written for CBGA's Budget Track - special issue on the 14th Finance Commission
Resource distribution between Centre and States is determined by provisions in the Constitution. The subjects are divided between the Centre and States and post 73rd/74th Amendment also further devolved to districts, municipalities and panchayats. There is a constant tussle between the Centre and States for a fair share of the resources and the mandate to determine this is given to the Finance Commission under Article 280. Each five years the Finance Commission defines the envelope of the share between the Centre and States as well as determines the broad parameters for sectoral allocations which states receive from the Centre’s share (Article 275) through the Planning Commission and/or centrally sponsored schemes. The Centre under Article 282 can also give discretionary grants as per its own prerogative.
On the state’s part they want a larger share in the overall envelope so that they can autonomously design their own policies and programs. At present states feel constrained in terms of resources earmarked as their direct share from the national kitty. They get only about 32 percent directly as their own share and the remaining from the central pool. From the latter the states get about half the share through policies and programs that is determined by the Centre mostly via the Planning Commission.
Politics of Fiscal Federalism
Being a federal country the states are perhaps right in their assertion that the share they get directly as their own resources is quite meagre and inadequate for them to plan boldly, especially for key social sector allocations like health, education, social welfare, rural development etc.., which are all primarily state subjects. In reality the states get only about one-third share of the revenues but share the burden of over two-thirds of the expenditure. This imbalance of spending with limited resource generation sources, since the Centre appropriates the main sources of revenues under its control, reduces state’s capacity to develop on its own free will. Given this asymmetrical fiscal federalism, the politics within the states has been changing over time with regional parties becoming dominant and national parties increasingly becoming dependent on the regional parties in coalition governments. This political scenario is now exerting pressure on liberalizing the fiscal federalism towards a much larger share for states but such a demand for increased regional hegemony is often construed by the Centre as being “anti-national” and weakening the unified integrity of the Indian nation state.
The Centre’s logic is that if states get a larger share directly or they are given more lucrative revenue raising options under their control there would be unhealthy rivalry amongst states leading to unnecessary conflicts which would be a burden for the Centre to manage. Further the huge regional imbalances of resources and capacities across different states, backwardness in development etc. may get exacerbated if the Centre has less control over distribution of resources. Also the states’ fiscal management capacities are questioned given that their ability to manage existing resources is weak and an increased volume of resources may be beyond their “capacity to absorb”.
The Quest for Fiscal Devolution
Politically the trend over the last two decades has been greater decentralization wherein more powers and subject devolution has moved from Centre to States and from States to local governments. Representative governance has been devolved, administrative devolution has happened but there is strong reluctance by the Centre for fiscal devolution. As mentioned earlier politics and administration has regionalized and good governance is not possible without adequate control over fiscal resources. So the new battle-ground in Centre –State relations is going to be greater fiscal devolution and so the task of the 14th and subsequent Finance Commissions is going to be achieving a more acceptable balance in resource distribution both between Centre and States as well as across sectors, especially the share for social sectors like health, education, social security, employment guarantee, food security, social welfare, dalit and adivasi development etc., given that many of these entitlements are being legislated into rights.
During the UPA decade under the flagship programs such entitlements have increased and have raised demand expectations. Resource commitments by the Centre to these flagships have also seen an increase but most of these programs being state subjects one has not seen in most states any substantial increases in state budget commitments. While allocations may have increased gross underspending happens and for this the Centre blames the states for lack of absorptive capacity. Is this allegation by the Centre correct? The story is not as simple as it is made out to be. The political economy of absorptive capacity is quite devious. I will illustrate this through the example of the health sector.
Absorptive Capacity Issue – the case of the Health Sector
To begin with I want to give the example of how underfunding destroyed one of the best healthcare systems in India, the health services run by the Municipal Corporation of Greater Mumbai (MCGM). Right through the sixties, seventies and eighties between one-fourth and one-third of the MCGM core budget was committed to public health and healthcare services. Almost everyone in Mumbai, especially for hospital care, utilized these services even though there was overcrowding and waiting in long queues. At the turn of the nineties, under structural adjustment reform policies the MCGM too came under its impact and social sector expenditures were compressed and a declining trend emerged. From 25 percent of its budget for healthcare in 1991 to 15 percent by 1996 and down to an abysmal 9 percent in 2014 the public health services of MCGM were starved of resources resulting in crippling them. The first impact was on consumables like medicines and diagnostic inputs for which prescriptions were provided to procure privately, next was maintenance of facilities and equipment which created frustration amongst staff and patients. The consequence was that the middle class patients deserted the system and opted for the emergent health insurance option, often with employer support, for treatment in private hospitals. This was a tremendous loss to the public health system as the voice of the system that kept it on its heels was snuffed out. As though this was not enough the MCGM introduced user fees from 1999 and this was the proverbial last straw that broke the camel’s back. Next a lot of the dedicated health professionals left, new recruitments stopped and the public health system, from a universal access system, became a system for the poor and consequently it became a poor and underfinanced system. This is reflected in declining budget commitments over the last two decades and which is at its lowest today.
