Local governments, at both rural level – Panchayati Raj Institutions (PRIs) and urban level – Urban Local Bodies (ULBs), have been receiving Grants-in-Aidas per the recommendations of the Central Finance Commission (CFC) and the State Finance Commissions (SFCs). Largely, the purpose of these grants is to give untied funds to the local government bodies – PRIs and ULBs, in order to prioritise, plan and provide basic services at the local level. Apart from the CFC and SFCs grants, PRIs and ULBs may also receive funds from different sources such as Centrally Sponsored Schemes (CSSs), State Sponsored Schemes, State Plan Fund, Own Source Revenue (OSR), Member of Parliament Local Area Development (MP LAD) Fund, Member of Legislative Assembly Local Area Development (MLA LAD) Fund and borrowings.
Decentralisation as a Tool for Better Governance
Decentralisation of financial power to lower level of government from the upper tier of the government has been the agenda of global development movements since a long time. In a large number of countries, lower tier of government is being made responsible for provisioning of the majority of public services, and national and sub-national governments have transferred large part of decision-making power and control over public spending to the local government. In many developing countries, the process of decentralisation was initiated due to mainly poor public service delivery under the centralised system of governance. In such a system, the top-down approach in decision-making and supply-oriented system of delivery of goods and services resulted corruption and inefficiency in meeting the felt needs of local people. In this respect, the concept of decentralisation was conceived for addressing these problems through the bottom-up and demand-oriented approach for service delivery system by establishing the local self-government.
Essentially, the process of decentralisation aimed at bringingthe government closer to the people through transfer of power to the lower level of government (political, administrative and fiscal). The Fiscal decentralisation involves the transfer of decision-making power of revenue collection, generation and spending to local government. It makes governance system more responsive, efficient and effective in providing public services at appropriate levels. Also, it improves accountability and people’s participations in all the development programmes by preparing local level plan and budget.
Moreover, decentralisation could ensure that the benefit of development programmes reaches the poor. It would also improve utilisation of locally available scarce resources and public funds. The Government of India Task Force on decentralisation 2011 says that decentralisation in the context of Panchayats means that when the authority is transferred from the state to the local governments, that should have the prerogative to take decision on planning and implementation of such activity.
Constitutional Vision for Panchayati Raj
Following the Independence, the Constitution recognised the importance of Panchayats and Article 40 of DPSP reads the State shall take steps to organise village Panchayats and endow them such power and authority as may be necessary to enable them to function as units of local self-government. As per 73rd Constitution Amendment Act (CAA) 1992, power would be devolved to the panchayats along with funds, functions and functionaries (3 Fs) by each state government. The state governments evidently evolved their own Panchayati Raj Acts and the extent of devolution was left to be decided according to local needs, due to which it varied widely across the country. In terms of governance reforms and institutional restructuring, the 73rd CAA serves as a landmark, according to PRIs constitutional status and laying the foundation for their functioning as institutions of local self-governance. But nearly 17 years down the line, rural development programmes remain largely implemented through line departments and District Rural Development Agencies (DRDAs) that are prone to bureaucratic control.
The 73rd CAA provided an opportunity for establishing independent units of local self-government institutions and gave a clear mandate to PRIs to prepare plans for economic development and social justice by being entrusted implementation of schemes. Accordingly, the 11th Schedule of the Constitution laid down a list of 29 subjects to be devolved to the panchayats along with funds, functions and functionaries (3 Fs) by each state government.
Finance Commissions and Local Government Financing
Following Articles 280(3)(bb) and 280(3)(c) of the Constitution, the Terms of Reference of the 16thFinance Commission direct it to recommend “the measures needed to augment the Consolidated Fund of a State to supplement the resources of the panchayats and municipalities in the State on the basis of the recommendations made by the Finance Commission of the State”.
The Central Finance Commission (CFC) was set up in 1951 to define the financial relations between the Union Government of India and state governments. It is constituted once every five years by the President of India under Article 280 of the Constitution to recommend on sharing of fiscal resources between the Union and the States, a major part of which pertains to sharing of revenue collected in the Central Tax System. The total amount of revenue collected from all Central taxes, excluding the amount collected from Cesses, Surcharges and taxes of Union Territories, and an amount equivalent to the cost of collection of Central Taxes, is considered the shareable/divisible pool of Central tax revenue. In the recommendation period of the 13th FC (2010-11 to 2014-15), 32 per cent of the divisible pool of Central tax revenue used to be transferred to States every year, which was increased to 42 per cent by the 14th FC (for 2015-16 to 2019-20).
