reasonable level mutually agreed to. 9. 15. Evolving a systemic arrangement, giving full freedom to LSGs in handling their funds including their share in State taxes could pose some operational problems. This cannot be done in one go. Development of such a system will take some time. In the interim, we feel that there should be an arrangement, which tackles the issue midway. Both are dealt with in the coming two chapters.

CHAPTER 10 LAPSE OF FUNDS, REMOVAL OF DIFFICULTIES OF BILL SYSTEM 10. 1 Differences of perception about the flow of funds from State Government to LSGs have sometimes led to arguments about the lapsing of those funds. Demands for allowing extension of time beyond 31st March, resistance to that demand, occasional permission to allow time for a part of the funds etc. have resulted from this debate. Commission would like to highlight the Constitutional position so that such needless controversies may be avoided in future. 10. 2 According to Article 204 (3) no money shall be withdrawn from the Consolidated Fund of the State except under the Appropriation Bill passed under that Article. Appropriation under that Article is for grants passed by the Assembly and for the amounts charged on the Consolidated Fund. Article 203 makes this clear. Both the grants and the charged expenditure are based on the estimates of "...expenditure of the State for that year..." included in the Annual Financial Statement caused to be laid before the House by the Governor "in respect of every financial year". Similar is the position regarding appropriation under Articles 205 and 206 also (of course, for vote on account time limit will be the period for which vote on account is taken). 10. 3 It is therefore obvious that no authority can extend the period of appropriation from the Consolidated Fund of the State beyond the end of the respective financial year. Any such extension is clearly unconstitutional. 10. 4 This position however does not apply to Public Account. 10. 5 The definition of 'Consolidated Fund' and the definition of 'Public Account' are given in Article 266 of the Constitution. Public Account holds "other public moneys" and they do not go into the Consolidated Fund. So the procedure of passing Appropriation Act does not apply to those moneys (as Appropriation Act is only for outgo from

Consolidated fund).

So moneys held in Public Account do not attract the limits of 'financial

year'. Therefore there cannot be any 'lapsing of funds' in the Public Account. 10. 6 Incidentally, it may be useful if public finance experts and legal luminaries would examine the constitutionality of the practice (followed by almost all Legislatures in India) to include in the amounts in the Appropriation Acts, net surpluses in the Public Account. Strictly speaking, in such cases, the appropriation allowed by the Legislature from the Consolidated Fund is for amounts which are (partly) not available inside the Consolidated Fund. To that extent, appropriation is being allowed for moneys which do not exist at the source from which they are supposed to be drawn. 10. 7 What is stated in the foregoing paragraph is a small (but not irrelevant) diversion from our subject. The point directly relevant to the issue on hand is that expenditure from Consolidated Fund cannot go beyond 31st March and that for outgo from Public Account, there is no such restriction.

10. 8 It follows that funds for LSGs, as long a:, they are held in the Consolidated Fund, will be available for expenditure only till 31st March. If any part of those funds are moved to Public Account, no authority can withhold its outgo merely on account of the fact that the financial year is over. However transferring funds from Consolidated Fund to Public Account merely to avoid the limitation of the financial year is obviously unethical and unsound from the public interest angle. 10. 9 Keeping all the relevant aspects in view and taking into account the fact that as per our recommendations in the chapter on share of taxes, funds for traditional functions, maintenance and for development will be devolved as compensation for LSGs' share in State taxation we recommend the following system for drawal of funds. 10, 10 As per the schedule given in the chapter 'Release of funds', funds will be transfer credited from the Non Plan revenue account ( major head 3604) to Public Account under the major head 8448. For this purpose, there will be three Deposit Accounts under 8448. Account I will be for funds for traditional functions (eg. Rs. 300 crore in 2006-07), as

of now. Account II will be for funds for maintenance (eg. Rs. 350 crore in 2006-07). Account III will be for funds for development (eg. Rs. 1400 crore in 2006-07). 10. 11 The officers responsible for drawing the funds from Non Plan Revenue Account ( head of account 3604) and crediting them to Public Account as per the schedule of release will be, Director of Panchayats

Grama Panchayats

Director of Urban Affairs

Municipalities

Commissioner for Rural Development

Block Panchayats

Additional Secretary / Joint Secretary

District Panchayats,

in the LSG Department

Corporations

Individual LSGs will draw the funds for maintenance and development through Bills presented at the treasury, supported by all necessary documents based on actual requirement and for immediate disbursement. Funds for traditional functions (Rs. 300 crore in 2006-07) can be drawn by cheque as is the practice even now. 10. 12 Further details of transfer credit and drawal by bills from Public Account may be drawn up in consultation with the Accountant General. 10. 13 Then comes the issue of timely use of funds. As the amounts are held in Public Account, they do not lapse on 31st March. But carrying over large funds like that is highly improper. We therefore recommend the following system. 10. 14 If the amounts (for maintenance and development) remaining in the Public account to the credit of individual LSG on 31st March closing is more than 10 (ten) percent of the total amount released (deposited in the public account in the credit of that LSG) that financial year, the excess over 10 (ten) percent will be reduced from the budget provision for that LSG for the next year. A hypothetical illustration is given below.

10. 15 'A' is a LSG. A has Rs. 100 (one hundred) lakhs for maintenance and Rs. 500 (five hundred) lakhs for development in 2006-07. Both amounts have been fully released in 2006-07 and transfer credited to Public Account. On 31sl March 2007 closing, 'A' has a balance of Rs. 20 (twenty) lakhs in maintenance fund and Rs. 40 (forty) lakhs in funds for development. A's entitlement for next year 2007-08 is Rs. 110 (one hundred and ten) lakhs for maintenance and Rs. 550 (five hundred and fifty) lakhs for development.

10. 16- In this situation, there will be a cut of Rs. 10 (ten) lakhs (excess over ten per cent of 2006-07 release) from A's entitlement of maintenance fund for next year, 2007-08 and they will be given only Rs. 100 (hundred) lakhs in 2007-08. That cut will never be restored. For development, in this case, there will not be any cut in funds (five hundred and fifty lakhs) for 2007-08 as shortfall in outgo in 2006-07 is less than ten (10) per cent.

10. 17 To ensure that this system does not cause unfair treatment for LSGs, we recommend that for bills presemed for drawal from Public Account within the limits of the monthly release we have recommended in the chapter on Release of Funds, there should not be any treasury restrictions or need for ways and means clearance from Finance Department. However for utilizing that part of the funds, if any, carried over from the previous month's release, special authorization from Finance Department will be required. In order to ensure that this does not cause any operational problems, officers responsible for transfer crediting to public account should do that before the 5th (fifth) of the respective month.

10. 18 What we have recommended above is an arrangement which, we hope, will effectively remove most of the difficulties faced by LSGs in the existing bill system. The bill system itself is not discarded but made easier. At the same time the system would also ensure expenditure from the non plan revenue account so that the State Government's interests are not adversely affected when the Thirteenth Central Finance Commission takes up assessment of the State Government's non-plan revenue account deficit. And the expenditure will not be mere paper expenditure because the system of permanent loss of any short expenditure in excess of ten percent (and the requirements of ways and means clearance for drawal from previous month's balance) will alert LSGs to ensure that they do not sit on funds.

10. 19 In short the system outlined in this chapter ensures that for reasonably efficient LSGs. timely expenditure through bill system (against public account) will noi be difficult. The} know very much in advance how much funds will be transfer credited every month. They should plan their expenditure accordingly and utilise their monthly release by the month end. In the case of such LSGs there will be neither any lapse of funds nor any need for ways and means clearance from the Finance Department in the Government Secretarial, For less alert LSGs who leave some balance by the month end, special authorisation for that balance is required. Only such LSGs who leave a balance of more than 10 per cent of the amounts released in the year will suffer irrevocable loss of funds to that extent and they will have to be accountable lo the public. 10. 20 This brings the Commission to the issue of a permanent arrangement which fully accepts the position of LSGs as the third level of governance, after the Central and State Governments. In that arrangement LSGs will have full freedom for handling their fands. However there should be appropriate checks and balance. There should also be full accountability for those who take and implement decisions for utilisation of funds. The next chapter deals with this permanent arrangement.

CHAPTER 11 FISCAL FREEDOM TO LOCAL SELF GOVERNMENTS AND ACCOUNTABILITY 11.1 If the national initiative for decentralisation of local governance is to succeed, all concerned have to be clear about fundamentals. Does the nation accept that people at the level of villages and towns are capable of running their own local governance system or not? If the answer is 'yes', the direction of all that is done in that context should be to take the idea forward - not backward. There could be course correction on the way, even a strategic retreat from certain steps taken. But all that should be clearly with the ultimate aim of accelerating the pace of decentralisation. 11.2

