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.
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.
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.
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.
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)
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
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)
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
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)
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).
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
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.
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
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
place (i.e. 2008-09, as recommended in para 14.21 below).
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
There should also be a system for monitoring performance, as specified in para 11. 16.
Action Taken
Accepted
Structure of Developmental Financing (Chapter 12)
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
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
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.
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)

Regarding transfer of budget for payment of salary of employees working in
institutions transferred to Panchayats and Municipalities, the existing arrangement may
continue.
Action Taken
Accepted.
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.
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.
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.
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.
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.
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, self-
governments. 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 31-3-
2011. The main objective of collecting data for the earlier five years - from 1-4-2001 to 31-
3-2006 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 2001-
02,2002-03,2003-04 and 2004-05 (Latest Estimates given by LSGs in the Second half of 2004-
05) 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 non-
lax 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 pensions-
Commission 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 300 330 363 399 439 1831
functions
2 Maintenance 350 385 424 466 512 2137
3 Expansion,
1400 1540 1694 1863 2050 8547
Development
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 2004-
05, 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
Funds for Funds for
Month Traditional Total
Maintenance Development
functions
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
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)
No Itern 2006-07 2007- 2008- 2009-10 2010-11 2006-11
08 09
1 Properly Tax / Building Tax 782990 856686 937752 1026924 1125014 4729366
2 Profession Tax 584824 642757 706482 776581 853689 3564333
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
8 Management & Collection

1846584 2031242 2234366 2457803 2703583 11273578
Expenditure
9 Civic Services Expenditure 1123610 1235983 1359594 1495569 1645143
6859899
10 Other Expenditure 250953 276049 303654 334019 367421
1 532096
11 Repayment of Debt 48426 53269 58596 64455 70901 295647
12 Total Expenditure 3269573 3596543 3956210 4351846 4787048 19961220
13 Deficit (-)/ Surplus (+) -712730 -793614 -882811 -981164 -1089591 -4459910
14 TSFC Funds 12181464 13399610

(Excluding Maintenance Funds) 10067325 11074058 14739571 61462028
15 Net Position 9354595 10280444 11298653 12418446
13649980 57002118
16 ARM 217406 239049 262856 289044
317850 1326205
17 Funds Available for Developing 9572001 10519493 11561509 12707490 13967830 58328323
and Expanding Services and
Institutions
Table 12.2- Group Summary Financial Position of
MUNICIPALITIES during the period 2006-07 to 20 10- 11
(Rs. in Thousand)
No Item 2006-07 2007-08 2008-09 2009-10 2010-11 2006-11
1
Property Tax / Building
Tax
372573 407204 445298 487202 533296 2245573
2 Profession Tax 196369 215730 237028 260455 286224 1195806

4 Other Own Taxes 26356 28991 31891 35080 38588 160906
6 Non Tax Revenue 508649 559514 615466 677012 744713 3105354
Management & Collection

8
Expenditure
334334 367767 404544 444998 489498 2041141
9 Civic Services Expenditure 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
12 Total Expenditure 1385999 1525340 1678728 1847583 2033470 8471120
13 Deficit (-) / Surplus (+) -73525 -94948 -119144 -146438 -177184 -611239
TSFC Funds
14 (Excluding Maintenance 1480425 1628467 1791314 1970445 2167489 9038140
Funds)
15 Net Position 1406900 1533519 1672170 1824007 1990305 8426901
16 ARM 102812 113093 124402 136842 150526 527675
17 Funds Available for

Developing and Expanding 1509712 1646612 1796572 1960849 2140831 9054576
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 2010-11 2006-11
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
12. Total Expenditure 74662 82129 90341 99376 109313 455821
13. Deficit (-) / Surplus (+) -56189 -61809 -67989 -74788 -82267 -343042
14. TSFC Funds 2041914 2246106 2470716 2717788 2989566 12466090

(Excluding Maintenance Funds)
15. Net Position 1985725 2184297 2402727 2643000 2907299 12123048
16. ARM 1846 2031 2234 2457 2704 11272
17. Funds Available for Developing 1987571 2186328 2645457 2910003 12134320
and Expanding Services and 2404961
Institutions
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 2008-09 2009-10 2010-11 2006-11
1 Property Tax / Building Tax 0 0 0 0 0 0
2 Profession Tax 0 0 0 0 0 0
4 Other Own Taxes 0 0 0 o 0 0

6 Non Tax Revenue 10058 11064 12171 13388 14726 61407
Management & Collection

8 Expenditure
59072 64979 71477 78624 86487 360639
9 Civic Services Expenditure 121 138 157 179 204 799
10 Other Expenditure 181 199 218 240 264 1102
Repayment of Debt 0 0 0 0 0 0
11
Total Expenditure 59374 65316 71852 79043 86955 362540
12
13 Deficit (-) / Surplus (+) -49316 -54252 -59681 -65655 -72229 -301133
14 TSFC Funds (Excluding 2057022 2262724 2488997 2737896 3011686 12558325

