GOVERNMENT
OF INDIA
MINISTRY
OF FINANCE
DEPARTMENT
OF ECONOMIC AFFAIRS
EXPLANATORY
MEMORANDUM AS TO THE ACTION TAKEN ON THE RECOMMENDATIONS
MADE BY THE TWELFTH FINANCE COMMISSION IN ITS REPORT
SUBMITED TO THE PRESIDENT ON DECEMBER 17, 2004
1.
The
Twelfth Finance Commission was constituted by the President
on November 1, 2002 to give recommendations on specified
aspects of Center State fiscal relations during 2005-10. The
Commission submitted its Report covering all aspects of its
mandate on December 17, 2004.
2.
The
Finance Commissions are constituted by the President after
every five years or earlier under Article 280 of the
Constitution to give recommendations on specified aspects of
Centre-State fiscal relation. The recommendations of these
Commissions are based on detailed assessment of the
financial position of the Central and State government and
wide consultations with stakeholders. The Commissions
usually visit the States, sponsor studies, hold
consultations with experts and their recommendations are
backed up by detailed reasons disclosing the methodology
adopted by them.
3.
The
Report of the Twelfth Finance Commission (hereinafter
referred to as the Commission) covering the five years
period commencing from April 1, 2005 together with the
Explanatory Memorandum on the action taken on the
recommendations of the Commission is being laid on the table
of the House, in pursuance of Article 281 of the
Constitution. A summary of the Commission's main
recommendations relating to devolution of taxes and duties
to the State, grants-in-aid under Article 275 of the
Constitution, financing of relief expenditure and debt
relief to the States and other matters is contained in
Chapter 16 of the Report of the Commission.
4.
The
Government has carefully considered the main recommendations
contained in the Report of the Commission and the action
proposed to be taken on these recommendations is detailed
below.
DEVOLUTION
OF SHARE IN CENTRAL TAXES AND DUTIES TO STATES
5.
Under
Article 270 of the Constitution, as amended w.e.f. 1st
April, 1996 by the Constitution ( Eightieth Amendment) Act,
2000, a prescribed percentage of the net proceeds of all
Central taxes (except Union surcharge, cess levied for
specific purpose under any law made by Parliament and the
duties and taxes referred to in Articles 268 and 269) is to
be assigned to the States within which that tax is leviable
in that year and distributed among those States in terms of
Orders issued by the President on the recommendations of the
Finance Commission.
For
the period of five years commencing from April 1, 2005, the
Commission has recommended that 30.5 per cent of the net
proceeds of shareable Central taxes may be distributed
amongst all such States where any such Central tax is
leviable. If in any year during 2005-10, a particular
Central tax is not leviable in a State, the share of that
State in that tax should be put to zero and the entire
proceeds be distributed among the remaining State by
proportionately adjusting their shares. For this purpose,
additional excise duties in lieu of sales tax on textiles,
tobacco and sugar are treated as part of the shareable pool
of central taxes. If this tax rental arrangement is
terminated and the States are allowed to levy sales tax (or
VAT) on these commodities without any prescribed limit, the
share of the State in the net proceeds of shareable central
taxes shall be reduced to 29.5 percent. If any legislation
is enacted in respect of service tax after the Eighty Eight
Constitutional amendment is notified, it must be ensured
that the revenue accruing to a State under the legislation
should not be less than the share that would accrue to it,
had the entire service tax proceeds been part of the
shareable pool. The percentage share of each State in Union
taxes and duties and the criteria for devolution and
relative weights assigned to different factors is indicated
in Chapter 7 of the Report.
The
Government has accepted the above recommendations of the
Commission.
GRANTS-IN-AID
OF THE REVENUES OF STATE UNDER THE SUBSTANTIVE PROVISIONS OF
ARTICLE 275 OF THE CONSTITUTION
Non-plan Revenue Deficit Grant
6.
The
Commission has recommended grant-in-aid to be given under
Article 275(1) of the Constitution, other than those under
the proviso to Article 275(1), equal to the amount of
deficits assessed for each year during the period 2005-10. A
total non-plan revenue deficit grant of Rs.56855.87 crore is
recommended during the award period for fifteen States. The
amount of the grant for each State having non-plan deficits
is indicated in Chapter 10 of the Report for each of the 5
years starting from the financial year 2005-06.
The
Government has accepted this recommendation.
Grant
for education
7.
The
Commission has recommended grants for eight States amounting
to Rs.10171.65 crore over the award period for the education
sector, with a minimum of Rs.20 crore in a year for any
eligible State. The year-wise allocation for each State is
given in Chapter 10 of the Report. The grant for the
education sector is an additionality, over and above the
normal expenditure to be incurred by the States in this
sector. Conditionalities governing the release and
utilization of this grant have been specified in Annexures
10.1 to 10.3 of the Commission's Report.