A lot has been talked and written about the Kerala initiative of transferring to

LSGs not only a large number of services and institutions but also one third of plan investment. On the one side, there is the 'Big Bang' justification. In a nutshell, it meant that unless a great leap forward was taken without waiting for all the safety mechanisms to be in position, the wait might have turned out to be indefinite. In that case transfer of the responsibility to implement economic development programmes in basic services to the local level would always remain a distant goal, not a reality. Those who have a counter view feel equally strongly that sudden transfer of huge responsibilities (and huge funds) to the local level without putting systemic safeguards in position would be an act in hastiness and a compromise on the fundamentals of handling public money, 11. 3 There is validity in both approaches. But the relevant point is that, at this stage, nothing much will be gained by debating this issue. A change has taken place; everyone admits that it is good; everyone also concedes it has caused some aberrations. But the solution is appropriate course corrections and not abandonment of the change. That is why this Commission, in the chapter on our approach stressed on consolidation and stabilisation. 11.4 In this view, we feel that ultimately LSGs should be free to handle their funds, subject to guidance and monitoring from the State Government and, more importantly, the State Legislature. For ensuring this, Commission recommends the following system. Funds

transferred from State Government should be handed over to them as per a schedule known to them. LSGs should be allowed to hold the funds in (effectively Government controlled) banks and draw them as per their requirement. They should not have to go to State Government treasury except to get the fund releases as per schedule. Once the funds are received and deposited in banks, LSGs should be able to draw them by cheques. Such drawal should be preceded by a well structured procedure of financial scrutiny. 11.5 There should be four bank accounts for each LSG (I) for traditional functions expenditure, (ii) for maintenance expenditure (iii) for development of services and institutions (now known as decentralised plan) (iv) for agency functions like State sponsored schemes, centrally sponsored schemes, welfare pensions etc. Own lax and non-tax receipts and tax share for traditional functions (eg. Rs. 300 cores in 2006-07), will be the inflow in the first account. Tax share from State Government for maintenance (eg. Rs. 350 crore in 2006-07) will be the inflow in the second account. Tax share for development (eg.Rs. 1400 crore in 2006-07) will be the inflow in the third account. Funds received from State and Central agencies should be the inflow in the fourth account. There should be a separate stream of inflow and outflow for borrowed funds, their repayment and for the public contribution. The details of these accounts will have to be worked out in consultation with the Accountant General and Director of Local Fund Audit. 11. 6

However, for that system to work effectively, a strong finance and structure

has to be put in position in LSGs. In that context, the progress achieved so far in accounting reform has to be kept in view. 11.7 Commission had discussions with the Principal Accountant General, Kerala and his officers about the work done so far in the matter of accounts and budgeting reforms in LSGs. The discussions gave us very valuable inputs and a clear overall view of the work done by the Accountant General in a relatively short span of time for streamlining the system. We have also received useful guidance from them about the course of future steps required. Commission is grateful to the Principal Accountant General and his Officers for their help and co-operation extended to us. Annexure 11.1 gives the dates, names etc. of the discussion held.

11. 8 A brief summary of accounting reform implemented so far is given at Annexure 11.2 11.9 We had further discussions with the State Performance Audit Officer. In the chapter regarding lapse of funds and removal of the difficulties in bill system, we have made use of his advice and guidance. 11. 10 Representatives of the staff of the Local Funds Audit also met us and we had useful discussions with them, 11.11 As a result of all these, Commission recommends a framework for accounting and financial control, staff structure to be in position when LSGs are given full freedom to handle funds. It is essential to have a Finance and Accounts Wing even in Grama Panchayats. At least one person competent to handle these functions should be made available to each LSG. That could be on deputation to the maximum extent possible and unavoidable minimum number by fresh recruitment through Public Service Commission. The staff of the Performance audit can also be used to strengthen this structure. 11. 12 The personnel so appointed will be the nucleus of a Finance wing in LSGs. Major expenditure proposals (over a limit laid down depending on the volume of financial transactions of each LSG) should be seen by that unit, before the Secretary of the LSG clears it. After the Secretary clears the proposal it should be seen by the Chairperson of the respective Standing Committee and the Chairperson of the Finance Standing Committee before approval by Chairman/Council. After the proposal is so approved, cheques will have to be prepared for drawal of funds. Such cheques should be signed both by the Secretary and the Chairperson of the Finance Standing Committee. 11. 13 As we have pointed out earlier in the report, in all areas of administration, more particularly in financial matters, power should go hand in hand with accountability. For both the soundness of the decision taken on expenditure proposals and the accuracy and authority of the cheques, all those involved should be held accountable. The type of responsibility may vary; but no functionary can seek immunity from responsibility. It will be

the duty of the Finance Wing and the Secretary to point out the pros and cons of a decision proposed to be taken; that is their responsibility. If higher authorities (Chairpersons of Standing Committees, Deputy Chairperson, Chairperson) overrule them, they will have to own the responsibility for that decision. It may be noted that in our system, even the highest elected functionaries do not enjoy immunity. 11. 14 When the system explained in the foregoing paragraphs is implemented, giving total freedom to Local Self Government in handling funds, it is essential to put in place reasonable checks and balance. To an extent, the system of audit does this work. But audit has its own limitations. While endorsing the progressive implementation of that system in full, based on the work done and being done by the Accountant General, we are of the view that effective monitoring systems are also essential. 11. 15 We recommend the following system for such monitoring. First point is about timely use of funds and funds that remain unutilized. The same principle that we recommended in the previous chapter will apply here also. If shortfall in expenditure is more than ten percent of funds released in one year, the excess will be cut from the next year's allotment. That cut will never be restored. To assess the balance, the basic document will be the balance in the Bank Pass book (updated) of the accounts. There will be no cut in the first account, the one for traditional functions funds. We do not offer any opinion about cuts in the fourth account, as items like state sponsored schemes and centrally sponsored schemes are outside this Commission's purview (their location in the state plan will be part of our recommendations in the next chapter; but that will be a limited aspect). As about the second (maintenance share of taxes recommended by this Commission, eg; Rs. 350 crore in 2006-07) and third (share of taxes for development recommended by this Commission, eg: Rs. 1400 crore in 2006-07) there will be irrevocable cuts if the balance in the bank pass book is more than ten percent of the funds released by Government for these two purposes. The plea that cheques (which have a three month validity period) are pending collection should not be accepted as a reason to avoid the cut or reduce it to that extent. In a system where funds release is smooth, no bill system is in operation and the Local Self Government is free to handle their funds subject to statutes and rules, there should be no difficulty to ensure that the balance in the account is less than ten percent. It is essential to avoid the

malpractice, if any, of keeping aside cheque leaves for issue with dates shown as before 31st March, just to avoid cuts. Government may put in an effective vigilance system to check the malpractice, if any. 11. 16 Apart from this, there should also be monitoring of performance. For monitoring development expenditure, there is a competent body, the State Planning Board and its district set up. For the traditional functions as well as maintenance, a monitoring system is very essential. We recommend a three pronged system. Firstly the community based monitoring system being introduced in the state could cover certain services also like strengthening anganwadis, schools and hospitals. Secondly a system akin to the Citizen Report Card developed by the Public Affairs Centre could be introduced in all corporations, municipalities and Grama Panchayats, with urban characteristics,. Thirdly as envisaged in the Sound Audit Policy, a committee of eminent citizens including professionals could be set up at the district level to go around selected institutions and Local Governments, verify records, consult users, assess levels of service and report to Government. At the Government level different reports can be collected and a single report prepared and placed before the legislature. 11. 17 The new system we have outlined in this chapter can be put in position only after necessary staff are in position. Decisions will also have to be taken about accounting details and other procedures. Monitoring agencies will have to be formed. All this will take some time. There is no merit in rushing into such a new system without adequate preparation. We therefore recommend that the new system should come into force in 2008-09. 11. 18 When the new system is finally in position with all necessary safeguards, the following positive results will emerge. a. Local Self Governments will have freedom in handling their funds

b. That freedom will be regulated with appropriate checks and balance c. Timely expenditure will be easy, delayed expenditure will meet with punishment as cuts in future allotments

d. Quality of services will be ensured through monitoring so that the citizen is assured of reasonably efficient service e. Cluttering of the Public Account of State Government budgets with Local Self Government funds will be cleared f. At the same time, full expenditure from the relevant non-plan revenue head of account will be ensured, so that there will be a reasonable chance of the State's non plan revenue deficit on this item being substantially, if not fully, accepted by the respective Central Finance Commissions g. All Local Self Government functionaries,

appointed or elected, will be held

accountable for the decisions they take and the views they record in the process of decision-making. 11. 19 With the Right to Information Act in place, the Commission hopes that the common citizen will exercise the inalienable right to seek information on the process of decision making. That would, in the immediate future, not only demand accountability but also enforce it at the grassroot level.

CHAPTER 12 STRUCTURE AND SCOPE OF DEVELOPMENT EXPENDITURE 12. 1 The most important part of the work done by this Commission is the preparation of the summary financial profiles of all the Local Self Governments. We have explained earlier the advantages which the profiles could provide to Local Self Governments, State Government and academic institutions, in this chapter, we would bring out how the profiles would help in designing a well structured financing scheme for the developmental activities taken up by Local Self Governments as part of the State's Annual Plan. 12. 2 At present, the structure of financing the decentralized plan of Local Self Governments is that in the State Plan outlay, the amount given by State Government as plan grant is shown. The amount is fixed based on the policy decision that a given part of the Annual Plan should be implemented by Local Self Governments. Funds equal to that part (generally stated to be one third) of annual plan are to be given to Local Self Governments from the total resources assessed for financing the annual plan. 12. 3 This arrangement often causes two genuine difficulties for those who manage State Government's finances. Firstly, total resources for annual plan are not available to the State Government as such. Part of those resources is that of the State Electricity Board. Those resources of the Electricity Board are spent on their plan outlay, which is, no doubt, part of the State's annual plan. That part of the plan resources does not however go through State Government or their budget appropriations. But as the Local Self Governments have to be given plan grant equal to one third of annual state plan outlay (which includes power sector outlay fully financed by Electricity Board). State Government have to find funds additionally to make up the difference. The second difficulty is regarding some parts of State Plan outlay which (unlike in the KSEB case) do go through State Budget but cannot be touched for any other purpose. The main item is the outlay on externally aided schemes in the plan. That part of the outlay is funded by additional central assistance (major portion) and State's own plan funds (minor portion). Unless the total outlay on those schemes is spent, additional central assistance will be fully or partially lost. So in that context also, to find one third (of the total