Maintenance Funds)
15 Net Position 2007706 2208472 2429316 2672241 2939457 12257192
16 ARM 1006 1106 1217 1339 1473 6141
Funds Available for 2008712 2209578 2430533 2673580 2940930 12263333

17 Developing and Expanding
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 2010-11 2006-11
1. Property Tax / Building

Tax 782990 856686 937752 1026924 1125014 4729366
2. Profession Tax 584824 642757 706482 776581 853689 3564333
4. Other Own Taxes 30907 33996 37393 41130 45240 188666
6. Non Tax Revenue 1098549 1208374 1329180 1462062 1608237 6706402
8. Management & Collection 1979811 2177792 2395571 2635128 2898641 12086943

Expenditure
9. Civic Services 1123731 1236121 1359751 1495748 1645347 6860698

Expenditure
13. Deficit (-)/ Surplus (+) -818235 -909675 -1010481 -1121607 -1244087 -5104085
14. TSFC Funds (Excluding 14166261 15582888 17141177 18855294 20740823 86486443
Maintenance Funds)
15. Net Position 13348026 14673213 16130696 17733687 19496736 81382358
16. ARM 220258 242186 266307 292840 322027 343618
17. Funds Available for 568284 14915399 16397003 18026527 818763 82725976
Developing and
Expanding Services and
Table 12.7- Sectoral Summary Financial Position of URBAN LSGs during
the period 2006-07 to 20 10- 11
(Rs.in Thousand)
No Item 2006-07 2007-08 2008-09 2009-10 2010-11 2006-11
1. Property Tax / Building 900697 984192 1076036 1177066 1288198 5426189

Tax
2. Profession Tax 401376 441067 484729 532755 585584 244551 1

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
8. Management &
Collection Expenditure 612370 673607 740968 815064 896571 3738580
9. Civic Services 2056465 2262855 2489993 2739975 3015101 12564389
Expenditure
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
16. ARM 209456 230403 253442 278784 306662 1278747
17. Funds Available for

Developing and 2736073 2983429 3254488 3551550 3877151 16402691
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)
No Items 2006-07 2007-08 2008-09 2009-70 20IO-11 2006-11
1. Property Tax / Building

Tax 1683687 1840878 2013788 2203990 2413212 10155555
2. Profession Tax 986200 1083824 1191211 1309336 1439273 6009844
4. Other Own Taxes 66311 72940 80232 88253 97075 404811
6. Non Tax Revenue 1940671 2134708 2348147 2582927 2841188 11847641
8. Management & Collection

Expenditure 2592181 2851399 3136539 3450192 3795212 15825523
9. Civic Services Expenditure
3180196 3498976 3849744 4235723 4660448 19425087
11. Repayment of Debt 130109 143120 157431 173174 1 90492 794326
13. Deficit (-)/ Surplus (+) -1125357 -1273761 -1438259 -1620547 -1822474 -7280398
14. TSFC Funds (Excluding 17000000 18700000 20570001 22627000 24889699 103786700
Maintenance I Funds)
15. Net Position 15874643 17426239 19131742 21006453 23067225 96506302
16. ARM 429714 472589 519749 571624 628689 2622365
17. Funds Available for 16304357 17898828 19651491 21578077 23695914 99128667
Developing and
Institutions
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 2009-10 2010-11 2006-11
Funds Available for

Developing and
1
Expanding Services 9572001 10519493 11561509 12707490 13967830 58328323
and Institutions
Further improvement
2
in own revenues
255684 280293 307340 337068 369746 1550131
3 Borrowing 127842 140146 1 53670 168534 184873 775065
4 Public contribution 1 27842 140146 1 53670 168534 184873 775065
5 Total 10083369 11080078 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
Developing and
1 1509713 1646611 1 796572 1960848 2140830 9054574
Institutions
Further improvement in
2 131248 143039 155958 170115 1 85629 785989
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 1226361 1336817 1457916 1590701 1736320 7348115
Institutions
2 Further improvement 123691 1 34842 147068 160474 175176 741251
in own revenues
3 Borrowing 61845 67421 73534 80237 87588 370625
5 Total 1473742 1606501 1752052 1911649 2086672 8830616
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
1 987571 2186328 2404961 2645457 2910003 12134320
Institutions
2 0 0 0 0 0 0
own revenues
3 Borrowing 99378 109316 120248 132273 145500 606715
Public contribution 99378 109316 120248 132273 145500 606715
5 Total 2186327 2404960 2645457 2910003 3201003 1 3347750

Table 12.13 - District Panchayats
(Rs. in Thousand)
No Item 2006-07 2007-08 2008-09 2009- 10 2010-3 1 2006-11
1 Funds Available for 2008712 2209578 2430533 2673580 2940930 12263333

Developing and Expanding
2
own revenues
0 0 0 0 0 0
3 Borrowing 100436 110479 121527 133679 147047 613168
5 Total 2209584 2430536 2673587 2940938 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 13568284 14915399 16397003 18026527 19818763 82725976
................
2
own revenues
255684 280293 307340 337068 369746 1550131
3 Borrowing 327656 359941 395445 434486 477420 1 994948
5 Total 14479280 15915574 17495233 19232567 21143349 88266003