The
Government has accepted this recommendation of the
Commission.
Grant
for health
8.
The
Commission has recommended grants for seven States amounting
to Rs.5887.08 crore over the award period for the health
sector, with a minimum of Rs.10 crore in a year for any
eligible State. The year-wise allocation for each State is
given in Chapter 10 of the Report. The grant for the health
sector is additionality, over and above the normal
expenditure to be incurred by the States in this sector.
Conditionalities governing the release and utilization of
this grant have been specified in Annexures 10.1 to 10.3 of
the Commission's Report.
The
Government has accepted this recommendation of the
Commission.
Grants
for maintenance of roads and bridges and public buildings
9.
The
Commission has recommended grants amounting to Rs.15000
crore for maintenance of roads and bridges and Rs. 5000
crore for maintenance of public buildings over the award
period. The State-wise year-wise allocations are given in
Chapter 10 of the Report. These grants are an additionality,
over and above the normal expenditure to be incurred by the
States. Conditionalities governing the release and
utilization of these grants have been specified in Annexures
10.4 to 10.6 of the Commission's Report.
The
Government has accepted the above recommendations of the
Commission.
Grant
for maintenance of forests
10.
The
Commission has recommended grants amounting to Rs.1000 crore
over the award period for maintenance of forests. The
State-wise, year-wise allocation is given in Chapter 10 of
the Report. This grant is an additionality, over and above
the normal expenditure to be incurred by the State for this
purpose.
The
Government has accepted this recommendation of the
Commission.
Grant
for heritage conservation
11.
The
Commission has recommended grants amounting to Rs.625 crore
over the award period for heritage conservation. This grant
is to be used for preservation and protection of historical
monuments, archaeological sites, public libraries, museums
and archives, and also for improving the tourist
infrastructure to facilitate visits to these sites. The
State-wise, year-wise allocation is given in Chapter 10 of
the Report. This grant is an additionality, over and above
the normal expenditure to be incurred by the States for this
purpose.
The
Government has accepted this recommendation of the
Commission.
Grant
for State specific needs
12.
The
Commission has recommended grants amounting to Rs.7100 crore
over the award period for State specific needs. The
State-wise, purpose-wise details of these grants are given
in Chapter 10 of the Report.
The
Government has accepted this recommendation of the
Commission subject to the condition that the grants would be
released based on the level of preparedness of the States to
utilize the grants for the specific purpose for which they
have been recommended.
Grants
for local bodies
13.
The
Commission has recommended grants amounting to Rs.25000
crore over the award period for local bodies. Of this
Rs.20000 crore is for Panchayats and Rs.5000 crore is for
urban local bodies. The inter-State distribution and the
criterion adopted in arriving at the proposed distribution
are given in Chapter 8 of the Report. The Commission has
emphasized that of the grants allocated to panchyats,
priority should be given to expenditure on the O&M costs
of water supply and sanitation and that at least 50% of the
grants provided to each State for the urban local bodies
should be earmarked for the schemes of solid waste
management. Besides expenditure on O&M costs of water
supply and sanitation in rural areas and on the schemes of
solid waste management in urban areas, panchayats and urban
local bodies should, out of the grants allocated, give high
priority to expenditure on creation of data base and
maintenance of accounts.
The
Government has accepted this recommendation of the
Commission as per the provisos to recommendation summarized
in paras 8.52 to 8.55 of the Report.
Financing
of calamity Relief expenditure
14.
The
Commission has recommended the continuance of the scheme of
Calamity Relief Fund in its present form with contribution
from the Centre and the States in the ration of 75:25. The
size of the CRF for the period 2005-10 is worked out at
Rs.21333.33 crore. This includes the Centre's share of
Rs.16000 crore, and the State's share of Rs5333.33 crore.
The State-wise distribution of CRF giving the Centre and
State's share is indicated at Annexure 9.1 to 9.3 of the
Report. The Commission has also recommended continuance of
the scheme of NCCF in its present form with core corpus of
Rs.500 crore. The outgo from the fund may continue to be
replenished by way of collection of National Calamity
Contingent Duty and levy of special surcharges.
The
Government has accepted the above recommendations of the
Commission.
Sharing
of Profit Petroleum
15.
The
Commission has recommended the sharing of the non-tax
revenue of 'Profit Petroleum' arising out of contractual
provisions under NELP with the States from where the mineral
oil and natural gas are produced in the ratio of 50:50. The
details are given in Chapter 13 of the Report.