annual plan outlay) to he given to Local Self Governments , Government has to find other funds (notwithstanding lower than budgeted additional central assistance coming in the form of reimbursement). Put in other words, though the policy decision is to have one third of the State's annual plan outlay spent on decentralized plan implemented through Local Self Governments, in effect, it will be possible only if Government locates funds substantially more than one third of the funds available in the budget (or even if available in budget, can be used for meeting the commitment to Local Self Governments). At the same time, the policy commitment to give one third outlay as plan grant to Local Self Governments cannot be violated. Government finds itself in a tough situation indeed. So, in actual practice, the amount provided for Local level planning in the Annual Plan goes below one third of the outlay. Further, actual releases is even less because of Government's ways and means as well as resources difficulties. 12. 4 What could be the solution? It is the Government's prerogative to decide what part of the State Plan should be implemented by Local Self Governments. So that cannot be altered except at the policy level. Even if it were altered as one fourth or so, the problem would still remain; only its dimension will change. 12. 5 Commission feels that this problem arose because of the method in which the policy decision was implemented. In public finance, it is a fundamental principle that there should be no confusion between source of funds and application of funds. These are two different things; there is no one to one linkage. We may explain this a little further. Outlay is application of funds. Grant (Plan grant in this case) is one source of funds. The policy decision that Local Self Governments should implement one third of annual plan does not necessarily mean that an amount equal to that should be given to them. They may need that amount; they may need only a lesser amount; they may need a higher amount. That depends on the financial position of Local Self Governments. Of course in that financial position of Local Self Governments, a major part is money given by Government for traditional functions, maintenance and also for development. 12. 6 We recommend the structure explained below for financing LSGs' developmental expenditure. Whatever funds Local Self Governments can generate from all

those sources for investment in plan, after meeting their non-plan expenditure, should be taken as their contribution in the plan financing Table. Whatever Government give to the Local Self Governments will reflect in the item Government's 'Balance from Revenues' in Plan financing Table. Plan outlay is a different thing. There, the total amount contributed by Local Self Governments should be shown as outlay to be implemented by Local Self Governments. If that amount falls short of one third (or any other proportion as decided by Government) of the State's total outlay, obviously Government will have to find funds to make up the shortfall as Local Self Governments would have exhausted all their sources of funds (For perfectionists who may ask for Constitutional mandate to give such grant, we would point out Article 282). In such a situation, commitment to any particular proportion will have to be given only after an assessment of State Government's ability to find and actually release funds required to meet that shortfall (in addition to the due share of taxes for development expenditure). If that is done, the conflict of interest between management of planning and management of public finance within Government would vanish. Local Self Governments should also be happy as what matters to them is not the size of the money promised in policy decisions, but the size of funds actually released to them.

12. 7 The foundation for erecting such a sound structure of decentralized planning is, Commission believes, in having a clear blueprint of the resources generation potential of LSGs. Commission attempted the mammoth work of assessing the finances of each Local Self Government keeping this (along with other advantages we have mentioned earlier) in view. From the 1215 summary financial profiles in Appendix II (see Chapter 7), we have consolidated Group summary financial position for each level of Local Self Government. So there are five such Group Summaries. From these five Group Summaries, we have worked out two Sectoral (Rural and Urban) summaries and then an Overall Summary Financial Position of all the five levels of Local Self Governments together. From these eight Tables (supported by 1215 Tables in Appendix II) a clear picture of the resources available with Local Self Governments for investment in developmental schemes during 2006-2011 emerge. We are adding to that some funds as further resources from their own revenue and reasonable level of borrowing and public contribution. Together, all that will add up to substantial contribution by Local Self Governments to Plan during each of the five years 2006-07 to 2010-11.

12. 8 Before proceeding to give those Tables, Commission would like to make one clarification. As the first attempt involving gigantic dimensions of data collection and complex series of discussions involved, there may perhaps be some shortcomings in the exercise. In spite of such shortcomings if any, we feel that these Tables do make a valuable contribution to the management of the fiscal relations between the State Government and the Local Self Governments. 12. 9 One more point needs to be clarified here before the eight Tables are presented. In the system we have just now explained, there is the possibility that when Annual Plan financing Table is prepared, deficit in non-plan revenue account will increase by the compensation given (as per our recommendation in the chapter on share of taxes) for development (eg: Rs.1400 crore in 2006-07). Of course that will not have any adverse impact on the overall position in the Plan financing Table, as that transfer will come back as Local Self Government contribution to plan financing. But in terms of State Government budget, non-plan revenue deficit will increase. Plan revenue deficit would however decrease as budget appropriations from Consolidated Fund will not be required for Local Self Governments' spending on plan. (Only drawals from public account and, ultimately, from LSGs' bank accounts will be involved). To those who may possibly criticise the increase in non plan revenue account deficit, we have to point out two aspects. The first is that, once the outgo from State budget is on the non plan revenue account side (and not on plan revenue account as of now), State can legitimately include it in the estimates of non plan revenue account expenditure presented before future Central Finance Commissions. That would make the shift of this expenditure from plan to non plan side revenue deficit neutral and may even result in higher gap grants under Article 275. The second aspect we have to point out is more important. In the existing system, the revenue deficit on account of plan grant to Local Self Governments is shown on the plan side. So it (the revenue deficit) does not go away; it is in Plan revenue account, though not in non plan revenue account. If revenue account deficit is bad for the management of public finance in our country, it is the total revenue account deficit which has to be tackled. Eliminating revenue account deficit or reducing it on non plan side but ignoring it or increasing it on plan side is like treating a patient for half the disease, leaving the other half to take its own course.

12. 10 Now we come to the Summary Tables. Five Group Summary Tables and one Overall Summary Table are given below. After the Group Summary Tables and before the Overall summary Table two Sectoral Summary Tables are given showing the total position of rural LSGs (Grama Panchayats, Block Panchayats and District Panchayats) and urban LSGs (Municipalities and Corporations). Under each Table, a diagram of the components of each item of receipt and expenditure included in the profile is also given. That will help immediate understanding of the relative importance of each item of receipt and expenditure.

Table 12. 1 -Group Summary Financial Position of GRAMAPANCHAYATS during the period 2006-07 to 2010-1 1 (Rs. in Thousand)

1 Properly Tax / Building Tax

782990

200708 856686

2 Profession Tax

584824

642757

706482

3 Entertainment Tax

88104

92500

97115

101961

107049

486729

4 Other Own Taxes

30907

33996

37393

41130

45240

188666

5 Total Tax Revenue

1486825 1625939 1778742

1946596

2130992

8969094

6 Non Tax Revenue

1070018 1176990 1294657

1424086

1566465

6532216

7 Total Own Revenues

2556843 2802929 3073399

3370682

3697457

15501310

1846584 2031242 2234366

2457803

2703583

11273578

1123610 1235983 1359594

1495569

1645143

No Itern

8 Management & Collection Expenditure 9 Civic Services Expenditure

2006-07

200809 937752

2009-10

2010-11 2006-11

1026924 1125014

4729366

776581 853689

3564333

6859899

10 Other Expenditure

250953

276049

303654

334019

367421

11 Repayment of Debt

48426

53269

58596

64455

70901

295647

12 Total Expenditure

3269573 3596543 3956210

4351846

4787048

19961220

13 Deficit (-)/ Surplus (+)

-712730

-981164

-1089591

-4459910

14739571

61462028

13649980

57002118

317850

1326205

9572001 10519493 11561509 12707490 13967830

58328323

14 TSFC Funds (Excluding Maintenance Funds) 15 Net Position 16 ARM 17 Funds Available for Developing and Expanding Services and Institutions

-793614

10067325 11074058

-882811

12181464 13399610

9354595 10280444 11298653 12418446 217406

239049

262856

289044

1 532096

Table 12.2- Group Summary Financial Position of MUNICIPALITIES during the period 2006-07 to 20 10- 11 (Rs. in Thousand) No Item 1

Property Tax / Building Tax

2006-07

2007-08

2008-09

2009-10

2010-11

2006-11

372573

407204

445298

487202

533296

2245573

196369

215730

237028

260455

286224

1195806

208527

218953

229901

241396

253465

1152242

26356

28991

31891

35080

38588

160906

5 Total Tax Revenue

803825

870878

944118

1024133

1111573

4754527

6 Non Tax Revenue

508649

559514

615466

677012

744713

3105354

1312474

1430392

1559584

1701145

1856286

7859881

334334

367767

404544

444998

489498

2041141

936430

1030816

1134751

1249208

1375258

5726463

10 Other Expenditure

67097

73806

81187

89306

98236

409632

11 Repayment of Debt

48138

52951

58246

64071

70478

293884

1385999

1525340

1678728

1847583

2033470

8471120

-73525

-94948

-119144

-146438

-177184

-611239

1480425

1628467

1791314

1970445

2167489

9038140

1406900

1533519

1672170

1824007

1990305

8426901

102812

113093

124402

136842

150526

527675

1509712

1646612

1796572

1960849

2140831

9054576

2 Profession Tax

3

Entertainment Tax

4 Other Own Taxes

7 Total Own Revenues

8

Management & Collection Expenditure

9 Civic Services Expenditure

12 Total Expenditure 13 Deficit (-) / Surplus (+)

TSFC Funds 14 (Excluding Maintenance

Funds) 15 Net Position

16 ARM 17 Funds Available for Developing and Expanding Services and Institutions

SUMMARY RECEIPT PROFILE FOR MUNICIPALITIES

Table 12. 4 - Group Summary Financial Position of BLOCK PANCHAYATS during the period 2006-07 to 2010-11 (Rs. in Thousand)