Table 12. 15 - Urban LSGs
(Rs. in Thousand)
No Item 2006-07 2007-08 2008-09 2009-10 2010-11 2006-11
Funds Available for

2 Further improvement in 254939 277881 303026 330589 360805 1527240

own revenues
3 Borrowing 127469 138941 151513 165294 180402 763619
5 Total 3245951 3539191 3860540 4212726 4598759 19457167
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 Item 2006-07 2007-08 2008-09 2009-70 20/0- 1 1 2006-11
Funds Available for

Further improvement in own

2 revenues 510623 558174 610366 667657 730551 3077371
3 Borrowing 455125 498882 546958 599780 657822 2758567
5 Total 17725231 19454765 21355773 23445293 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 2007-08 2008-09 2009- 10 2010-11 2006-11
1 Share of Taxes for 14000000 15400000 16940000 18634000 20497400 85471400

financing development
expenditure
2 Total amount available for 17725140 19454704 21355774 23445332 25742220 107723170
development expenditure,
including share of taxes
(column 1 above)
3 Percentage of total amount 126.60 126.32 126.06 125.82 125.58 126.03
(column 2) to share of
taxes (column 1)
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 K.V.Rabindran Nair P. Kamalkutty

Member Chairman 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.
NOTIFICATION
No. 74601/SS/2005/Fin. Dated, Thiruvananthapuram, I9th October, 2005.
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.
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.

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THIRD STATE FINANCE COMMISION

Devolution of State Tax Revenues to LSGs (Chapter 6)

Accepted. However, Funds for Road Maintenance will be provided under an

Other Issues (Chapter 13)

PERFORMANCE and D.C.B

COLLECTION AND PROCESSING OF DATA

LSGs before the 73rd and 74th Constitutional amendments

LSGs as instruments of economic development resulting from Kerala's widely acclaimed

1. Proforma 1: - Receipts and Expenditure of Local Self Governments - Abstract

iii. Proforma 3: - Statement showing Receipt and Expenditure under transferred

v. Proforma 5: - Statement showing details of Receipts and Expenditure under

2. 14 The Commission, after preliminary study of the consolidated Tables on proformae

2. 17 In the matter of data collection and processing Finance Commissions do come

3. 2 In proforma 1, we faced the first real difficulty. In drawing up that proforma,

3. 13 Proforma 3 also posed some difficulties. Non-Plan expenditure on services

3. 14 Figures of maintenance expenditure showed a peculiar phenomenon. Generally

3. 16 In spite of the infirmities mentioned above. Commission is broadly satisfied

FORECAST OF RECEIPTS AND EXPENDITURE OF LOCAL SELF

4. 5 In the case of profession tax, we assumed collection equal to demand. However

4. 6 In the case of entertainment tax there is a special problem. Owing to some

4. 11 Civic services expenditure is obviously the most important item in the

4. 14 Expenditure on maintenance is a major item, particularly after the transfer of a

4. 16 What is important in the immediate context of this chapter is the difficulty in

4. 20 Whatever or whoever is at fault, this is an area which need immediate

5. 14 Terms of reference of the Commission include certain other important issues.

5. 15 Another area of concern on which Commission would like to indicate an approach

5. 16 Put in a nutshell, our overall approach will be one of consolidation and

DEVOLUTION OF STATE TAXES TO

6. 2 This Commission's recommendations cover the five-year period 2006-2011. Of

6, 3 In the forecast submitted by the State Government to the Central Finance

6. 13 We are deliberately avoiding the concept of grant in recommending devolution.

Suppose A is one item of State's own tax.

FINANCIAL PROFILE OF LOCAL SELF GOVERNMENTS

7.1 Having formulated the recommendations regarding devolution of taxes,

7. 6 After the exclusion of some items as explained above, we prepared a proforma

7. 8 As we explained earlier in the report, financial assessment of each of the 1215

MOBILISATION OF ADDITIONAL RESOURCES

Need for additional resources

9. 1 When a substantial amount of money has to be transferred from State Government to

Timely release of funds

9. 7 We therefore recommend that the share of taxes payable to LSGs as recommended

9. 11 In spite of such an arrangement, difficulties could still arise in smooth release of

LAPSE OF FUNDS, REMOVAL OF DIFFICULTIES

10. 4 This position however does not apply to Public Account.

Director of Panchayats Grama Panchayats

Director of Urban Affairs Municipalities

Commissioner for Rural Development Block Panchayats

Additional Secretary / Joint Secretary District Panchayats,

10. 18 What we have recommended above is an arrangement which, we hope, will

FISCAL FREEDOM TO LOCAL SELF GOVERNMENTS AND

11.1 If the national initiative for decentralisation of local governance is to succeed,

11.11 As a result of all these, Commission recommends a framework for accounting

a. Local Self Governments will have freedom in handling their funds

b. That freedom will be regulated with appropriate checks and balance

g. All Local Self Government functionaries, appointed or elected, will be held

STRUCTURE AND SCOPE OF DEVELOPMENT EXPENDITURE

2 Profession Tax 584824 642757 706482 776581 853689 3564333

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

8 Management & Collection