Centre-State Revenue Sharing Framework
The share of states in the divisible pool of central taxes has been recommended by the 16thFinance Commission at 41% but it makes no recommendation on non-shareable cess and surcharge, which has been a concern for all States. Former RBI governor, Mr. C.Rangarajan said: “This is unfortunate. The Sixteenth Finance Commission recommended a ‘grand bargain’ between the Centre and States, so that States would agree to a smaller share provided the Centre agreed to merge a large part of the cesses and surcharges in the regular taxes.”
This recommendation is same as the share recommended by the 15thFinance Commission (2021-2025). Divisible pool is arrived at after excluding cost of collection and cesses and surcharges from the gross tax revenue collected by the UnionGovernment.
The central Finance Commission (16thFC) adopted objective parameters for horizontal devolution among states by the government of India. The parameters include population, with a weight of 17.5 percent, demographic performance, area, forest cover and contribution to GDP (10 percent for each) and per capita GSDP (42.5 percent). The highest weightage was given to per capita GSDP in terms of 42.5 percent in total weight. It shows the income distance as the difference between the per capita GSDP of a state and the average of the per capita GSDP of the top three large states with the highest per capita GSDP. Per capita GSDP has been computed as the average over the period 2018-19 and 2023-24, excluding the pandemic year of 2020-21.
Promoting Equity Through Income Distance and Demographic Performance
In case of the parameter of income distance, the States with a lower per capita GSDP will receive a higher share to maintain equity among states. The second highest weight was given to population and through this parameter, the share in devolution is determined based on the share in the population as per the 2011 Census. The 16thFC has redefined this to account for population growth between 1971 and 2011 instead of relying on change in TFR. States with lower population growth will have a higher share under this parameter. The 16thFC has assigned weightage to both the share of a state in the overall forest area, and its share in the increase in overall forest area between 2015 and 2023. The 16thFC has introduced the parameter to gauge the contribution to national GDP. This parameter has been replaced with tax and fiscal effort used by the 15thFC which rewarded states with a higher tax collection efficiency.
Table 1: Criteria adopted for distribution of central taxes among states by 16th FC
| Criteria | 15th FC (2021-26) | 16th FC (2026-31) |
| Income Distance | 45% | 42.50%
|
| Population (2011) | 15% | 17.50% |
| Demographic Performance | 12.50% | 10% |
| Area | 15% | 10% |
| Forest | 10% | 10% |
| Tax and Fiscal Efforts | 2.50% | – |
| Contribution to GDP | – | 10% |
| Total | 100% | 100% |
Source: Compiled from Report of the 15th and 16th Finance Commission
The Commission recommended reducing the Union government’s fiscal deficit to 3.5% of GDP by 2030-31 and maintaining the states’ fiscal deficit at 3% of GSDP annually. It emphasised ending the practice of off-budget borrowings and incorporating all such liabilities into official budgets. The definitions of fiscal deficit and public debt should also be revised to include these borrowings. According to the Commission’s projections, the combined debt of the Centre and states is expected to decline from 77.3% of GDP in 2026-27 to 73.1% in 2030-31.
Power Sector Reforms and Rationalisation of Subsidies
To improve efficiency in the power sector, the Commission encouraged states to pursue the privatisation of electricity distribution companies (DISCOMs). It proposed creating a special purpose vehicle (SPV) to absorb existing DISCOM debt, thereby reducing the financial burden on private investors. Funds available under the Special Assistance Scheme for Capital Investment may be used to repay this debt, but only after the privatisation process has been completed. The Commission advised states to reassess and streamline their subsidy programmes. It highlighted concerns that unconditional cash transfer schemes often benefit a broad and poorly targeted population. To improve effectiveness, states should establish clear eligibility and exclusion criteria and regularly review beneficiary coverage.
The Commission also recommended ending the use of off-budget borrowings to finance subsidies. Furthermore, it called for a uniform accounting and disclosure framework for subsidies and transfers, as current practices vary significantly across states and often result in misclassification of expenditures.
