A Study of the Finances of Karnataka After 2000

Vinod Vyasulu and Kriti Toshniwal

Introduction

In a developing country and a welfare state like ours, it is mainly public spending on the provision of basic necessities and infrastructure that promotes human development. It is therefore the principal responsibility of the state to improve the quality of life of its people, and to promote an environment of equity and social justice. In addition, development is also linked to economic growth, which is the state's other priority. With limited resources at its disposal however, the state faces the classical problem of scarcity which necessitates prioritization of the existent competing demands on its resources. Thus arise a number of questions. How much should the state spend on education? Should it give greater priority to irrigation or health care? How should it allocate its resources between salary payments, and the creation of infrastructure?

Depending on the current economic and social environment, and expectations for the future, the state chalks out its priorities. Based on these, it aspires towards certain goals, and sets targets to achieve them within a stipulated time frame. A budget is prepared to create a systematic account of the required and anticipated expenditure. Any government spending requires revenues to pay the bills, and therefore the budget also outlines the routes from which resources are to be raised for this purpose. Revenue is generated from a number of sources such as taxes, fees, penalties and fines, borrowings, etc., but taxes form the major component. Moreover through taxes, the government sometimes deliberately interferes with the workings of the market in an effort to promote some social goal.

Thus, the budget is an extremely important document and needs to be studied not only from the point of view of slated expenditures, but also concentrating on the means through which these are to be met. It can be used to study different aspects of government functioning such as priorities and policies, delivery performance on stated goals of human and economic development, and efficiency and sustainability of operations. It can be used to account for changes in a particular sector, or to give an overall view of the State's situation. This analysis does more of the latter by presenting a general picture of State finances, but throws open the field for a number of issues that come up as a result, and can stem into a series of subsequent analyses. At a more basic level, it brings up the issue of how government resources are being used by analyzing the various major heads under which expenditure is incurred by the State, and comparing its claims against achievements.

Background

The fiscal reforms adopted in Karnataka following the White paper on State Finances released in 2000, were an off-shoot of the fiscal crisis of the late 1990s witnessed by all states in India. The slow secular fiscal deterioration over the 1980s and early 1990s, catalyzed into a state-level fiscal crisis by the Fifth Central Pay Commission pay awards in the late 1990s which resulted in a real wage increase of about 30%. The Commission ruling also indexed pensions to real wages leading to a rapid growth in pensions in the late 90s. These changes coupled with the revenue shortfalls of the states, caused a sharp deterioration in their fiscal performance. The states experienced a severe liquidity crunch in this period of distress with rising deficits, an increase in interest payments feeding the debt stocks, and rapidly growing off-budget liabilities particularly to finance subsidies in the power sector.

This secular worsening of the current revenue balances of the states however, was not just a consequence of the large pay awards, but can be traced as far back as the past two decades and was related to the growth of populist policies, expansion in public employment, and the provision of free power to farmers which was introduced in many states in the 1980s as well. The rising revenue deficits of the states moreover, led them to compress capital expenditures in order to contain the fiscal deficit. Growing concern regarding the resulting weakening of the developmental and poverty impact of state governments, gave impetus to intense state-level reform efforts.

The story of Karnataka was not very different, and it was subject to fiscal deterioration despite the high growth rates it achieved overall, and in all sectors individually during this period. Though Karnataka's fiscal situation did not reach a crisis point as in many other states, realizing it would surely do so if the present trends continued, the state released a White paper on its finances in 2000. The paper identified the reasons for stagnancy of revenues and proliferation of public expenditure, and outlined directions and guidelines for undertaking corrective measures.

As a sequel to the White paper, the Government of Karnataka released its first Medium Term Fiscal Policy (MTFP) for the period 2000-01 to 2004-05 during the budget session in 2001. The idea was to have an implementable fiscal policy in the short run to ensure fiscal sustainability and make available funds to achieve the objective of poverty reduction. In the 2002 budget speech, the MTFP was announced to be a rolling annual document by the Finance Minister, and is subsequently updated every year and dovetailed to annual budgetary exercises.

The MTFPs stated the priorities of the Government as raising revenues, weeding out unproductive expenditure, rationalizing and targeting subsidies, enhancing efficiency and accountability in public spending, and stabilizing debt, all for the broader purpose of achieving fiscal rectitude. In the initial MTFPs of 2001 and 2002, this was aimed at through specific targets to be achieved by 2005-06 such as:

i.	Phasing out the revenue deficit so that borrowing is not used to finance current expenditure.
ii.	Reducing the fiscal deficit to 3% of GSDP to stabilize debt stock and avoid an increasing burden of interest payments.
iii.	Safeguarding adequate allocation to the development of physical infrastructure and the social sector.

A number of strategies were slated for the purpose of achieving these twin objectives of revenue mobilization and expenditure reduction and prioritization. An overview of these is presented below to provide a backdrop for comparing aims with achievements of the government policies in the continuing analysis:

i.	With the idea of improving the revenue productivity of taxes, strategies were laid out to bring about systematic changes in the tax base and rates, ensure efficient administration and enforcement, simplify the sales tax system and introduce VAT.
ii.	The flow of non-tax revenues was to be increased by revising user charges through greater community participation, and ensuring better quality and reliability of services in return.
iii.	Reducing budgetary support to public enterprises by disinvesting, closing down or restructuring as need be, and introducing the Voluntary Retirement Scheme (VRS) to reduce over-employment.
iv.	Identifying and reducing implicit and explicit subsidies for food, transport, and in particular, electricity, by means of proper targeting, economic pricing and greater cost recoveries. Further reforms in the power sector such as increasing productivity of generation, transmission and distribution by separating the three processes, achieving universal metering and privatizing distribution, strengthening anti-theft provisions, etc., were aimed at.
v.	Curbing of unproductive expenditure was also to be brought about by reducing government employment and re-deployment to social sectors such as health and education.
vi.	Attempts were to be made on the other hand, to increase both allocation and efficiency of government expenditure for the purpose of human development and creation of physical infrastructure.
vii.	Expenditures in irrigation were also to be assessed, and sequenced to major projects to minimize time and cost over-runs.
viii.	In order to contain the debt burden, a debt management plan was to be implemented to limit contingent liabilities, and encourage borrowing on the basis of repayment capacity rather than availability.

As recorded by the recent MTFPs of 2006 and 2007, Karnataka has achieved a considerable level of success in the implementation of the above strategies. By 2004-05, the revenue deficit was eliminated and a surplus of Rs.1638 crores was registered. The fiscal deficit was also brought below 3% of GSDP. A similar performance was repeated in 2005-06 with an estimated revenue surplus of Rs.1187 crores and a fiscal deficit estimated at 2.85% of GSDP. The Tax/GSDP ratio stood at 10.3% and salaries, pensions and interests were brought in line with the Tenth Finance Commission prescriptions of below 35%. In view of its achievements with regard to the fiscal correction targets, the state was awarded various incentives as promised by the Union Government. For achieving an annual reduction of 5% in the Revenue deficit to Revenue receipts ratio, Karnataka received an incentive amount of Rs.286.15 crores. For enacting the Karnataka Fiscal Responsibility Act (KFRA) in 2000, eliminating the revenue deficit, and containing fiscal deficit to 3% of GSDP as recommended by the Eleventh Finance Commission, by 2004-05 itself, the state was given debt re-scheduling benefit of Rs.304 crores in 2005-06, and further, central loans due to an extent of Rs.358.33 crores in 2005-06 were waived off.

