Who will pay for local services?
Business Standard, January 01, 2003
The key to better utilisation of central funds is to have accountability at the state level
The run up to the Budget will be marked by important debates on tax and expenditure decisions of the government.
The focus of these debates, especially after the recommendations of the Kelkar committee and the reactions to it, is expected to be on the questions of simplification of taxes and the elimination of ‘exemption raj’.
These are certainly very important matters, and the country should get its tax system in order. At the same time, we have serious problems on the expenditure side that need more focus and attention than is being given to them.
Most debates on public expenditure revolve around the big issues of subsidies, interest payments and the recommendations of pay commissions or freeze on government jobs.
Most of these expenditure items, as far as the tax payer is concerned, is money that goes into a bottomless pit.
The major concern of tax payers in terms of public expenditure are the tangible deliverables such as a good public hospital around the corner, a good government school to send a child to, clean drinking water, clean and usable roads, a safe neighbourhood and so on. All these are local services, in other words, local public goods.
The state is increasingly failing to provide these services and citizens are organising their private provision in the face of this failure.
It is the deterioration in these services in cities such as Delhi that have led many residential areas to have their own clean water supply, water pumps to supply the water and filters to clean water, private garbage collection, their own little generators and invertors, hiring of private security guards for the colony and, of course, private health and education.
Clearly, there are many functions that the Centre has to perform. These are those that have benefits beyond the local area. These include not just the classic cases of national defence and border security, but also services such as financial regulation, monetary policy, national highways and air controls.
Yet, there is clearly a case for provision of services such as water, roads, health, education and local policing and security at a more local level.
However, though the needs of local communities can best be addressed by local governments, the power of these governments to raise resources is limited. Local taxes consist of property taxes and octroi.
While it is efficient to collect property taxes locally, there are few countries where property taxes exceed 1 per cent of GDP. Octroi is considered to be extremely distortional and today India is the last country in the world that has not yet done away with octroi.
This raises the obvious question: who will pay for local services? The main problems here are: One, how are local governments going to get money to provide local public goods? And, second, how do we establish accountability for these tasks?
From the viewpoint of economic efficiency, the most important two taxes — personal income tax and the VAT — can be best implemented at the Centre. Yet, a great deal of expenditure has to happen at the local level, in producing local public goods.
The problem is not unique to India. Many countries are grappling with similar problems. As far as expenditure at the local level is concerned, the situation in India is better than most developing countries. Compared to a developing country average of 14 per cent, the share of subnational governments in total expenditures in India is over 45 per cent.
However, the size of cities is growing and so is the need for provision of local services. It is clear that more and more money will be needed to provide services to the growing population of these cities. Since the revenue generation power of the cities is expected to be limited, a large part of the money may have to come from transfers from the Centre.
The key to better spending, even with the transfer of centrally collected taxes to local levels of government, is to have accountability at the local level. Local governments should be able to make hiring and firing decisions.
It has been seen, for instance, that when school teachers are accountable to local communities who have the power to fire them for non-attendance, the attendance of teachers in schools goes up significantly.
Currently, one major difficulty lies with the level of centralisation of the system. It lies in the fact that with the funds that come from the Centre, comes interference from the Centre. What gets lost in this game is who is accountable for running the schemes properly. The states claim the Centre is responsible, while Delhi points a finger at the states.
Further, a lot of money is spent by the central government directly at the local level through centrally sponsored schemes. Often a large number of schemes are targeted through the district administration system which is ill equipped to implement them.
At the same time, since the control of the scheme lies with the Centre, delays in allocation of resources, misallocation, and other problems abound.
Even when money is not routed through a centrally sponsored scheme but is transferred to the local government, the control over release of money and accountability remains with the Centre.
This top down approach makes it difficult for local governments to take decisions that are in line with the needs of the local population. It also gives them little incentive to do so as they are accountable to the Centre and not to the people who would benefit. Thus, despite huge levels of public expenditure, the standard of local services remains abysmal.
The constitution empowers the central government to collect taxes which have to be devolved to lower levels of governments. The transfer of money from the Centre to the states is decided by the finance commissions, but further decentralisation is still an unresolved issue.
The initiatives taken by Rajiv Gandhi resulted in amendments to the constitution and giving constitutional status to local governments. Unfortunately, the amendment did not adequately address the fiscal aspects involved.
There is no clear system of generation, transfers and accountability of resources for local governments. Thus the devolution of funds remained top down. And, so did accountability.
As has been realised everywhere else in the world, decentralisation is not an event, it is a process and these problems will not be solved in a day. However, it is time to start thinking about them sooner rather than later.
(The author is at ICRIER. These are her personal views.)