The Commission proposed the review and closure of 308 inactive State Public Sector Enterprises (SPSEs) and recommended that states develop disinvestment policies focusing on inactive and poorly performing enterprises. It further suggested that any state or union public enterprise reporting losses in three out of four consecutive years should be reviewed by the respective Cabinet, which may decide whether to close, privatise, or continue the enterprise based on its strategic importance.
Local Body Grants: A Major Push for Grassroots Governance
The 16th FC has recommended grants worth Rs. 9.47 lakh crore over the five-year period. These comprise grants for: (i) urban and rural local bodies, and (ii) disaster management. But it has discontinued the grants recommended by the 15th FC such as revenue deficit grants, sector-specific grants and state specific grant. According to the recommendation made by 16th FC, the grants worth Rs. 4.4 lakh crore and Rs. 3.6 lakh crore to be transferred for rural and urban local bodies, respectively. These grants have been divided into two components namely basic (80%) and performance-based (20%). The urban local bodies would also receive special Infrastructure Grants and Urbanisation Premium Grants. All local body grants will be made available upon fulfilment of three entry-level criteria: (i) constitution of local bodies as per the Constitution, (ii) publication of provisional and audited accounts of local bodies in the public domain, and (iii) timely constitution of the State Finance Commission.
Basic Grants: Half of the basic grants will be untied, allowing local bodies flexibility in spending. The remaining 50% will be earmarked for sanitation, solid waste management, and water management activities.
Performance Grants: Performance-based grants are divided into two categories:
- State Performance Grants, linked to the extent of financial transfers made by states to local bodies from their own resources.
- Local Body Performance Grants, awarded based on the achievement of targets for increasing own-source revenues.
Special Infrastructure Grants and Urbanisation Premium Grant: The Commission proposed ₹56,100 crore over five years for the development of comprehensive wastewater management systems in cities with populations between 1 and 4 million (10–40 lakh), as per the 2011 Census. A one-time allocation of ₹10,000 crore has been recommended to support states to integrate peri-urban villages into neighbouring urban local bodies, and formulate policies to manage the transition from rural to urban areas.
Disaster Management Grants: The Commission recommended a total disaster management corpus of ₹2,04,401 crore for State Disaster Relief Funds (SDRFs) and State Disaster Mitigation Funds (SDMFs). The Centre and states will share this expenditure in the ratio of 90:10 for north-eastern and Himalayan states and 75:25 for all other states. The Centre’s contribution is estimated at ₹1,55,916 crore.
Table: Grants to the Local Bodies
| Grants | Amount |
| Local governments | 7,91,493 |
| Rural local bodies | 4,35,236 |
| Basic Grant | 3,48,188 |
| Performance Grant | 87,048 |
| Urban local bodies | 3,56,257 |
| Basic Grant | 2,32,125 |
| Performance Grant | 58,032 |
| Special Infrastructure Component | 56,100 |
| Urbanisation Premium | 10,000 |
| Disaster management | 1,55,916 |
| Total | 9,47,409 |
Source: Compiled from the Report of the 16th Finance Commission
Gram Panchayat Development Plans and Participatory Planning
For inclusive development, a decentralised planning Gram Panchayat Development Plan (GPDP) was introduced by Ministry of Panchayati Raj (MoPR) in the backdrop of increased devolution of fund to Gram Panchayats (GPs) by the 14thFinance Commission and starting of Intensive Participatory Planning Exercise for MGNREGA. GPDP started in 2015 for preparing exclusive development Plan for providing the basic services within the functions devolved to Gram Panchayats as per State laws before incurring expenditure under the 14th Finance Commission award. GPDP processes had the several development sectors and components like poverty reduction, human development including children, social development, economic development, ecological development, and public service delivery, good governance for addressing vulnerabilities of poor and marginalised people.
GPDP processes should also ensure the participation SCs, STs, OBCs and minorities while using the 16thFinance Commission Grant. In the usage guideline of 16thFinance Commission Grant, the Ministry of Finance should specifically mention the SCs, STs, OBCs and minorities for earmarking the fund for them.
[The writer is Director of the Institute of Policy Studies and Advocacy, New Delhi. (jawedalamk@gmail.com)]