Thus the picture of Karnataka's fiscal position over the last few years emerges as quite a rosy one, with the state well on its path of fiscal rectification and consolidation. The question that arises then is whether the improved fiscal situation is being translated to developments in social and physical infrastructure and the consequent reduction of poverty, as emphasized and envisioned by the state. An independent study of the state's revenues and expenditure allocations is a step towards addressing this query. But it should be noted at the outset that a more comprehensive answer to this question can be obtained only after analyzing the efficiency in the translation of revenues to expenditures, and the impact of the proposed expenditure on the specified priority areas i.e. by analyzing the impact per Re. of expenditure on for instance, education, or health. This however is beyond the scope of this report, and will constitute a separate study itself. Nevertheless, it would need to be attempted at a later stage as an augmentation to this report and to draw more meaningful conclusions for the purpose of policy making.

Also, these achievements though commendable, are at the state level. Expenditures however, are mainly carried out at the local level and therefore proper budgeting and accounting is needed at the local level to improve transparency and efficiency in government spending. The Karnataka Local Fund Fiscal Responsibility Act approved by the Governor in 2003 was drafted with the intention of making local bodies more responsible with regard to management of the funds at the local level by asking them not only to prepare MTFPs to chart out an action plan, but also prepare performance related policies, exercise prudence in spending, and maintain and publish systematic accounts of local expenditures. The Act however, seems to have failed implementation. Local level data is still a mess with hardly any accounts being maintained, and local level planning still remains a mystery. A reason for nearly no progress on this front could be the political instability prevailing after the S. M. Krishna government was voted out of power. Another, more compelling reason could be the turf war between the states and local bodies. Whatever be the reason, the issue needs to be addressed with utmost priority with recognition of the importance of fiscal decentralization as a pre-requisite to a strong and stable financial situation.

State Revenues: Performance and Expectations

The State is the main financer of priority sectors critical for enhancing growth and reducing poverty, such as health, education, irrigation, power, water supply and sanitation, etc. Thus in order to be able to sustain and encourage development, the state needs to generate sufficient revenues. Revenues under the Consolidated Fund of the State are categorized under a number of heads. Of these, Revenue receipts form the major component of overall receipts of the state, and comprise Tax Revenue, Non Tax Revenue, and Grants-in-aid and Contributions. Tax Revenue in turn is constituted by State's Own Tax Revenue and Tax Devolution from the Centre. Apart from these, the other major heads of account under the Consolidated Fund of the State are Capital Receipts, Public Debt, Loans and Advances, Inter-state settlements, and Transfers to the Contingency Fund.

As mentioned earlier, Revenue receipts form the major share followed by Public Debt and Loans and Advances. The contribution of capital receipts to overall State receipts on the other hand, is close to zero. It is also interesting to note how the share of revenue receipts which includes tax receipts, fell initially, reaching 60% in 2003-04, but have subsequently risen once more and were estimated to be close to 90% in 2006-07. Correspondingly, the share of public debt in overall state receipts rose to as high as 40% in 2003-04, but declined thereafter. This is important in light of the fact that various studies have identified connections between how states obtain revenue, and the quality of their governance. Greater dependence on tax can enhance government responsiveness and accountability when citizens demand better services and transparency in the way their money is spent. But revenue generation is not the only motivation for taxes. When used with deliberation, taxes can also function as incentive mechanisms to sway the public towards particular actions as required by the government. For instance, high taxes on cigarettes are meant to discourage smoking which is a serious health hazard. In the following sections revenue receipts and public debt; the predominant contributors of State revenue, will be analyzed separately and in detail to give a clearer picture of the trends in State finances over the years. Also, as the year 2000 marked the beginning of major state fiscal reforms, the analysis mainly covers the period post 2000 in order to capture the changes that have occurred since then.

(i) Revenue Receipts

State revenue receipts are those receipts for which the State has no repayment liability and which are used to finance items of revenue expenditure. As stated earlier, they consist of State tax revenues, non-tax revenues and grants from the Central Government. Graph 2 shows the percentage share of the components of State revenue receipts. Tax revenue formed the major component of revenue receipts. The percentage share of non-tax revenue after 2001-02 increased till 2004-05, but has been on the decline since then. Prior to the constitutional amendment in August 2000, only selective central taxes, namely the income tax and union excise duties were shared with the states. The State's share of Union Excise Duties was then accounted for under the head of Grants-in-Aid and Contributions. However, the Constitutional Amendment in August 2000 paved the way for making all the Central taxes shareable with the State, and consequently these were brought under the head of Tax Revenue as Tax Devolution from the Centre. This explains the increase in the share of Tax Revenue and the corresponding decline in the share of Grants-in-Aid and Contributions in 2000-01 over the previous year. After an initial fall from 20% though, the share of Grants-in aid and contributions to the State from the Centre has remained between 10%-15%.

(A) Tax Revenue

The State's tax revenue includes the State's own tax revenue, and tax devolution to the State from the Centre. Devolution refers to the revenue sharing between the Centre and States where the States receive a percentage of the net tax revenues of the Centre. The proportion in which these taxes are to be shared between the Centre and the States and amongst the States is determined by the Finance Commission, a statutory body. Only around 20% of the State's Tax Revenue on an average is contributed by Devolution from the Centre. The remainder is generated by the State from its own revenue sources. Table 1 below shows a gradual increase in the percentage share of State's own tax revenue and a corresponding gradual decline in tax devolution from the Centre in total State tax revenue from 2000-01 onwards. This is because State's own tax revenue grew at an average of 17% per annum as opposed to the average yearly growth of 14% in tax devolution from the centre.

Table 1. Components of State Tax Revenue (figures in lakhs)

Heads of Account	State's Own Tax Revenue	Tax Devolution From Centre	Total Tax Revenue
2000-01	904268	257383	1161651
2000-02	985327	262338	1247665
2000-03	1043971	278620	1322591
2000-04	1257013	324481	1581494
2000-05	1607232	387844	1995076
2000-06	1863155	421342	2284497
2000-07 (RE)	2388794	500962	2889756
2000-08 (BE)	2669117	630000	3299117
Avg. Annual Growth Rate (%)	17.01	13.92	16.33
Avg. Percentage Share (%)	81.19	18.81	100.00

Table 2 shows the receipts under different components of State's own tax revenue. Tax revenues under all heads grew phenomenally from 2000-01 to 2006-07. Growth in Other Taxes and Duties is the most striking, followed by Land Revenue, and Stamps and Registrations. In fact, there is almost a 300% jump in Other Taxes and Duties in 2005-06 from the previous year. Although still insignificant as compared to the other constituents of State's Tax Revenue, more probing is needed to understand this occurrence, once data on the constituent minor heads is obtained7.