No

Item

2006-07 2007-08

2008-09

2009-10

2006-11

2010-11

1. Property Tax / Building Tax

0

0

0

0

0

0

2. Profession Tax

0

0

0

0

0

0

3. Entertainment Tax

0

0

0

0

0

0

4. Other Own Taxes

0

0

0

0

0

0

5. Total Tax Revenue

0

0

0

0

0

0

6. Non Tax Revenue

18473

20320

22352

24588

27046

112779

7. Total Own Revenues

18473

20320

22352

24588

27046

112779

8. Management & Collection Expenditure

74155

81571

89728

98701

108571

452726

9. Civic Services Expenditure

0

0

0

0

0

0

10. Other Expenditure

31

34

37

41

45

188

11. Repayment of Debt

476

524

576

634

697

2907

74662

82129

90341

99376

109313

455821

-56189

-61809

-67989

-74788

-82267

-343042

14. TSFC Funds (Excluding Maintenance Funds)

2041914

2246106

2470716

2717788

2989566

12466090

15. Net Position

1985725

2184297

2402727

2643000

2907299

12123048

1846

2031

2234

2457

2704

11272

1987571

2186328

2645457

2910003

12134320

12. Total Expenditure 13. Deficit (-) / Surplus (+)

16. ARM 17. Funds Available for Developing and Expanding Services and Institutions

2404961

SUMMARY RECEIPT PROFILE OF BLOCK PANCHAYATS

Table 12.5- Group Summary Financial Position of DISTRICT PANCHAYATS during the period 2006-07 to 20 10- 11 (Rs.in Thousand) No Item

2006-07

2007-08

2009-10

2008-09

2006-11

2010-11

1

Property Tax / Building Tax

0

0

0

0

0

0

2

Profession Tax

0

0

0

0

0

0

3

Entertainment Tax

0

0

0

0

0

0

4

Other Own Taxes

0

0

0

o

0

0

5

Total Tax Revenue

0

0

0

0

0

0

6

Non Tax Revenue

10058

11064

12171

13388

14726

61407

7

Total Own Revenues

10058

11064

12171

13388

14726

61407

8

Management & Collection Expenditure

59072

64979

71477

78624

86487

360639

9

Civic Services Expenditure

121

138

157

179

204

799

181

199

218

240

264

1102

0

0

0

0

0

0

59374

65316

71852

79043

86955

362540

-49316

-54252

-59681

-65655

-72229

-301133

2057022

2262724

2488997

2737896

3011686

12558325

2007706

2208472

2429316

2672241

2939457

12257192

1006

1106

1217

1339

1473

6141

2008712

2209578

2430533

2673580

2940930

12263333

10 Other Expenditure Repayment of Debt 11 Total Expenditure 12 13 14

Deficit (-) / Surplus (+) TSFC Funds (Excluding Maintenance Funds)

15 Net Position 16 ARM

17

Funds Available for Developing and Expanding Services and Institutions

SUMMARY RECEIPT PROFILE FOR DISTRICT PANCHAYATS

Table 12. 6 - Sectoral Summary Financial Position of RURAL LSGs during the period 2006-07 to 20 10- 11 (Rs.in Thousand) No

Item

2006-07

2907-08

2008-09

2009-10

1.

Property Tax / Building Tax

782990

856686

937752

1026924

2.

Profession Tax

584824

642757

706482

3.

Entertainment Tax

88104

92500

97115

4.

Other Own Taxes

30907

33996

37393

5.

Total Tax Revenue

1486825

1625939

6.

Non Tax Revenue

1098549

7.

Total Own Revenues

8.

2010-11

2006-11

1125014

4729366

776581

853689

3564333

101961

107049

486729

41130

45240

188666

1778742

1946596

2130992

8969094

1208374

1329180

1462062

1608237

6706402

2585374

2834313

3107922

3408658

3739229

15675496

Management & Collection Expenditure

1979811

2177792

2395571

2635128

2898641

12086943

9.

Civic Services Expenditure

1123731

1236121

1359751

1495748

1645347

6860698

10.

Other Expenditure

251165

276282

303909

334300

367730

1533386

11.

Repayment of Debt

48902

53793

59172

65089

71598

298554

12.

Total Expenditure

3403609

3743988

4118403

4530265

4983316

20779581

13.

Deficit (-)/ Surplus (+)

-818235

-909675

-1010481

-1121607

-1244087

-5104085

14.

TSFC Funds (Excluding Maintenance Funds)

14166261

15582888 17141177

18855294

20740823

86486443

15.

Net Position

13348026

14673213 16130696

17733687

19496736

81382358

16.

ARM

220258

266307

292840

322027

343618

17.

Funds Available for Developing and Expanding Services and

568284

14915399 16397003

18026527

818763

82725976

242186

Table 12.7- Sectoral Summary Financial Position of URBAN LSGs during the period 2006-07 to 20 10- 11 (Rs.in Thousand)

Item

2006-07

2007-08

2008-09

2009-10

2010-11

2006-11

1.

Property Tax / Building Tax

900697

984192

1076036

1177066

1288198

5426189

2.

Profession Tax

401376

441067

484729

532755

585584

244551 1

3.

Entertainment Tax

369747

388234

407646

428028

449429

2043084

4.

Other Own Taxes

35404

38944

42839

47123

51835

216145

5.

Total Tax Revenue

1 707224

1852437

2011250

2184972

2375046

10130929

6.

Non Tax Revenue

842122

926334

1018967

1120865

1232951

5141239

7.

Total Own Revenues

2549346

2778771

3030217

3305837

3607997

15272168

8.

Management & Collection Expenditure

612370

673607

740968

815064

896571

3738580

9.

Civic Services Expenditure

2056465

2262855

2489993

2739975

3015101

12564389

10. Other Expenditure

106426

117068

128775

141653

155818

649740

11. Repayment of Debt

81207

89327

98259

108085

118894

495772

12. Total Expenditure

2856468

3142857

3457995

3804777

4186384 17448481

13. Deficit (-)/ Surplus (+)

-307122

-364086

-427778

-498940

-578387

-2176313

14. TSFC Funds (Excluding Maintenance :Funds)

2833739

3117112

3428824

3771706

4148876

17300257

15. Net Position

2526617

2753026

3001046

3272766

3570489

15123944

209456

230403

253442

278784

306662

1278747

2736073

2983429

3254488

3551550

3877151

16402691

No

16. ARM 17. Funds Available for Developing and Expanding Services and

SUMMARY RECEIPT PROFILE FOR URBAN LSGs

Table 12. 8 - OVERALL SUMMARY Financial Position of Local Self Governments during the period 2006 -07 to 2010-11 (Rs.in Thousand)

Items

No 1.

Property Tax / Building Tax

2.

2006-07

2007-08

2008-09

2009-70

20IO-11

2006-11

1683687

1840878

2013788

2203990

2413212 10155555

Profession Tax

986200

1083824

1191211

1309336

1439273

6009844

3.

Entertainment Tax

457851

480734

504761

529989

556478

2529813

4.

Other Own Taxes

66311

72940

80232

88253

97075

404811

5.

Total Tax Revenue

3194049

3478376

3789992

4131568

4506038 19100023

6.

Non Tax Revenue

1940671

2134708

2348147

2582927

2841188 11847641

7.

Total Own Revenues

5134720

5613084

6138139 6714495

8.

Management & Collection Expenditure

2592181

2851399

3136539

3450192

3795212 15825523

9.

Civic Services Expenditure

3180196

3498976

3849744

4235723

4660448 19425087

10.

Other Expenditure

357591

393350

432684

475953

523548

2183126

11.

Repayment of Debt

130109

143120

157431

173174

1 90492

794326

12.

Total Expenditure

6260077

6886845

7576398

8335042

9169700

38228062

13.

Deficit (-)/ Surplus (+)

-1125357 -1273761

-1438259 -1620547 -1822474

-7280398

14.

TSFC Funds (Excluding Maintenance I Funds)

17000000 18700000 20570001 22627000 24889699 103786700

15.

Net Position

16.

ARM

17.

Funds Available for Developing and Expanding Services and Institutions

7347226 30947664

15874643 17426239 19131742 21006453 23067225 429714

472589

519749

571624

96506302

628689

2622365

16304357 17898828 19651491 21578077 23695914

99128667

SUMMARY RECEIPT PROFILE FOR LSGs

12, 11 From the Tables, the resources available at each level for expenditure on development and expansion of services and institutions transferred to Local Self Governments can be seen.

12. 12 The total funds available with all 1215 Local Self Governments together for each of the five years may be seen in column 17 of the Overall Summary Table. To this we would like to add some funds from their own revenue (in addition to what is included in the Summary Profiles), borrowing and public contribution.

12. 13 Keeping in mind our approach, as described in the chapter on mobilization of additional resource we are of the view that Grama Panchayats, Municipalities and Corporations can raise ten percent of their total own revenue receipts (column 7) as further resources from own revenue. This is to be achieved through better systemic arrangements we have narrated in that chapter. An equal amount (10 % of Column 7) should be raised as public contribution and borrowing together. Block Panchayats and District Panchayats do not have scope for additional revenue yields. However they should be able to raise a 10 (ten) per cent of the funds available (column 17) as borrowing and public contribution. We consider these reasonable and achievable targets. Taking these also into account the funds availability for developmental expenditure is given in the following Tables.

12. 14 At this stage Commission came across some cases of Local Self Governments where the funds available for development are less than what the Commission has recommended as share in taxes for financing development expenditure. For such Local Self Governments, we recommend grants to make up that shortfall for development expenditure. A list of the Local Self Governments in this group and the gap grants they get are given in Appendix III (Three). However as the total amount is too small, we are not including it for purposes of finalizing the funds availability for total Local Self Government Plan.