Why I have narrated the Mumbai story is because there is an important message in it for the Finance Commission to reflect upon - running any service delivery system requires a reasonable amount of resources which need to be costed properly. The failure to do so in India has wasted huge resources in the social sectors, especially health and education. Health centres and hospitals, schools and colleges are set up without proper determination of unit cost of these services for the population it is supposed to serve. Budget allocations are made in an ad hoc manner and consequently they do not result in effective services and benefits that reach people. For instance according to WHO to run a robust comprehensive primary health care system with adequate support of secondary and tertiary services a country on average would need to invest about 5% of its GDP. In India’s case we are still hovering around 1% of GDP despite the UPA promise of upto 3% GDP commitment before the end of its term. Without such a volume of rationally allocated resources the healthcare system will continue to remain a targeted and selective health system which would prevent any significant progress towards better health outcomes. The Finance Commission needs to consider this very seriously and push for budgetary allocations which have a rational cost basis. The absence of the latter is what brings to the fore the question about absorptive capacity.
To illustrate the problem of absorptive capacity let us look at how resources are allocated. A Primary Health Centre is set up, staff sanctions are made and most staff recruited, medicines, diagnostics etc. are provided. But if we look at allocations they are not adequate to meet the needs of the PHC which has to cater to 20000 to 30000 population. Studies for instance show that medicine requirement for outpatient care is Rs. 50 to 60 per capita per year whereas the average PHC gets only Rs. 8 to 10 per capita annually for medicines. Naturally this reduces credibility of the PHC and only the very poor come to it. So there is clearly underfunding in the PHC budget. Further because of the poor conditions of the PHCs it is difficult to find doctors and nurses, the key professionals, to work at the PHC. So because sanctioned posts are not filled there is underspending. The story for rural, district and teaching hospitals is the same – underfunded budgets, leading to loss of credibility, poor quality, frustration, sanctioned posts not filled up leading to underspending. This underfunding and underspending viciousness is the root cause of poor service delivery and this can certainly not be termed as lack of absorptive capacity at the service delivery level.
The problem therefore is not the absorption capacity but the bureaucracy itself which does not have the capacity to plan and budget in a way that service delivery is appropriately structured and financed so it can meet the demands of the people. Further, the central and state bureaucracies are unwilling to let loose their control over the healthcare delivery system, despite a lot of talk about decentralization. They may allow decentralized planning through the panchayats and even provide some untied funds for the direct use by the latter, but they will never transfer fiscal, governance and management autonomy and control to units who directly provide services and have to face the direct flak of people day in and day out for inadequate and poor quality services. This is where the problem lies in resource allocation and use. Those who deliver care, who understand and know the situation and hence can plan and budget the resources, have no role in decision making and those who govern from the state and national capitals take all decisions without having a clue to what the ground realities are.
To conclude the question of absorptive capacity is a convenient tool which the bureaucracy uses to circumvent real issues that are a cause of the underfinancing and underspending of social sector budgets. The lack of bottom up planning and budgeting that is based on expressed needs and demands of the community for which services are being provided, and the lack of decision-making power and autonomy to govern and manage the provider institutions are the main causes for poor service delivery. This needs to be remedied immediately if resources invested in public services have to realize the policy goals. The 14th Finance Commission must engage with these concerns and suggest mechanisms which will strengthen local capacities to take charge of fiscal management and determine their own budgetary requirements to fulfil demands of its communities.
 Budget documents of various years of the MCGM; also see DNA Mumbai edition 25-09-2013 Minimum Healthcare for Maximum City (pg 4) and Ravi Duggal: An increase in healthcare budget to 1991 levels is urgent need DNA 25-09-2013 (pg 4)
 Ravi Duggal: Sinking Flagships and Health Budgets in India, Economic and Political Weekly, Vol XLIV No 33, Aug 15 2009