Table 2. Receipts (in lakhs) under different components of State's own tax revenue

Heads of Account	Commercial Taxes	State Excise	Taxes on Vehicles	Stamps and Registrations	Land Revenue	Taxes and Duties on Electricity	Other Taxes & Duties	States Own Tax Revenue
2000-01	616601	152313	50182.2	63812.5	4316.29	16210.2	834.1	904268
2000-02	607931	197694	71236.8	85504.4	4954.07	17129.9	876.15	985327
2000-03	631324	209418	67570	111535	5960.81	17213.5	949.78	1043971
2000-04	773322	233396	800063	135569	6783.65	27291.9	642.88	1257013
2000-05	1005719	280553	98299	175984	11776.4	33902	998.86	1607232
2000-06	1148399	339679	110545	221220	11650.1	27708.8	3953.86	1863155
2000-07 (RE)	1412013	451995	147966	333114	10761.4	30000	2944	2388794
2000-08 (BE)	1697379	330000	156000	440000	8621.52	34020	3096.06	2669117
Avg. Annual Growth Rate (%)	16.05	13.50	18.55	32.02	13.42	13.19	44.57	17.01
Avg. Percentage Share (%)	62.35	17.81	6.21	11.31	0.53	1.68	0.10	100

While various reforms undertaken after the Tax Reforms Commission submitted its report in October 2001 - such as the rationalization of tax rates and slabs, systematic changes in tax base and better administration and enforcement - played a role in increased revenue mobilization from all taxes, the revenue from Stamps and Registrations in recent years shot up due to the growth in the housing sector. Adoption of other measures like the phasing out of stamp papers to prevent misuse, computerizing the process of registration, the setting up of a Central Valuation Committee, and the revision of market value of properties to bring the guidance value in line with the actual market rates have also worked in favor of generating greater revenues under this head. However, the MTFP 2007-2011 notes that the scarcity of housing stock in urban areas and the irreversible move towards urbanization might limit the growth in Stamps and Registrations in the coming years. Moreover, the acceleration in recent years caused due to the revision in guidance values, should stabilize once they are aligned with the actual market rates.

Growth in the number of vehicles on the road in recent years has led to a steady increase in revenues obtained under the Motor Vehicle Tax as well. With a rapidly growing economy creating the need for an expansion of the transport sector, suitable reforms in this area could create the potential for significant revenue generation in the future. As mentioned in the MTFP 2005-09, however, reforms in this area are not mere tax reforms but are mainly sector-oriented, targeted towards structural improvements in the transport sector and improving the tax base only as a corollary. Thus, additional revenue should be aimed at only in addition to the primary objectives of reducing pollution and congestion by encouraging a shift towards greater use of public transport instead of private vehicles. The Centre for Science and Environment (CSE) recently proposed a number of measures for this purpose, such as scrapping the excise duty on buses to make public transport cheap, while scaling up the bar for those aspiring to own and use private vehicles. The resultant loss to the exchequer can be compensated by increasing the number of buses. Existing tax categorizations also need to be reviewed, to account for all the new brands of vehicles in the market, so that the differential between small and big cars is maintained, and excise duties are linked to the fuel efficiency of a vehicle.

State excise collections have witnessed good buoyancy following the canalization of IMFL and rectified spirit to address the problem of non-duty paid and illicitly produced alcohol, and a change in the arrack policy which legalized the manufacturing of arrack and required a third party check for quality, accompanied with stringent enforcement. Various other measures such as replacing the current step-based excise duty structure to an ad-valorem one, modernizing the excise and police departments, developing other stakeholders and incentives against illicit distillation and sale of prohibited liquor, rationalizing the license fees, etc. have also been chalked out to increase revenue from state excise. But with the ban on arrack in place once again from the current excise year, there are bound to be limits to revenue growth under this head. Although the ban was introduced following the plea from women's self-help groups and health considerations, there have been discussions considering its retraction, mainly because of the contention that more than 50% of revenue in the excise portfolio comes from the sale of arrack. However such ground should be treaded carefully after a thorough cost-benefit analysis; weighing the loss of revenue to the state, against the welfare considerations at stake.

Under Commercial Taxes, tax collections on Agricultural Income have seen a decline over the years with a sizeable fall in 2001-02. On the other hand, collections under Sales Tax; one of the biggest components of Commercial Taxes, has been steadily on the rise. The introduction of VAT, along with the rationalization of tax rates and efforts to expand the tax base, are expected to lead to greater revenue buoyancy by ensuring stability and predictability of the tax burden. In addition, the Central Government has proposed to safeguard state revenues against the initial losses from VAT imposition through a number of tax and non-tax compensatory measures. The general boom in the economy can be expected to keep up the revenue flow from this source as long as it continues, and currently Sales Tax revenues seem to have a healthy future. In line with the economic performance, Taxes on Goods and Passengers have also exhibited an upward movement, so have Other Taxes and Duties on Commodities and Services; comprising Entertainment Tax, Betting Tax, and Luxury Tax. Betting Tax and Luxury Tax in particular, show substantial revenue expectations, as reflected by recent budget estimates.

Table 3. Receipts (in lakhs) under different components of tax devolution to the State from Centre

Heads of Account	Corpo ration Tax	Income Tax Other than Corpn.Tax	Other Taxes on Income	Taxes on Wealth	Customs Duty	Union Excise Duty	Service Tax	Other Taxes & Duties	Tax Devolution From Centre
2000-01	51858	41944	486	203	65959	92529	3241	1163	257383
2000-02	55482	48166	435	97	59285	92222	5304	1347	262338
2000-03	60535	46640	435	97	63865	98214	7366	1468	278620
2000-04	88031	52454	0	77	69233	101210	12228	1248	324481
2000-05	110388	71064	-26	242	77894	107888	20603	-209	387844
2000-06	116333	82006	-25	229	82142	109619	31072	-34	421342
2000-07 (RE)	145511	96214.1	-24.57	217.78	99667.6	112844	46561.6	-29.12	500962
2000-08 (BE)	195009	121868	-31	263	121049	124824	67100	-82	630000
Avg. Annual Growth Rate (%)	21.63	17.00	-	21.71	9.54	4.43	54.54	-3.35	13.92
Avg. Percentage Share (%)	25.78	17.99	0.06	0.05	21.40	29.21	5.29	0.22	100.00

Tax Devolution from the Centre on the other hand has also grown but at a lower rate than State's Own Tax Revenue and consequently its share in the overall Tax Revenue of the State has been consistently declining. Receipts from Service Tax grew at an average of around 54% per annum. This can be attributed to an increase in the rates as well as widening of the services brought under the net of service tax over the last few years. As an accompaniment to economic growth, receipts from corporation tax, income tax, customs and union excise duties have also increased over the years. These trends can be observed from Table 3 above which presents the receipts from tax devolution to the state, classified under the constituent heads.

(B) Non-tax Revenue

Table 4. Receipts (in lakhs) under different components of state's non-tax revenue

Heads of Account	Interest Receipts	Dividends and Profits	Total Interest Receipts	General Services	Social Services	Economic Services	Total Other Non-tax Revenue	Total Non-Tax Revenue
2000-01	72118.4	274.64	72393	18979.8	12212.9	62411.5	93604.3	165997
2000-02	14191.6	513.66	14705.3	16665	14366.8	63605.4	94637.2	109342
2000-03	3435.82	1493.23	4929.05	34926.3	18613.8	69298	122838	127767
2000-04	11133.8	1690.05	12823.9	178381	12326.3	92306.3	283014	295838
2000-05	14479	1666.09	16145.1	209812	14713.2	206564	431089	447234
2000-06	28299.9	1687.68	29987.6	203021	12913.4	141549	357483	387471
2000-07 (RE)	17860.7	1760.21	19620.9	293199	13259.7	103596	410055	429676
2000-08 (BE)	18753.9	273.16	19027.1	15423.4	13923.8	137335	166683	185710
Avg. Annual Growth Rate (%)	23.08	30.09	12.58	67.45	4.03	20.30	21.70	15.17
Avg. Percentage Share  (%)	10.96	0.47	11.43	36.27	7.05	45.25	88.57	100.00

Non-tax revenues largely comprise interest receipts, and receipts from general, social, and economic services. Table 4 shows that after a fall in 2001-02, non-tax revenues almost quadrupled by 2004-05, but declined again in 2005-06. The decline in 2001-02 is because of the huge fall in interest receipts for that year. This was primarily because of a significant fall in interest rates to just 6.5%, the lowest rate recorded since the 1970s. Interest receipts fell further in 2002-03, but this fall was more than compensated by increased receipts from other non-tax revenue sources leading to a slight increase in overall non-tax revenues of the state. Though interest receipts followed an upward trend from 2003-04, they failed to come up to their original level in 2000-01. The decline in overall non-tax revenue in 2005-06 was caused by the fall in other non-tax revenue receipts in that year. Again, detailed scrutiny is required to completely comprehend these trends.