Table 12. 9 - Grama Panchayats (Rs. in Thousand) No

Item

2006-07

2007-08

2008-09

1

Funds Available for Developing and Expanding Services and Institutions

2

Further improvement in own revenues

255684

280293

307340

3

Borrowing

127842

140146

4

Public contribution

1 27842

140146

5

Total

9572001 10519493

10083369 11080078

2009-10

11561509 12707490

2010-11

2006-11

13967830

58328323

337068

369746

1550131

1 53670

168534

184873

775065

1 53670

168534

184873

775065

12176189 13381626

14707322

61428584

Table 12. 10 - Municipalities (Rs. in Thousand) No

Item

2006-07

2007-08

2005-09

2009-10

2010-11

2006-11

Funds Available for 1

Developing and Expanding Services and

1509713

1646611

1 796572

1960848

2140830

9054574

131248

143039

155958

170115

1 85629

785989

Institutions

Further improvement in 2

own revenues 3

Borrowing

65624

71520

77979

85057

92814

392994

4

Public contribution

65624

71520

77979

85057

92814

392994

5

Total

1772209

1932690

21 08488

2301077

2512087

10626551

Table 12.11 -Corporations (Rs. in Thousand) No Item

2006-07

2007-08

2008-09

2009-10

2010-11

2006-11

Funds Available for 1 Developing and Expanding Services and Institutions

1226361

1336817

1457916

1590701

1736320

7348115

123691

1 34842

147068

160474

175176

741251

3 Borrowing

61845

67421

73534

80237

87588

370625

4 Public contribution

61845

67421

73534

80237

87588

370625

1473742

1606501

1752052

1911649

2086672

8830616

2 Further improvement in own revenues

5 Total

Table 12.12 - Block Panchayats

(Rs. in Thousand) No Item

2006-07

2007-08

2008-09

2009-70

2010-11

2006- / 1

Funds Available for Developing and 1 Expanding Services and Institutions

1 987571

2186328

2404961

2645457

2910003

12134320

Further improvement in own revenues

0

0

0

0

0

0

99378

109316

120248

132273

145500

606715

99378

109316

120248

132273

145500

606715

2186327

2404960

2645457

2910003

3201003

1 3347750

2

3 Borrowing Public contribution 5 Total

Table 12.13 - District Panchayats (Rs. in Thousand) No 1

Item Funds Available for Developing and Expanding Services and Institutions

2006-07

2007-08

2009- 10

2008-09

2006-11

2010-3 1

2008712

2209578

2430533

2673580

2940930 12263333

0

0

0

0

0

0

2

Further improvement in own revenues

3

Borrowing

100436

110479

121527

133679

147047

613168

Public contribution

100436

110479

121527

133679

147047

613168

2209584

2430536

2673587

2940938

4

5 Total

3235024 13489669

Table 12. 14 - Rural LSGs (Rs. in Thousand) No

Item

2006-07

2007-08

2008-09

2009- 10

2010-11

2006-} I

Funds Available for 1

Developing and Expanding Services and Institutions

13568284

14915399

16397003

18026527

19818763

82725976

................

2

Further improvement in own revenues

255684

280293

307340

337068

369746

1550131

3

Borrowing

327656

359941

395445

434486

477420

1 994948

4

Public contribution

327656

359941

395445

434486

477420

1994948

5

Total

14479280

15915574

17495233

19232567 21143349

88266003

Table 12. 15 - Urban LSGs (Rs. in Thousand) No

Item

1

2006-07

Funds Available for Developing and Expanding Services and Institutions

2 Further improvement in

2007-08

2008-09

2009-10

2010-11

2006-11

2736074

2983428

3254488

3551549

3877150

16402689

254939

277881

303026

330589

360805

1527240

127469

138941

151513

165294

180402

763619

127469

138941

151513

165294

180402

763619

3245951

3539191

3860540

4212726

4598759

19457167

own revenues 3

Borrowing

4 Public contribution 5

Total

12. 15

So now Commission is in a position to draw up the picture of overall availability

of funds for expenditure on development and expansion

of services

and institutions

transferred to Local Self Governments, The following Table gives the picture. Table 12.16 Overall Position

(Rs. in Thousand) No

1

Item

2006-07

2007-08

Funds Available for Developing and Expanding Services and Institutions

16304358

17898827 19651491

Further improvement in own

2008-09

2009-70

20/0- 1 1

2006-11

21578076

23695913

99128665

2 revenues

510623

558174

610366

667657

730551

3077371

3

455125

498882

546958

599780

657822

2758567

455125

498882

546958

599780

657822

2758567

19454765 21355773

23445293

Borrowing

4 Public contribution

5 Total

17725231

25742108 107723170

12. 16 The Table given above is the final product of the efforts made by the Commission to assess the financial position of the LSGs, which is part of the Commission's mandate in terms of Articles 243 (I) and (Y) of the Constitution. The diagram given below shows the structure of the voluminous of work done in a relatively short period.

STRUCTURE OF DATA COLLECTION, ANALYSIS AND COMPILATION WORK DONE BY THIRD STATE FINANCE COMMISSION

GRAND TOTAL FUNDS (1 TABLE) (30 NUMBERS)

ADDITIONAL RESOURCES (7 TABLES) (210 NUMBERS)

OVERALL SUMMARY (1 TABLE) (102 NUMBERS)

SECTORAL SUMMARY RURAL AND URBAN (2 TABLES) 204 NUMBERS

GROUP SUMMARY (5 TABLES) 510 NUMBERS

FINANCIAL PROFILES (1215 TABLES) (ABOUT 1.25 LAKH NUMBERS)

MINI STATEMENTS (1215 x 3 TABLES) (ABOUT 6 LAKH NUMBERS)

PROFORMAE and D. C. B. (ABOUT 7 MILLION NUMBERS)

12. 17 The amounts given in the Overall Table can be investable funds of the Local Self Governments for the decentralized plan during the respective years. Those resources are higher than what State Government would give (as per our recommendations) as share in taxes for development expenditure, as may be seen in the Table below: Table 12. 17 Grand Total Funds available for Development Expenditure (Rs. in Thousand) 2006-07

1 2

3

2007-08

2008-09

Share of Taxes for 14000000 15400000 16940000 financing development expenditure Total amount available for 17725140 19454704 21355774 development expenditure, including share of taxes (column 1 above) Percentage of total amount 126.60 126.32 126.06 (column 2) to share of taxes (column 1)

2009- 10 18634000

2010-11 20497400

23445332 25742220

125.82

125.58

2006-11 85471400

107723170

126.03

During 2006 - 11, while Government would give Rs. 8547 crore (column 1) as share of taxes to meet development expenditure, the total funds available for development expenditure (including that amount of Rs. 8547 crore) will be Rs. 10772 crore. So total funds are 26.03 % higher than what Government gives. This means that, in our scheme, raising resources for development is a task in which State Government and Local Self Governments participate. We recommend that the structure of developmental financing of LSGs explained in this chapter may be adopted by Government and LSGs. 12. 18 In fairness to the Local Self Governments they should be allowed to include in their outlays their contribution to State sponsored and centrally sponsored schemes, as they have no other funds to meet that requirement. In case of State Government schemes implemented through LSGs, State Government share of funds to be separately given to LSGs. In other words State Governments financial responsibility in respect of such schemes should not be shifted to LSGs.

12. 19 We have made all these assessments on available data. The data should be continuously updated. Every year a resources forecast for Local Self Governments should be made just as a resource forecast for State Government is made. It should be on that basis that the availability of funds with Local Self Governments is to be assessed. If in any year, State Government want to have a level of decentralized plan (implemented by LSGs) higher than funds available with the Local Self Governments as per the resources forecast, the difference should be given as grant to them. 12. 20 It follows that there should be an institution which will do the resources assessment for Local Self Governments. But that should not be the only work of that institution. They should carry forward the work the Commission has initiated. If it is done, there will always be updated data on finances of Local Self Governments - both availability and requirement. Besides considerably improving the quality of the management of Local Self Government finances, that will also help in effectively presenting State's case before Central Finance Commissions. 12. 21 We recommend the establishment of a 'Board for Fiscal Research'. It should have a governing body headed by the Chief Secretary. The two Vice Chairmen may be Finance Secretary and Secretary of the Local Self Government Department. Members may be nominated by Government from among Secretaries to Government and acknowledged experts in the area of public finance and experts in the area of local governance. Member Secretary of the Board may be an officer of the rank of Special Secretary/ Additional Secretary experienced in this type of work drawn from Finance Department. The Board need not be a legal entity. Secretariat to service the Board may be decided by Government. But most of them should be from existing staff strength in the departments from which Government decide to take the staff for this work. Additions need be only two or three experts from academic /research institutions taken on contract basis for specific tenures. Till such an institution comes in position, the secretariat of this Commission (but not the Commission) may continue for updating and analyzing the mass of data now available.