The
government has accepted the above recommendations of the
Commission subject to the condition that this should be
within the overall ceiling of transfers recommended by the
Commission (38% of gross revenues). This would imply that
once the total transfers cross 38% of gross revenues of the
Centre, sharing of non-tax revenue of Profit Petroleum would
not accrue in that year. Further, this should not be
considered by the State as establishing a general principle
of sharing of the Centre's non-tax revenues.
Debt
relief to States
16.
The
Commission has recommended that the scheme of Fiscal Reform
Facility may be replaced by a scheme of Debt Relief over the
period 2005-10. The scheme of Debt Relief recommended by the
Commission envisages:-
(i)
The rescheduling of all Central Loans contracted till
31.3.2004 and outstanding as on 31.3.2005 into fresh loans
for 20 years carrying 7.5% interest w.e.f. the years a State
enacts the Fiscal Responsibility Legislation.
Details
of the scheme are given in Chapter 12 of the Report.
The
Government has accepted the above recommendations of the
Commission subject to the condition laid down by the TFC
that the debt relief (re-scheduling and consolidation and
lowering of interest rate) would be admissible on the State
enacting the Fiscal Responsibility legislation and would
take effect prospectively from the year in which such
legislation is enacted. It is also expected that the States
would comply with the obligations regarding reduction of
Fiscal Deficit and Revenue Deficit imposed by the Fiscal
Responsibility Legislation. The Centre would request the
next Finance Commission to make appropriate adjustment in
case the State availing of the debt relief is not able to
comply with the Fiscal Responsibility Legislation.
(ii)
A debt write-off linked to reduction in revenue
deficit by a State. The quantum of write-off of repayment
would be linked to the absolute amount by which the revenue
deficit is reduced in each successive year during the award
period. In accordance with the recommendation of the TFC,
the benefit of write-off would be available only if the
fiscal deficit of the State is contained to the level of
2004-2005. If in any year the fiscal deficit exceeds this
level, the benefit of write-off, even if eligible otherwise,
would not be given. The details of the scheme are given in
Chapter 12 of the Report.
The
Government has accepted the above recommendations of the
Commission.
Central
Assistance for State Plans
17.
The
Commission has recommended that the Centre should release
only the grant portion of Central Assistance for State plan
(CPA) and leave it to the State to raise loan portion from
any source. For States unable to raise loans from market,
the Centre may act as a financial intermediary but without
any subsidization of cost. The details are given in Chapter
10 of the Report.
This
approach has been accepted by the Government, in principle,
to be implemented in phases in consultation with RBI. Form
2005-06, the States would be allowed at their discretion,
not to draw the loan portion of the CPA.
External
Assistance Loans
18.
The
Commission has recommended that the Centre should pass on
external assistance on back-to-back basis to State and
manage it through a separate Fund in the Public Account. The
details are given in Chapter 12 of the Report.
The
Government has accepted the recommendation to pass on
external assistance on the same terms and conditions on
which it was received subject to the condition that the
service cost and exchange rate fluctuations would also be
passed on to the States under this arrangement.
Accounting
Procedure
19.
The
Commission has recommended a move by the Centre towards
introduction of accrual accounting and standardization of
accounting classification down to the object head for all
State to improve fiscal management. The details are given in
Chapter 14 of the Report.
The
Government has accepted this recommendation in principle.
The Government Accounting Standards Board in the office of
the Comptroller and Auditor General of India would be asked
to draw a detailed road map and operational frame work for
its implementation.
Miscellaneous
20.
The
Commission has recommended that the total transfers (tax
devolution and Plan/Non-Plan grants) from the centre to the
States should not exceed 38% of gross revenue receipts of
the Centre (both tax and non-tax). The details are given in
Chapter 7 of the Report.
The
Government has accepted this ceiling on total Revenue
account transfers, from the Centre to the States subject to
the condition that the acceptance does not imply the
establishment of a principle of mandatory sharing of a fixed
percentage of Centre's revenue receipts with the States.
IMPLEMENTATION
21.
The
Commission's recommendations fall in the following
categories:
(i)Those to be implemented by an Order of the
President.
(ii)Those to be implemented by executive orders.
(iii)Those to be examined further.
22.
The
recommendations under Articles 270 and 275(1) of the
Constitution relating to share in Union taxes and duties and
grants-in-aid, respectively, fall in the first category and
the necessary order will be submitted to the President for
approval.
23.
The
recommendations relating to sharing of Profit Petroleum,
Debt Relief, Central Assistance for State Plans and External
Assistance Loans will be implemented by executive orders.
24.
Other
recommendations of the Commission will be considered in due
course.
New
Delhi
P.CHIDAMBARAM
February
26,2005
Minister of finance
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