The main reason cited for low Non-Tax Revenues has been the poor recovery of user charges. But despite suggested measures to improve cost recovery such as asking the beneficiaries to contribute to capital costs, and allowing the departments to retain their own revenues so that they have an incentive to collect them, the MTFP for 2006-10 recorded a declining Non-Tax Revenue to GSDP ratio. In his budget speech delivered on July 19, 2004, the then deputy chief minister and finance minister for Karnataka, Sri Siddaramaiah, stated that the performance on non-tax revenue mobilization has been far from satisfactory. He mentioned that there is a need to review the rates of non-tax levies in all sectors, streamline the administrative arrangements for effective collection, and enhance non-tax revenues in a sustained manner. In line with this argument, it might also be useful to study the pattern of receipts from various minor heads constituting the major heads of account presented above, in order to identify and understand the causes of the observed trend and appropriately target policies.

(C) Grants-in-Aid and Contributions

Table 5. Receipts (in lakhs) through Grants-in-aid from the centre

Heads of Account	Non-Plan Grants	Grants for State Plan Schemes	Grants for Central Plan Schemes	Grants for Centrally Sponsored Schemes	Total Grants -in -Aid  and Contribution
2000-01	24604.2	62170.9	15439	52409.7	154624
2001-02	21273.8	73343.5	15187.7	65313.1	175118
2002-03	42054.6	57016.8	4524.13	62922	166518
2003-04	52985.5	79557.7	4194.66	61919.2	198657
2004-05	31748.9	103603	4601.46	74702.8	214656
2005-06	173574	91527.7	3692.1	94443.1	363237
2006-07 (RE)	116411	184749	13568.4	165419	480148
2007-08 (BE)	113128	203720	14947.3	259588	591382
Avg. Annual Growth Rate (%)	68.72	23.70	26.93	28.36	22.90
Avg. Percentage Share	23.24	37.85	4.00	34.91	100.00

Receipts under this head have grown at an average of around 23% per annum from 2000-01 to 2007-08. Non-plan grants showed a persistent increase till 2005-06. This hints at the negative sign of increasing gaps between State revenues and expenditures which are bridged using these grants. The estimates for the last two years (2006-08) however, show a slight decline in these figures. Grants for Centrally Sponsored Schemes have also increased, whereas Grants for Central Plan Schemes have shown a considerable decline, except for the estimates of the last two years which seem considerably high in comparison to previous years. Central Schemes (CS) are fully financed by the Union Government, but are implemented at the local level by the District Collector of the District Rural Development Agency (DRDA). Expenditures on Centrally Sponsored Schemes (CSS) on the other hand, are shared between the State and the Centre. These schemes can have a distorting effect on a State's priorities as it has to pre-empt some of its own resources in order to receive a share from the Centre. An increase in Grants for CSS as observed above thus, is definitely uncalled for, and is a little imposing in the sense that the states are indirectly pushed into doing what the Centre wishes. Grants for State Plan Schemes on the other hand, did not follow any continuous pattern of growth or decline. However, they have increased overall in 2007-08 when compared to 2000-01. The tremendous increase in the overall Grants-in-aid spells an unfavorable situation for the state with lesser financial independence and greater dependence on the Centre.

(ii) Public Debt

Public Debt comprises Internal Debt and Loans and Advances from the Central Government. The Internal Debt of the state consists of loans that the state raises from the market, small savings, various financial institutions such as REC, LIC, GIC, NABARD, or through ways and means advances from the RBI. Loans and Advances from the Central Government comprise non-plan loans, loans to state plan schemes comprising of block loans, loans for centrally sponsored schemes, loans for special schemes, and other such loans. While 30% of the total money disbursed by the centre to the states is in the form of grants, the remaining 70% is disbursed as loans. State receipts under various components of public debt are given in Table 6 below. Although public debt increased considerably during 2000-01 to 2003-04, the state was finally able to achieve greater fiscal consolidation in the following years by bringing down overall debt.

Table 6. Receipts (in lakhs) under different components of Public Debt

Heads of Account	Internal Debts	Loans and Advances from Central Govt.	Total Public Debt
2000-01	229558	107565	337123
2001-02	370536	217688	588224
2002-03	798181	154422	952603
2003-04	1191297	195700	1386997
2004-05	841647	155575	997222
2005-06	499489	66865.4	566355
2006-07 (RE)	320000	118752	438752
2007-08 (BE)	255000	199071	454071
Avg. Annual Growth Rate (%)	14.26	23.97	13.10
Avg. Percentage Share  (%)	79.04	42.28	100.00

Total internal debt of the state follows a similar pattern as overall public debt with a significant increase till 2003-04 followed by a decline, as market loans rose from 2000-01 to 2003-04 but consequently showed a significant decline. Looking at Loans and Advances from the Central Government, there has been a decline in non-plan loans from the centre. State plan loans and loans for centrally sponsored schemes do not show a fixed trend. There is an increased share of public debt in overall public debt of the state and correspondingly, a decline in the percentage share of loans and advances from the central government following 2001-02 till 2005-06. This is in line with the objective of the centre of encouraging the states to borrow more competitively from the market and reduce state dependence on central loans. However, the estimates of 2006-07 and 2007-08 reveal a reverse trend with market loans estimated at 0, bringing down the percentage share of Internal Debt, and the percentage share of Loans and Advances from the Centre going up as a consequence.

An Overview of the situation on the Revenue front

Studying past and present revenue trends forms the basis for an analysis of revenue expectations for the future. It helps us address the question of whether revenues will be able to meet the required expenditures in the future and thereby assumes considerable importance in the planning process. Thus every Medium Term Fiscal Policy brings out revenue and expenditure projections for the following years as well.

After the initial impact of the revenue reforms in Karnataka, revenue growth from a number of taxes such as Stamps and Registrations, and State Excise, are expected to stabilize, though State's Own Tax Revenue might continue to grow in response to increasing GSDP. If this does not happen, the state might have to resort to greater Grants-in-Aid and Public Debt to finance expenditures, both of which are undesirable. The state could however, focus on Non-tax sources to generate greater revenues by introducing suitable reforms. The MTFP for 2007-2011 reveals optimistic projections of State finances for the future assuming a real GSDP growth of 8% per annum.

Following 2003-04, Karnataka has had a surplus of revenue over expenditure. Although the gap between receipts and expenditure shows a decline from 2006-07 to 2008-09, projections for 2009-10 and 2010-11 show the gap widening once again with a drop in the expected revenue expenditure. The projections also suggest increasing expenditure in capital formation indicated by an increase in the revenue surplus with a more or less stable fiscal deficit.

When observed in real terms however, the increase in revenue receipts is more gradual. Table 7 below gives both, nominal and real, annual average growth rate of major revenue sources, and brings out clearly the fact that revenue growth under various heads is overstated when observed in nominal terms alone. Nevertheless, the overall trends remain the same and indicate a reasonably comfortable financial situation for Karnataka in the years ahead.