CHAPTER 13 OTHER ISSUES 13. 1 In this chapter, Commission purposes to deal with two items in our terms of reference, not yet covered in the report. In addition, we would be dealing with certain issues which came to the notice of the Commission during discussions held at different levels. 13. 2 In S.R.O.No.1171/2004 dated 1st November 2004, the Commission has been asked to deal with the following issue. Annexure 13.1 "the transfer of budget to Local Self Governments for the payment of pay and allowances of employees working in institutions already transferred to Panchayats and Municipalities and modalities for the same". 13. 3 Commission has carefully considered this issue. The ultimate purpose of decentralisation initiated in the Constitutional amendment is to give full powers to LSGs to run the institutions transferred to them by the State Government. This will be realised only when LSGs are given authority over the establishments of those institutions. The most important aspect of such authority is the control of staff. For this purpose, in the ideal situation, recruitment of staff, determination of their wage levels and tenure and disciplinary control should be entirely within the power of the LSG concerned. In short, LSGs should have the same type of authority over those institutions as the State Government had while the institutions were under State Government control. Of course, the overriding power of the State Legislature will continue, as the LSGs do not have legislative bodies. All their powers and all their institutions are those authorised by the State Legislature either directly through statutes or through their executive arm, the State Government. Subject to such control as may be specified by the State Legislature, LSGs should have administrative, financial and disciplinary control in their assigned area of work and over institutions transferred to them. By this logic, it is obvious that disbursement of salary should also be done by the LSGs.

13. 4 While this is the theoretically correct situation, there are practical problems in achieving this. Unlike perhaps in any other State, vast powers and hugely expanded roles (including a substantial role in economic development) have been assigned to LSGs in Kerala. This also led to transfer of substantial amounts of public funds. As we have observed in different parts of our report, this transformation has created some problems. The major areas, relating to financial matters, have been dealt with in earlier chapters. In that context, we have stressed the need for a period of consolidation and stabilisation. Transfer of the salary budget of all employees of institutions will be another very major step. We are of the view that such a step should be considered only after the process of consolidation and stabilisation is well under way. Moreover in Kerala, salary disbursement cannot be handled in isolation. Nor would that be of any material use in promoting the interest of decentralisation, unless it is done as part of a well structured schedule to transfer effective control (administrative, disciplinary and financial) over staff and institutions. Taking all relevant aspects into account, we recommend that, for the time being, the existing arrangement may continue.

13.5 The other remaining issue in our terms of reference is, "the settlement of claims and dues of Panchayats ard Municipalities vis-a- vis Government and Governmental agencies".

The two main items are dues to Kerala Water Authority and

Kerala State Electricity Board.

Commission tried to study the issue in consultation with

both these organisations. Perhaps because of the complexity of* related accounts, these two institutions could give us data only at a late stage of our work when we had completed other work and were drafting the report. So there was no time to go into the data, obtain comments from LSGs concerned, examine the claims of both sides and make a recommendation. 13.6

However Commission would not like to pass over this important aspect

without expressing our view,

hi a matter of such divergent (if not conflicting) claims

(between the concerned institutions and the LSGs), no onetime settlement is practicable or desirable. There should be a process of continual dialogue and that should be umpired properly so that the argument does not go on indefinitely.

We recommend that a

permanent arrangement should be in position for this. Three officers (not below the rank of Joint Secretary) nominated by Finance, LSG and subject Departments should meet

once every quarter for adequate number of days and go in to the claims regarding the disputed part of the dues. Both sides should be heard and necessary records examined. The practicable arrangement will be to adjust at source (from share of taxes for traditional functions or development - depending on the nature of the claim) whatever amount is found to be payable by LSGs. But it should be done as per an agreed schedule which does not put the LSGs to financial difficulties. This should be the arrangement for future. For the past, Government may consider making appropriate grants from Government funds (in convenient annual instalments) to Kerala Water Authority and Electricity Board to liquidate half the arrears as assessed by the committee of officers. The other half may be recovered in easy annual instalments over a ten year period from funds to be released by Government to LSGs and paid to Kerala Water Authority/Kerala State Electricity Board. 13.7 Here we also deal with certain issues which came to our attention during various discussions. A serious problem adversely affecting the working of LSGs is the time taken in disbursement of different welfare pensions. Apart from our studies, the data collected by the Kerala University (while doing the study we entrusted with them) also bring out this position. Detailed data are available in their report. During our discussions with the staff of LSGs, this difficulty was highlighted repeatedly. 13. 8 In spite of this, Commission would not like to reverse the present arrangements totally. After all, these pensions benefit the weakest sections of our society. So LSG is the proper level to assess the eligibility of a person to get a pension. But this argument does not necessarily apply to disbursement of pension which is a mechanical work involving no selection or decision making. For disbursement to be effective, there should be adequate staff and other infrastructure with the agency which does the disbursement. 13.9 In view of these factors, Commission recommends that work of disbuiscrient (not the selection of beneficiaries) may be transferred back to the concerned Departments. They should be able to do this work at the District level or below without any additional staff and without recalling staff if any deployed to the LSGs. 13. 10 That brings us to the issue of staff availability in LSGs. At the Grama Panchayat level, there is real difficulty. Commission's impression is that with all the

shortcomings pointed out by various agencies, the staff in Grama Panchayats are doing strenuous work and that Grama Panchayats are understaffed. How to solve this problem is a difficult question. From the citizen's point of view there is no justification to spend public money on net addition to staff (in Government as LSGs together) as the total quantum of work remains the same. But the hard (and rather unpleasant) reality in Kerala is that it has not been possible to handle matters affecting staff, keeping (only or even primarily) the citizen's point of view in mind. The experience so far in transferring staff to LSGs is a pointer. In short, some addition to the staff strength in Grama Panchayats may be unavoidable. Another issue is audit work in LSGs. We do not want to go into the details of the present arrangement. The specific aspect brought to our notice is that too much time of the staff in LSGs is taken in responding to demands of audit. Some data collected by us also indicate this situation. It is being accepted worldwide that audit is not a policing function. It should be helpful and constructively corrective. 13. 12 Commission would recommend that, in consultation with Accountant General and Director of Local Fund Audit, a limit should be fixed on the number of days (in a month) when audit parties (of any organisation) would visit a particular LSG. 13. 13 A relevant point in this context is the issue of audit fees. Commission recommend that this system of levying audit fees may be dispensed with. Amounts involved are not so big as to make that a serious loss to State Government. Quit some paper work can be eliminated by doing so. 13. 14 One more issue remains; and that is important. In our discussions with Chairpersons of LSGs, the issue of exemptions/reduction in entertainment tax ordered by Government came up. Most of the Chairpersons were strongly of the view that such decisions affecting LSG finances should not be taken unilaterally by Government. Commission feels that it is a valid point. This will be particularly so when, in the structure of developmental financing recommended by us in this report, LSGs have to generate a part of the funds for development expenditure. Commission therefore recommends that before ordering any exemption/reduction in taxation which would adversely affect LSGs, State Government should obtain the recommendation of the LSGs.

CHAPTER 14 SUMMARY OF RECOMMENDATIONS Devolution of State Tax Revenues to Local Self Governments (Chapter 6)

14. 1 During the financial year 2006-2007, an amount of Rs. 2050 (Two Thousand and fifty) crore may be transferred to Local Self Governments, as their share of State tax revenues. Out of this amount, Rs.300 (three hundred) crore will be for expenditure on their traditional functions, Rs.350 (three hundred and fifty) crore for expenditure on maintenance of assets and Rs.1400 (fourteen hundred) crore for expenditure on developing and expanding services and institutions transferred to them by the State Government. During each of the four subsequent years, amounts derived by applying annual growth of ten percent may be so transferred. The total amount to be so transferred during the five years 2006-07 to 2010-11 will be Rs.12515 (Twelve thousand five hundred and fifteen) crore. 14. 2 Funds meant for expenditure on traditional functions and maintenance (eg. Rs. 300 crore and Rs.350 crore respectively in 2006-07) will be distributed among the LSGs following the same ratios as applied to the distribution of 3.5% and 5.5 % of State tax revenue (final audited figures) recommended by the Second State Finance Commission. The funds meant for expenditure on development (eg. Rs.1400 crore in 2006-07) will be distributed among the LSGs following the ratio applied for distributing plan funds. The amounts to be transferred to each LSG each of the five years for the three different types of expenditure are given in Appendix I. 14. 3 The entire amount may be provided in the State Government budget of the relevant years as 'Compensation and assignment to Local Self Governments' in Non-Plan revenue account under the major head of account 3604.

Mobilisation of additional resources (Chapter 8") 14. 4 Additional resources of three types can be raised by LSGs, (i) increase in tax and non tax revenues (ii) Public contribution (iii) borrowing. Additional revenue receipts should be raised through systemic improvement in administration of tax and non tax revenue items. 14. 5 Increasing rates may be done only after examining all the implications and not merely on the ground that there will be consequent increase in revenue receipts. Public contribution should be raised as cash contributions. Borrowing should be done only to a limited extent and there should be a clear schedule for repayment of outstanding debt. 14. 6 For systemic improvement, specific steps listed in para 8. 21 may be

implemented.

Release of funds (Chapter 9)

14. 7 Release of the share of tax revenue recommended in chapter 6 should be as per a schedule known to LSGs, so that they can plan their expenditure accordingly. Funds meant for traditional functions expenditure (eg.Rs.300 crore in 2006-07) should be released in twelve equal monthly instalments from April to March. Funds meant for maintenance expenditure (eg. Rs. 350 crore in 2006-07) should be released in ten equal monthly instalments from April to January. Funds meant for development expenditure (Rs. 1400 crore in 2006-07) should be released in ten equal monthly instalments from May to February (As illustration, for release of funds in 2006-07, a Table is given in para 9. 10).

14. 8 Problems arising in the smooth release of funds should be resolved through joint consultations, in a sprit of co-operation and mutual understanding, outlined in paras 9. 13(and9. 14

Drawal of funds (Chapter 10) 14. 9 Funds released as per the schedule specified in chapter 9 should be transfer credited from head of account 3604 to Public Account (major head of account 8448) before the 5l of every month. There will be three Deposit Accounts under 8448. Account I will be for funds for traditional expenditure (eg.Rs.300 crore in 2006-07). Account II will be for funds for maintenance (eg. Rs. 350 crore in 2006-07). Account III will be for development expenditure (eg. Rs. 1400 crore in 2006-07). The officers authorised to do the transfer credit are indicated in para 10.11.

14. 10 From head of account 8448, LSGs will draw funds for maintenance and development expenditure through Bills presented in the treasury, supported by all necessary documents based on actual requirement and for immediate disbursement. Funds for traditional functions (eg. Rs. 300 crore in 2006-07) can be drawn by cheques as is the practice now. Details of accounting procedure may be finalised in consultation with the Accountant General.

14. 11 If the amounts (for maintenance and development) remaining in the Public Account to the credit of individual LSGs on 31st March closing, is more than 10 (ten) percent of the total amount released (deposited in the Public Account to the credit of that LSG) during that financial year, the excess over ten (10) per cent will be reduced from the budget provision for that LSG for next year, as illustrated in para 10.15.

14. 12 For bills presented for drawal from Public Account within the limits of monthly release credited to the account of the LSG, there should not be any treasury restrictions or need for ways and means clearance from Finance Department. However for utilising that part of the fund, if any, carried over from the previous month's release, special authorisation from Finance Department will be required.

Fiscal freedom to LSGs (Chapter 11) 14. 13 Procedure specified in chapter 10 will be an interim arrangement 111 a system of full fiscal freedom is put in place. Under that system, funds released by Government from head of account 3604 should be allowed to be held by LSGs in Government controlled banks. LSGs should draw funds from bank, by cheques. Such drawal should be preceded by a procedure of financial scrutiny. 14. 14 There should be four bank accounts for each LSG (1) for traditional functions expenditure, (ii) for maintenance expenditure (iii) for expenditure on development of services and institutions (now known as decentralised plan) (iv) for agency functions like State sponsored schemes, centrally sponsored schemes, welfare pensions etc. 14. 15 Own tax and non-tax receipts and tax share for traditional functions (eg. Rs. 300 crore in 2006-07), will be the inflow in the first account. Tax share from State Government for maintenance (eg.Rs.350 crore in 2006-07) will be the inflow in the second account. Tax share for development (eg. Rs,1400 crore in 2006-07) will be the inflow in the third account. Funds received from State and Central agencies should be the inflow in the fourth account. There should be a separate stream of inflow and outflow for borrowed funds, their repayment and for the public contribution. The details of these accounts will have to be worked out in consultation with the Accountant General and Director of Local Fund Audit. 14. 16 It is essential to have a Finance and Accounts Wing even in Grama Panchayats. At least one person competent to handle these functions should be made available to each LSG. That could be on deputation to the maximum extent possible and unavoidable minimum number by fresh recruitment through Public Service Commission. The staff of the Performance audit can also be used to strengthen this structure. The personnel so appointed will be the nucleus of a Finance Wing in LSGs, 14. 17 Major expenditure proposals (over a limit laid down depending on the volume of financial transactions of each LSG) should be seen by that unit, before the Secretary of the LSG clears it. After the Secretary clears the proposal it should be seen by

the Chairperson of the respective standing Committee and the Chairperson of the Finance Standing Committee before approval by Chairman/Council. After the proposal is so approved, cheques will have to be prepared for drawal of funds. Such cheques should be signed both by the Secretary and the Chairperson of the Finance Standing committee. 14. 18 It will be the duty of the Finance Wing and the Secretary to point out the pros and cons of a decision proposed to be taken. If higher authorities (Chairpersons of Standing Committees, Deputy Chairperson, Chairperson) overrule them, they will have to own the responsibility for that decision. 14. 19 There should be a clear system to discourage delayed use of funds. The system will be as specified in para 11.15. 14.20 There should also be a system for monitoring performance, as specified in para 11.16.

14. 21

The new system of fiscal freedom can be put in position only after

necessary staff are deployed, accounting details worked out and monitoring agencies formed. The new system should come into force in 2008-09. Structure of developmental financing (Chapter 12) 14. 22 There should be a structure of developmental financing in which both the Government and the LSGs participate. Funds assessed as available for developmental expenditure in the financial profiles in Appendix II, enhanced by further mobilisation of resources from revenue receipts, borrowing and public contribution should be taken as LSGs' contribution in the Plan Financing Table. What Government gives as share of State taxes to LSGs should reflect in the item 'Balance from Revenues' in the Plan Financing Table. In the Plan outlay, the contribution from LSGs should be the outlay for decentralised Plan. 14. 23 If however the Government want that LSGs should have a higher share of State Plan (depending on Government policy) the difference between funds available with LSGs and that share of outlay should be given as grant by Government to LSGs. The detailed Tables given in chapter 12 illustrate the position regarding availability of funds with LSGs.

14. 24 In respect of a very small number of LSGs their total availability of funds for development expenditure is less than what Government gives as share of taxes for development expenditure. In such cases, gap grants may be given as indicated in Appendix III 14. 25 To update the financial profiles in Appendix II from time to time, make a resources assessment of LSGs each year before finalising the size of the decentralised plan to be implemented by LSGs and also to make other studies relevant in this area, a 'Board of Fiscal Research' headed by the Chief Secretary may be constituted. The details are in Para 12.21. Other Issues (Chapter 13) 14. 26 Regarding transfer of budget for payment of salary of employees working in institutions transferred to Panchayats and Municipalities, the existing arrangement may continue. 14. 27 For settlement of dues and claims between LSGs and Government agencies, there should a system of continual dialogue. The details are in para 13.6. 14. 28 Work of disbursement (not the selection of beneficiaries) of welfare pensions may be transferred to the concerned Departments. 14. 29 Some addition to staff strength of Grama Panchayats may be unavoidable. 14. 30 In consultation with Accountant General and Director of Local Fund Audit, a limit should be fixed on the number of days (in a month) when audit parties of any organisation would visit LSGs. 14. 31 Levy of audit fees may be dispensed with. 14. 32 Before ordering any exemption/reduction in taxation which would adversely affect LSGs, Government should obtain the recommendation of the LSGs.

CHAPTER 15 ACKNOWLEDGEMENTS 15. 1 We are grateful to each and everyone who helped us in this time consuming but challenging work. But for such help and co-operation, it would not have been possible to present our report within a period of fourteen months. 15. 2 First, we would like to express our gratitude to the State Government, the Chief Minister, Minister for Finance and Minister for Local Administration. Whenever we required any administrative clearance at that level, there was no delay in getting it. 15. 3 We had a series of perceptive discussions with the Chairpersons of the five levels of Local Self Government. This gave us a good idea regarding what the people feel about both the conceptual and operational problems faced by LSGs. The Chairpersons' suggestions to resolve them were also extremely useful inputs in our work. We record our gratitude to them. 15. 4 Principal Secretary, Finance ensured every infrastructural support required by the Commission. Such support kept the Commission secretariat well geared to bear the work load. Wherever we needed help from other Secretaries to Government and their officers, we had no difficulty in getting it. 15. 5 A special word of thanks is due to the Principal Accountant General and his officers. Apart from a very enlightening discussion we had with the Principal Accountant Genera] and his senior officers, we also .had the benefit of informal consultation whenever required. 15. 6 Commission also met eminent economists in a workshop session. Commission had the benefit of their technical inputs. We express our gratitude to them.

15. 7 The discussions we had with the staff of LSGs were very helpful to us. It gave us a good idea about problems at the grassroots level of administration. We also had the benefit of discussion with a few organizations representing staff. 15. 8. The cooperation we received from nodal officers of the departments of Panchayat, Urban Affairs and Rural Development helped us greatly in data collection work. 15. 9 Our work would not have been completed without the indomitable energy shown by the Commission Secretariat, A huge volume of work had to be done for the collection of data, analysis and compilation, working out of different formulae and their implications, preparation of Tables etc. All these were attended to with a high degree of diligence and dedication. Shri. E K Prakash, Secretary to the Commission put in untiring work in ensuring the smooth functioning of the Commission secretariat. Apart from personally handling the major part of the work, he could also inspire his team to put in their best. We are grateful to all the officers and staff of the Commission Secretariat. 15. 10 Now, a word about ourselves. The three of us -- Chairman and two members - worked as a team. The professional background of each one was complementary to that of the other two. This, we believe, enabled us to take a balanced view on issues regarding which widely differing views are possible.

V.S. Senthil Member

K.V.Rabindran Nair Chairman

P. Kamalkutty Member

GOVERNMENT OF KERALA Finance (SS) Department NOTIFICATION No. 30308/SS/04/Fin.

Dated, Thiruvananthapuram, 20th September2004.

S.R.O. No. 1037/2004.- Under clause (1) of Article 243-1 of the Constitution of India and section 186 of the Kerala Panchayat Raj Act, 1994 (13 of 1994), read with clause (1) of Article 243-Y of the Constitution of India, and section 205 of the Kerala Municipality Act, 1994 (20 of 1994), the Governor of Kerala is pleased to constitute a Finance Commission consisting of Sri. K.V. Rabindran Nair (Retired Chief Secretary) as the Chairman and the following two persons as part-time members, namely;(1)Sri. V.S. Senthil, Secretary (Finance Expenditure) (2)Sri. P. Kamalkutty, Secretary (Local Self Government Department). 2, The Chairman and other members of the Commission shall hold Office for a period of one year from the date of this notification. 3. The Finance Commission shall review the financial position of the Panchayats and Municipalities and make recommendations as to(a) The principles which should govern, (i)

the distribution between the State, Panchayats and Municipalities of the net proceeds of the. taxes, duties, tolls and fees leviable by the State, which may be divided between them under Part IX and Part IX- A of the Constitution and the allocation between the Panchayats at all levels and the Municipalities of their respective shares of such proceeds;

(it)

the determination of the taxes, duties, tolls and fees which may be assigned to or

appropriated by the Panchayats and the Municipalities; (iii)

the grants-in-aid to the Panchayats and the Municipalities from the Consolidated Fund

of the State, (b)

The measures needed to improve the financial position of the Panchayats and the

Municipalities with reference to;(i)

the scope for local bodies to raise institutional finance and to suggest a frame-work for local self governments to take recourse to such sources along with procedures to be followed and limits, if necessary, to raise such resources;

(ii)

the need for sharing the cost of maintenance of assets and institutions transferred to

local self-governments, and evolving criteria for it, with due regard to the fiscal position of the State Government and the local self governments; (iii)

the steps necessary for efficient financial management with particular reference to

efficiency in resource mobilisation and economy in expenditure. (iv)

the settlement of claims and dues of Panchayats and Municipalities vis-a-vis Government and Governmental agencies;

(v)

the procedures to be followed for smooth flow of funds to local self governments and

for ensuring proper financial accountability. (vi)

the systems and procedures with respect to budgeting, accounting and auditing.