Table 7. Average Annual Growth Rate of Principal Revenue Sources of Karnataka (2001-02 to 2005-06)

Head of Account	Avg. Annual Growth Rate (%)
	Nominal	Real
States Own Tax Revenue	15.82	10.76
Tax Devolution From Centre	10.55	5.72
Total Tax Revenue	14.73	9.71
Total Non-Tax Revenue	30.42	24.37
Total Grants-in Aid and Contributions	20.98	15.50
Total Revenue Receipts	15.90	10.80
Internal Debts	31.21	25.98
Loans and Advances from Central Govt.	4.50	0.58
Total Public Debt	22.14	17.32

From the earlier discussion in this section, it can be observed that apart from the revenue reforms and measures, the good performance of the State and a rapidly growing GSDP has also been a crucial factor in pushing up revenue receipts from taxes. However, reforms work more towards increasing administrative efficiency and keeping in pace with developments in the revenue arena, which imposes restrictions on the extent to which they can be used to generate greater receipts. This leaves the State dependent on continued increases in the GSDP in order to expand its revenue further.

Economic development in terms of higher GSDP places a number of demands on the government, including the provision of physical infrastructure and favourable policies. On the other hand, the State is also responsible for the provision of basic necessities and social services to enhance human development. This leads us to certain important questions. What are the raised revenues being used for? Are social priorities being discounted in front of economic growth? A review of expenditure trends is needed to answer these.

Expenditure Management

To achieve the goal of fiscal consolidation, the State embraced the policy of compressing expenditure and prioritizing it to enhance the efficiency in public spending. Wages and salaries form a substantial component of State expenses, and thus cutting down the wage bill was one of the main measures undertaken to restrict expenditure. This was aimed at through the abolition of a number of vacant posts, abolishing certain retired posts, and freezing further recruitments in all sectors except those of health, education, and police services. Additional posts and recruitments were observed on a case-to-case basis and had to be justified in terms of outcomes. Pensions and interest payments constitute another major chunk of State expenditure, but owing to the inflexibility of these commitments not much could be done to bring them down. Nevertheless, in the case of the latter, attempts were to be made to reduce the composition of loans bearing high interest rates. Compressing subsidies, both implicit and explicit, particularly those pertaining to power, transport, and food was also proposed to rationalize expenditure. Prioritization of expenditure on the other hand, was essentially based on two broad objectives; creation of physical infrastructure by means of stepping up expenditure on the construction and maintenance of roads, buildings, and irrigation works, and human development through sizeable allocations to social sectors like primary and secondary education, and health. The resulting reduction expected in revenue expenditure would lead to more funds being freed for capital outlay.

An Expenditure Review Committee was constituted for the purpose of achieving these objectives, and creating accountability and incentives for expenditure management. The Committee had a mandate to scrutinize all new expenditure proposals and underlying policies, particularly with reference to their medium term implications. Accountability and planning were also to be addressed at the department level through the implementation of Department Medium Term Fiscal Policies (DMFTPs) to indicate targets, strategies, resources, and major programmes that would be undertaken by the various departments in the MTFP period. As a consequence of these expenditure and revenue reforms, the State has been able to overcome its revenue deficit and has even generated revenue surpluses over the last few years. While revenue expenditure has grown at an average nominal rate of around 12% per annum and an average real rate of 8% per annum, revenue receipts have grown even faster at nominal and real rates of around 15% and 10% per annum respectively.

The sectoral trends in terms of expenditure on general, social and economic services are presented in Table 8. General services record expenditure on organs of state, fiscal services, interest payments and serving of debt, administrative services, pensions and miscellaneous general services, and defense services. Social services include expenditure on education, sports and youth services, art and culture, medical and public health, family welfare, water supply and sanitation, housing, information and broadcasting, welfare of scheduled castes and scheduled tribes, labour and labour welfare, social welfare and nutrition. Economic services comprise expenditure on agriculture and allied activities, rural development, special area programme, irrigation and flood control, energy, industry and minerals, transport, communication, science and technology, etc. While expenditure on general services consisting mainly of administrative expenses and interest payments has to be curbed, outlays should be increased in the sectors under social and economic services.

Excluding the last two years for which the actual expenditure details are yet not available, expenditure under economic services grew at an average rate of 17% per year from 2000-01 to 2005-06. Expenditure on general services showed an annual average growth rate of around 12.8%. Expenditure on social services on the other hand, showed a rather meager annual average growth rate of around 9.5% in comparison. The revised and budget estimates for 2006-07 and 2007-08 though, show expectations of improvement with the percentage share of expenditure on general and economic services coming down, and that of social services going up.

Table 8. Expenditure on General, Social and Economic Services

	Revenue Expenditure and Capital Outlay (in lakhs)				Percentage of Total Revenue and Capital Expenditure
Year	Total	General	Social	Economic	General	Social	Economic
2000-01	1863185	568127.3	643060.4	651997.2	30.49	34.51	34.99
2001-02	2071137	626685.2	664110.9	780341.2	30.26	32.07	37.68
2002-03	2175050	718797.6	662155.6	794096.5	33.05	30.44	36.51
2003-04	2431410	916755.3	739225.4	775429.7	37.70	30.40	31.89
2004-05	2960553	1003646	820879.2	1136028	33.90	27.73	38.37
2005-06	3386283	1025375	1000409	1360499	30.28	29.54	40.18
2006-07 (RE)	4318370	1258860	1355505	1704004	29.15	31.39	39.46
2007-08 (BE)	4734266	1220285	1692326	1821655	25.78	35.75	38.48

Social services such as education, healthcare, water supply, housing, etc., are all essential to promote the well-being of the citizens of the State and should therefore receive prime priority. Increased expenditure on general services represents greater administrative expenses indicating a high-cost government which is not desirable. Expenditure on economic services though needed to promote growth of the economy and industry, is also not desirable at the cost of providing social services.

The heads accounting for maximum expenditure under general services have been those of interest payments, police services, and pensions and other retirement benefits. As mentioned earlier, expenditure incurred on pensions is mostly inflexible owing to the commitments of the State, and cannot be controlled much. With regard to increasing interest payments, the proposal of swapping high cost borrowings with those having lower interest rates does not seem to have worked much in favor of bringing down expenses under this head. Again, increased expenditure on police services fails to have translated to greater security for the people. The increase in crime rates in the State bears testament to this. Maintaining law and order however, is a fundamental responsibility of the State, and definitely requires bigger outlays to cope with an increasing population. Nevertheless, the increased expenditures should be justified in terms of better output or service delivery.

Within the ambit of social services, the sectors of education and health consume the vast proportion of the State's expenditure. Under economic services, a sizeable proportion of expenditure is incurred on irrigation and power. These sectors being extremely vital for human and economic development, and imposing somewhat conflicting demands on the state resources, are subsequently analyzed in greater detail.

General Education

As mentioned earlier, education is one of the priority sectors in which the State would like to increase allocations. General education, which includes primary and secondary education, university and higher education, adult education and language development, accounts for the highest level of spending by the State. Although the MTFP for 2007-11 mentions that the State is committed towards earmarking substantial outlays under both revenue and capital heads of high priority development expenditure, revenue expenditure alone accounts for around 98% of the total expenditure on general education. Table 9 below gives the nominal and real expenditure and growth rates of expenditure on general education, taking into consideration both the revenue and capital account. While the nominal expenditure shows a continued trend of increase over the years, expenditure in real terms shows an actual decline initially between 2000-01 and 2002-03. The figures in brackets also reveal that expenditure on general education as a percentage of total expenditure of the state has declined from 17% in 2000-01 to around 13% in 2007-08.

Table 9. Expenditure and Growth rate of expenditure on General Education

	Expenditure		Growth Rate of Expenditure
Year	Nominal	Real	Nominal	Real
2000-01	335569.86 (18.01)	332552.3
2001-02	336078.63 (16.23)	326608.9	0.15	-1.79
2002-03	340634.69 (15.66)	318545.2	1.36	-2.47
2003-04	361524.23 (14.87)	319272.9	6.13	0.23
2004-05	418978.82 (14.15)	354623.5	15.89	11.07
2005-06	462349.09 (13.65)	367091.7	10.35	3.52
2006-07 (RE)	556592.2 (12.89)		20.38	—
2007-08 (BE)	669986.7 (14.15)		20.37	—

Figures in brackets indicate percentage of total revenue and capital expenditure of the State

The economy measure of lowering expenditure on salaries by reducing the number of sanctioned posts has not been applied to the education sector in recognition of the fact that teachers and staff are just as important in the provision of education as other infrastructure such as textbooks, buildings, blackboards, etc. The low real growth rate of education expenditure then, indicates that most of the increase goes towards salary payments particularly after the pay scale revisions, while little priority is given to simultaneously improving infrastructure in this sector. Apart from subject knowledge, a teacher also needs textbooks and a blackboard to be able to teach well. Developments in the area of education thus, are impossible unless this situation is corrected, and the necessary infrastructure is provided in addition to good teachers. This would call for a further increase in allocations to education beyond the amount paid as salaries.

The right to education requires the State to commit itself towards the goal of primary and secondary education for all. Consequently, the major proportion of the expenditure on general education is in the field of elementary education followed by that on secondary education. It should be noted while studying expenditure patterns however, that only around 85% of the overall expenditure on general education is spent on elementary and secondary education. A majority of the remaining share is spent on university and higher education. Adult education, language development and general expenses form the leftover, very minor share.

As observed from the recorded data, a sizeable portion of the general education expenditure is in the form of block grants and block assistance to Zila and Gram Panchayats. That the Grants-in-Aid (GIA) system is an inefficient and less effective way of deploying resources is a long accepted fact. However, the revamping and rationalization of this system though announced in all subsequent budget speeches since 2000-01, is yet to be implemented. Education subsidies in the form of GIA are input linked, i.e. linked to the salary and other benefits of the teachers in the absence of administrative control by the Government over these teachers, and hence do not have a bearing on the performance.

Suggestions to modify the existent GIA system have been proposed recurrently over the years. The idea was introduced in the first MTFP and reinstated in the following ones. The MTFP-2004 stated that a protocol to implement GIA reforms and a rationalization and monitoring system will be put in place by the end of the fiscal year 2004-05. The GIA institutions should meet current expenditures out of their current revenue and the gap will be bridged by the Government through the medium of block grants but on a diminishing scale. Grants will be performance related and a database would be prepared to prevent misuse. Savings from GIA rationalization will be funneled back into primary and secondary education to enable better provision of services in Government schools and to substantially improve infrastructure in rural Government primary schools. This however did not happen, and once again the most recent MTFP-2007 mentions the 2007-08 budget proposal of graduating to a student-centric GIA model rather than the present teacher-centric one.

Again, this is just an overview of the education expenditure in the state and its performance against the slated proposals and projections. Studying the efficiency of these expenditures is the next step and is even more important from the point of view of policy revisions and planning for the future. This is not such a simple calculation however, and first requires the identification of suitable measures of output which is a difficult task by itself. Nevertheless, it is beyond the scope of this analysis and would constitute a separate study. Another interesting subject to study in this area, is the inequality in district allocations. A CBPS study on the education and health expenditures for two districts in Karnataka; Chitradurga and Udupi, led to some disturbing revelations. It was observed that better performing districts were still allocated greater amounts, as compared to the poor performers with lower allocations to improve their status. Thus Udupi, with its higher literacy rate was awarded higher allocations rather than Chitradurga which had a lower literacy rate, but also lower allocations to tackle the problem with.

There are also a number of other notable issues which need to be studied with regard to education. Improving the quality of education is one. A study on secondary education and the labour market for Karnataka disclosed a number of problems which de-link the existent education system from the labour market demands. These included failure to impart good communication and basic arithmetic skills to students which are essential for success in the labour market, and ignorance and disconnectedness of the teachers with the outside world and the skills required to pursue a good job. Besides this, a review of the inequalities relating to gender or social groups present in the education system, and a revision of the current syllabi, are other issues which need to be addressed. While CBPS has attempted studies on the education system of the State in the past, this current attempt at studying state allocations to the sector just provides an opening to a vast area of work in this sphere which still needs to be done.

Medical and Public Health

In the context of human development, health is the other key priority of the State apart from education. With regard to health too, the State had envisioned substantial increases in allocations over the years, with the non-salary expenditure progressively overtaking the salary expenditure. Also, in contrast to the expenditure curbing measure of freezing employment in other sectors, the MTFP-2001 proposed additional posts for health and education to ensure a better spread and quality improvement in the provision of these social services. Thus, enhanced outlays in health and education were to involve both higher revenue expenditure in terms of enhanced recruitments of teachers and doctors to ensure service reach, and higher allocations for asset creation and maintenance. However, while the earlier section on education already shows almost negligible capital outlays when compared to the revenue expenditures in that sector, the percentage share of capital outlays in total expenditure on medical and public health has also been consistently decreasing over the years. Table 10 gives the revenue and capital outlays on medical and public health and their percentage share in the total expenditure on medical and public health. Except for the optimistic estimates for the last two years, capital expenditure on medical and public health shows a declining trend. Table 11 presents the nominal and real growth rates in expenditure on medical and public health taking into account both revenue and capital outlays. Expenditure on family welfare has not been included here within the health expenditure as it concentrates mainly of family planning programmes. Moreover, in an earlier CBPS study on budget allocations for maternal health care in Karnataka it was observed that family welfare programmes in the State operated mainly on central funds.

	Expenditure on Medical & Public Health
Year	Total	Revenue	Capital
2000-01	83836.42	76675.67 (91.46)	7160.75 (8.54)
2001-02	86523.35	78620.53 (90.87)	7902.82 (9.13)
2002-03	83731.68	79370.81 (94.79)	4360.87 (5.21)
2003-04	81415.49	78902.62 (96.91)	2512.87 (3.09)
2004-05	86672.88	85875.81 (99.08)	797.07 (0.92)
2005-06	101174.8	100405.92 (99.24)	768.86 (0.76)
2006-07 (BE)	138151.7	121268.99 (87.78)	16882.72 (12.22)
2007-08 (RE)	171818.3	143478.33 (83.51)	28340 (16.49)

Figures in brackets indicate percentage share in total expenditure on medical & public health

Table 11. Expenditure and Growth rate of Expenditure on Medical & Public Health

	Expenditure		Growth Rate of Expenditure
Year	Nominal	Real	Nominal	Real
2000-01	83836.42 (4.50)	332552.3
2001-02	86523.35 (4.18)	326608.9	3.20	1.21
2002-03	83731.68 (3.85)	318545.2	-3.23	-6.88
2003-04	81415.49 (3.35)	319272.9	-2.77	-8.18
2004-05	86672.88 (2.93)	354623.5	6.46	2.03
2005-06	101174.78 (2.99)	367091.7	16.73	9.50
2006-07 (BE)	138151.71 (3.20)		36.55	-
2007-08 (RE)	171818.33 (3.63)		24.37	-

Figures in brackets indicate percentage of total revenue and capital expenditure of the State

In the area of health, achievement of Millennium Development Goals (MDGs) has been the main objective of state policy. Access to universal health care has to be ensured for every citizen, and maternal and infant mortality rates have to be brought down. The Planning Commission in the Tenth Plan (2002-2007) laid down even more ambitious goals of reducing the Maternal Mortality Rate (MMR) to 2 by 2007 and 1 by 2012, and the Infant Mortality Rate (IMR) to around 30 per 1000 live births by 2012. Achieving these would no doubt require substantial increases in outlays for the health sector. However public expenditure on health has been only a small proportion of the total expenditure on health; with private expenditure playing the major role. Moreover, the table above reveals a decline in state health expenditure between 2001-02 and 2003-04 even in nominal terms.