(vii)

the incentives for higher resource mobilisation and efficiency in resource use.

(viii)

the systems and procedures for monitoring the fiscal performance of local self governments,

(ix)

providing for specific fiscal responsibilities on local self - governments.

4. Orders regarding the terms and conditions of appointment of the Chairman and other members of the Commission will be issued separately. By order of the Governor, K. JOSE CYRIAC, Principal Secretary (Finance).

Explanatory Note (This does not form part of the notification, but is intended to indicate its general purport.) As per clause (i) of Article 243-1 of the Constitution of India, and section 186 of Kerala Panchayat Raj Act, 1994 (Act 13 of 1994) read with clause (1) of Article 243-Y of the Constitution of India and section 205 of the Kerala Municipality Act, 1994 (20 of 1994) the Governor shall constitute a Finance Commission to review the financial position of the panchayats and municipalities and make recommendations. Accordingly, the Governor of Kerala has been pleased to constitute the Finance Commission. The notification is intended to achieve the above object.

GOVERNMENT OF KERALA Finance (SS) Department NOTIFICATION Dated, Thiruvananthapuram, I9th October, 2005.

No. 74601/SS/2005/Fin.

S.R.O. No. 951/2005. - Under clause (1) of Article 243-1 of the Constitution of India and Section 186 of the Kerala Panchayat Raj Act, 1994 (13 of 1994), read with clause (1) of Article 243-Y of the Constitution of India, and Section 205 of the Kerala Municipality Act, 1994 (20 of 1994), the Governor of Kerala is pleased to extend the term of the 3rd State Finance Commission from 20th September, 2005 to 30th November, 2005 and consequently makes the following Amendment to Notification No. 30308/SS/04/Fin. dated 20th September, 2004 published as S.R.O. NO. 1037/2004 in the Kerala Gazette Extraordinary No. 2023 dated the 22nd September, 2004, namely;AMENDMENT In the said Notification in paragraph 2, for the words "for a period of one year form the date of this Notification" the words and figures " till 30Ib November 2005" shall be substituted.

By order of the Governor, K JOSE CYRIAC, Principal Secretary (Finance)

Explanatory Note (This does not form part of the notification, but is intended to indicate its general purport). The term of the commission was fixed as one year form the date of notification constituting the 3rd State Finance Commission as S.R.O. No. 1037/2004 in Kerala Gazette Extraordinary. As such the period of the 3rd State Finance Commission expires on 19th September, 2005. The Commission has recommended the extension of its term since the preparation of tables for each of the Local Self Governments would take time upto 30th November 2005. Accordingly, the Governor of Kerala has been pleased to extend the term of the 3rd State Finance Commission from 20th September 2005 to 30th November, 2005. The Notification is intended to achieve the above object.

A NOTE ON ACCOUNTING REFORMS DONE SO FAR

In pursuance of the recommendations of the Eleventh Central Finance Commission and the advice of the Government of India the Government of Kerala entrusted the audit of LSGs in Kerala under Section 20(1) of the Controller and Auditor General's (DPC) Act, 1971 to the Comptroller and Auditor General of India in October, 2002. The Government order on entrustment (G O (P) 631/2002/Fin dated 17 October, 2002) provided for Technical Guidance and Supervision of Comptroller and Auditor General over the Director of Local Fund Audit (DLFA) for the audit of LSGIs, transaction audit often per cent LSGs on random basis and supplementary audit often per cent LSGs where Director of Local Fund Audit had conducted audit. In addition to the audit as above, Comptroller and Auditor General has been conducting audit of the accounts of all LSGs in the State on the authority of sections 14 and 15 of the Comptroller and Auditor General's (DPC) Act, 1971, which empowers him to conduct audit of bodies or authorities receiving grant or loans from the consolidated Fund. 2. The Eleventh Central Finance Commission also recommended that the CAG report shall be presented to a Committee on Local Funds constituted by the Legislature. The State Legislature has constituted a committee on Local Fund Accounts. The first report of the Comptroller and Auditor General on the LSGs of the State was placed in the State Legislature in July 2005. This relates to the year ended 31st March 2004. Earlier, the paragraphs relating to LSGs were included in the CAG Report (Civil). Accounts

3. The Eleventh Central Finance Commission also recommended that the Comptroller and Auditor General shall prescribe the formats for budgets and accounts for the LSGs. Comptroller and Auditor General has prescribed the formats for Rural LSGs and Urban LSGs separately. While the LSG Budget - Account formats are on cash basis and on a pattern similar to that of the State Government Accounts, the Urban LSGs- Accounts formats are on accrual basis. The state Government have approved both the formats (LSG formats by GO (P) 319/2003/Fin dated 12 June 2003 and the Urban LSGs formats in September 2004. Pending adaptation by the State Government, the Urban LSGs have not become operative.

Steps taken by the Accountant General 4. Auditing standards for LSGs and Urban Local Bodies and the Guidelines for certification of LSG Accounts' have been forwarded to Government for adopting them and making them applicable to the Local Fund Audit Department.

Supplementary Audit of institutions where DLFA had

conducted audit was conducted. Besides, transaction audit as entrusted by State Government and also under section 14 and 15 were conducted. The results are included in the Comptroller and Auditor General Report prescribed to the Governor in addition to the Local Audit Reports issued to each LSG.A training for the senior officers of the Local Fund Audit was conducted in the office of the Accountant General. In the regular training courses conducted in the Office of the Accountant General, a few slots are provided for the officers /staff of the Local Fund Audit Department. 5. The Officers of the Principal Accountant General (Audit) imparted training to above 4500 employees belonging to the tree-tier LSGs, Local Fund Audit Department and performance Audit Wing. The first batch of training was conducted in the Kerala Institute of Local Administration (KILA), Thrissur and at the Institute of Management in Government (IMG) at Thiruvananthapuram during January-February March 2004. Subsequent batches were trained between June 2004 and July 2005 at KILA, Thrissur. 6. Besides the direct training as above imported to the tree-tier LSG employees including Secretaries, Local Fund Audit and Performance Audit Officer and Staff, Training of trainers (TOT) programme was conducted at KILA, Thrissur. The Training of trainers Programme was also conducted by the officers of the Accountant General's Officer. The trainers who were trained in the Training of trainers Programme imported training to 5000 persons including elected representatives and employees in the Training programmes held at the 14 District Centers. 7. The Principal Accountant General (Audit) provides faculty support for the training programme on accounts conducted at KILA, Thrissur whenever he is requested.

8. In the three tier LSGs, the formats of budgets and accounts have become operative from 1 April 2004. Consequently, incorporation of the entire transaction of the LSGs in a single cash book, closing of the cash book daily, entrusted of accounting book to an 'Accountant' in each LSG and the background for the preparation of an Annual Financial statement incorporating the entire transactions of the LSGs have become features of the LSG Accounts keeping. 9. The clearance of arrears in the preparation of the Accounts and Demand, Collection, Balance (DCB) Statements for the previous years and the issue of Accounts Rules, Accounts Manual, Budget Rules and Budget Manual are the tasks lying ahead for the LSGs.

GOVERNMENT OF KERALA Finance (SS) Department NOTIFICATION No. 843317/SS/04/Fin.

Dated; Thiruvananthapuram, 1st November 2004.

S.R.O. No. 1171/2004.- Under clause (I) of Article 243-1 of the Constitution of India and section 186 of the Kerala Panchayat Raj Act, 1994 (13 of 1994), read with clause (1) of Article 243-Y of the Constitution of India, and section 205 of the Kerala Municipality Act, 1994 (20 of 1994), the Governor of Kerala is pleased to add an item within the terms of reference of the Finance Commission constituted for their recommendation and consequently makes the following amendment to the Notification No. 30308/SS/04/Fin. dated 20th September, 2004 published as S.R.O No. 1037/2004, in Kerala Gazette Extraordinary No. 2023 dated the 22nd September, 2004, namely: -

AMENDMENT In the said Notification, after item (ix) in Sub-clause (b) of Clause 3, the following item shall be inserted, namely:"(x) the transfer of budget to Local Self Governments for the payment of pay and allowances of employees working in institutions already transferred to Panchayats and Municipalities and modalities for the same". By Order of the Governor,

K. JOSECYRIAC, Principal Secretary (Finance).

Explanatory Note (This does not form part of the notification, but is intended to indicate its general purport.) Government have decided to refer the issue of transfer of budget to Local Self Governments for the payment of pay and allowances of employees in the institutions already transferred to Panchayat and Municipalities and the modalities of the same, to the Finance Commission for their recommendation. This notification is intended to achieve the above object.