In all the years, the actual expenditure was well below what was allocated. This is not new, and has in fact been observed in earlier CBPS studies as well. The CBPS study on maternal health mentioned above addresses this issue as well. It suggests that if the money allocated is not being spent, there must be other bottlenecks in the administrative system. Also, as the maximum proportion of expenditure is on the revenue account which is mainly constituted by salary payments, expenditure being below allocations could also indicate vacant positions that have not been filled up; probably in the rural areas in particular. The MTFP-2004 discussed cutting these vacant positions by 50%. But good healthcare cannot be provided unless a sufficient number of doctors, nurses, and staff are employed, and hence the state should try to fill these vacant positions through recruitment rather than using it as an opportunity to curb expenses and reaching a strong financial position. This does not imply that fiscal consolidation is not a priority; it should just not be carried out at the cost of social priorities.

As mentioned in the section on education expenditure, district allocations for the provision of medical and public health facilities raise a number of questions too. How does the State allocate funds to the various districts? What is the pattern of need assessment that the State uses for this purpose- the age of the district, its population, or some other measure?

To add to all of this, the problem of using output based measures to analyse the efficiency of expenditure stands out here as well. Assuming that the State allocates sufficient resources to the provision of health services, which itself is doubtful, information asymmetry and inadequate access to health care facilities on account of poverty may not allow the citizens to make use of the new developments in health care. Sometimes social stigma may also reduce the accessibility of a service. This was observed in the case of maternal health care, where iron tablets though distributed were not used as they were believed to lead to dark skinned babies. The existing data; mainly at the state level, is inadequate for such assessments and needs to be supplemented with more data at the local level where the services are actually delivered. A CBPS study aimed at highlighting this fact, collected data at the local level in the districts of Chamarajanagar and Chitradurga in Karnataka to study the cost of providing reproductive and child health services. This though, is only a small first step and needs to be supplemented with increased attempts to improve the database at the district and household levels.

Major/Medium Irrigation

The irrigation potential from all sources is estimated at 55 lakhs and the potential created up to 2003-04 was only around 30.61 lakh hectares. In the irrigation sector, allocations have risen by 21% over 2002-03 to 2005-06. Initially, in the absence of sufficient resources greater reliance was laid on Off-budget borrowings. However, with the achievement of fiscal consolidation and the gradual elimination and replacement of the high cost Off-budget borrowings, irrigation projects are being provided with on budget support, and in recent times much of the investment in irrigation has been through market borrowings.

Investments in irrigation have to be shared among a menu of options consisting of minor irrigation, major irrigation, watershed and ground water improvement works. However, out of the total state expenditure on irrigation over the last few years, a vast proportion has been allocated for the completion of a number of ongoing major/medium irrigation projects particularly in the Krishna Basin with the objective of freeing resources for other critical sectors. Following 2001-02, more than 95% of the expenditure on major/medium irrigation projects has been on the capital account and while an increase in expenditures is observed on the capital account, revenue expenditure has been on the decline. To bring these trends out clearly, a disaggregated analysis of revenue and capital expenditure under this head is presented.

On the revenue account, there has been a tremendous decline in the expenditure on major and medium irrigation over the years. This can be observed in Graph 7 on the following page. The graph shows that after an initial increase from 1999-2000 to 2000-01, there was a steep decline in the expenditure on major and medium irrigation in 2001-02, with the low trend continuing since then. On further probing the data, it was observed that this dramatic difference can be attributed to Interest on Capital under Interest on Irrigation Works, which was close to Rs.56000 lakhs in 1999-2000, but disappeared from the accounts from 2001-02. A closer look also showed that while the actual expenditure was far below the budget estimates on the plan front, on the non-plan front, the actual expenditure incurred exceeded the budget estimates, although the differences have been decreasing over the years. Table 12 on the following page gives the observed differences between accounts and budget estimates for revenue expenditure on major and medium irrigation. Probably greater expenditure than foreseen on the non-plan front, most of which is incurred on maintenance and payments to staff, creates a paucity of funds for plan projects, where the expenditure is still below the committed levels. But it could also be inappropriate planning, or that the procedures adopted for capital expenditure take a long time and do not fall into the annual budget cycle. Whatever the case, this matter needs serious investigation, beyond mere budget scrutiny.

Table 12. Differences between Accounts and Budget Estimates (in lakhs) for Expenditure on Major/Medium Irrigation

	Non plan		Differences	Plan		Differences
Year	Accounts	BE	(BE-Accounts)	Accounts	BE	(BE-Accounts)
1999-2000	58606.98	47436.13	-11170.9	758.6	1179.43	420.83
2000-01	64370.79	54516.31	-9854.48	689.86	792.93	103.07
2001-02	6177.27	1835.11	-4342.16	682.24	860	177.76
2002-03	6400.95	2124.28	-4276.67	500.34	810	309.66
2003-04	6116.65	2132.87	-3983.78	202.64	187.06	-15.58
2004-05	5750.13	1936.71	-3813.42	310.03	350	39.97
2005-06	6542.22	1903.24	-4638.98	290.26	358.93	68.67

On the other hand, capital outlay on major/medium irrigation has been increasing over the years, as illustrated by Graph 8 on the following page. Again, analysis of the data reveals that a vast part of this trend can be attributed to the object head of Capital Expenses on both plan and non-plan fronts, which appears on the accounts only from 2003-04 onwards. Capital Expenses rose from just around Rs.5852 lakhs in 2003-04, to as high as Rs.93665 lakhs in 2005-06. Observing the trend in accounts in isolation, the peak in 2002-03 can be mainly attributed to expenditure on major works for the Krishna Basin Project, which was close to Rs.23888 lakhs. In 2003-04 however, the expenditure on the Krishna Basin Expenditure was almost 0, which probably explains the slight dip in the trend. The steep rise in 2004-05 was because of the tremendous debt servicing burden of Krishna-Bhagya Jala Nigam Ltd. And Karnataka Neeravari Nigam Ltd., which together amounted to almost Rs.178962 lakhs. The differences between the Budget Estimates and Accounts however, do not seem to indicate any particular pattern, with Accounts being greater than Budget Estimates in certain years and less in others.

Table 13. Growth Rate of Expenditure on Irrigation

	Expenditure			Growth Rate
Year	Major/Medium	Minor	Total	Major/Medium		Minor		Total
				Nominal	Real	Nominal	Real	Nominal	Real
2000-01	175022.83 (9.39)	19701.31 (1.06)	194724.14 (10.45)
2001-02	149523.78 (7.22)	17736.81 (0.86)	167260.59 (8.08)	-14.57	-16.22	-9.97	-11.71	-14.10	-15.77
2002-03	198626.68 (9.13)	18566.85 (0.85)	217193.53 (9.99)	32.84	27.83	4.68	0.73	29.85	24.95
2003-04	182765.47 (7.52)	19879.12 (0.82)	202644.59 (8.33)	-7.99	-13.10	7.07	1.11	-6.70	-11.89
2004-05	286552.76 (9.68)	33061.85 (1.12)	319614.61 (10.80)	56.79	50.27	66.31	59.40	57.72	51.16
2005-06	321153.06 (9.48)	28255.38 (0.83)	349408.44 (10.32)	12.07	5.13	-14.54	-19.83	9.32	2.55
2006-07 (RE)	393820.83 (9.12)	65224.88 (1.51)	459045.71 (10.63)	22.63	-	130.84	-	31.38	-
2007-08 (BE)	322994.7 (6.82)	83321.66 (1.76)	406316.36 (8.58)	-17.98	-	27.75	-	-11.49	-

Figures in brackets indicate percentage of total revenue and capital expenditure of the State

Accounting for both revenue and capital expenditure, total expenditure on major/medium irrigation has increased over the years. Expenditure on minor irrigation has also gone up.

When observed as a percentage of total expenditure however, expenditure on major/medium and minor irrigation declined till 2003-04, and subsequently rose again. Table 13 gives an overview of the nominal and real growth in irrigation expenditure. Although the overall trends observed in nominal and real terms are the same, the growth rates are much less exaggerated when observed in real terms.

Irrigation forms a major outlet of expenditure of the state. Though developing the irrigation potential is required to promote growth, there is a serious need to assess expenditures in this area. Though the state has undertaken to sequencing expenditure on major projects to minimize time and cost overruns, most deadlines are not met and many projects still await completion. Recoveries from irrigation are also low. Besides, provision of pump sets to enhance the irrigation potential creates another problem in terms of increased power usage and theft, and consequently pushes up the subsidy bill of the power sector thereby causing a significant drain in the state resources. It is also necessary to study the efficiency of these expenditures. What matters finally to the state economy is the return per rupee spent on these projects. Is there a benchmark against which this can be assessed? For instance, compared to similar projects elsewhere, has the state spent the right amount, or over/under spent? Such questions need to be asked, but are beyond the scope of this paper.

Power

The burden placed by the power sector on the State's resources has been recognized and discussed in every MTFP right from the start. The MTFP 2001 for Karnataka states, "The power sector represents a huge drain on the Government's resources and poses the biggest fiscal risk in the near future. It will be impossible to eliminate the revenue deficit without comprehensive structural reforms in this sector." With this understanding, the Government undertook a number of measures beginning with the setting up of a regulatory commission, and drawing a Financial Restructuring Plan (FRP) to give a road map for eliminating the subsidy obligation as a result of the financial losses in the power sector. Among the reforms put in place to overcome the fiscal stress in this sector were the corporatisation of the electricity board, and the separation of generation, transmission, and distribution. Four new distribution companies for Bangalore, Mangalore, Hubli and Gulbarga were set up. Universal metering and privatization of distribution were also targeted to minimize losses.

Power theft is one of the main causes of the persistent financial losses in this sector. The significance of this problem is clearly visible from the outcome of the one-time regularization scheme implemented in March-April 2002 which resulted in around 8.8 lakh illegal customers being regularized and generated a one-time revenue of around Rs. 93 crores. Subsequently, the Electricity Act was amended to strengthen the anti-theft provisions, and inspection drives are being conducted to clamp down on power thefts.

The major cause of the problem though, is the provision of electricity to the farmers almost free of cost. With electricity to agriculture unmetered, and charged at a highly subsidized rate often not paid, the Government through its subsidy to the power sector is effectively the purchaser of electricity on behalf of the state's farmers. Table 14 and Graph 9 on the next page clearly bring out the size of this predicament. A significant component of expenditure was allocated and incurred on the non-plan front, particularly on subsidies given to KPTCL for loss due to rural electrification. The trends in overall expenditure on power is thus more or less a reflection of the trend in these subsidies, and the differences between the expenditure estimates and the accounts can also be mainly attributed to the differences between allocation and spending on these subsidies. Following the steep rise in expenditure in 2001-02 due to a fully met subsidy obligation amounting to Rs. 2300 crores, the total expenditure incurred by the State on power has not decreased as much as required, and continues to remain a strain on its resources.

To overcome this problem, the Government also proposed the Purchaser-Provider model wherein the government as purchaser and the KPTCL/ESCOMs as providers will enter into a Memorandum of Understanding which will set out annual and monthly schedules of ESCOM - wise subsidy requirement calculated on the basis of 80 MU per day supply, targeted T&D losses, category-wise collection efficiency, retention of adjustable duties and net cross subsidy. The monthly releases will be made as per actual requirement based on the above parameters and within the overall ceiling. This arrangement, which explicitly recognizes the Government's role as underwriting the sector, is expected to bring much needed fiscal discipline to it. The Government subsidy will also be proportional to actual payments made by farmers so that the more farmers pay, the more governments will pay, and the more electricity KPTCL/ESCOMS will be able to supply to the farmers. At present, in the absence of direct metering of pump sets, distribution companies extrapolate and account that 49% of the power consumed in Karnataka is attributable to the Irrigation Pump (IP) sets. As IP sets in Karnataka are not metered, it is difficult to check whether this is indeed the case. Moreover, this also creates comfortable room for power thefts. Hence to prevent misuse of this subsidy, accounting for the power consumed by the farmers is also needed. This calls for 100% metering of agricultural pump sets; a big task in itself.

Table 14. Expenditure and Growth rate of Expenditure on Power

	Expenditure		Growth Rate
Year	Nominal	Real	Nominal	Real
2000-01	92020.27 (4.94)	91192.82
2001-02	232115.13 (11.21)	225574.8	152.24	147.36
2002-03	190095.15 (8.74)	177767.9	-18.10	-21.19
2003-04	172224.36 (7.08)	152096.5	-9.40	-14.44
2004-05	189228.28 (6.39)	160162.7	9.87	5.30
2005-06	188330.54 (5.56)	149528.9	-0.47	-6.64
2006-07 (BE)	258199.75 (5.98)		37.10
2007-08 (RE)	252608 (5.34)		-2.17

Figures in brackets indicate percentage of total revenue and capital expenditure of the State

Although the power sector financial losses have started to fall, there still remains a significant gap to be bridged. Progress on most areas of reforms suggested within this sector remains far from satisfactory. Once again, expenditure on power is mainly on the revenue account and increased capital outlays are needed to improve infrastructure, promote efficiency and prevent misuse. In addition, many more structural changes are required to make the sector more investment friendly. Various policy alternatives for the future are now being looked at, such as the unbundling and privatization of service providers, an incentive based capital assistance programme for the ESCOMs, a rural load management system in which supply to IP sets at the distribution level is separated from household power supply, and attempts to link investment grants to FRP to create robust foundations for future expansions. Hopefully these will take shape and work towards improving the situation in this sector. Once resources are freed from this sector, they can be employed to enhance conditions in the social sector, more critical from the point of view of bringing about human development and offering a better quality of life to the people.



Vinod Vyasulu is a developmental economist and started his teaching and research career at the IIM Bangalore. He has taught at the XLRI Jamshedpur and was the RBI Chair Professor of Development at the ISEC Bangalore for over five years. He was briefly the Director of the Institute of Public Enterprises, Hyderabad before starting the Development Research Foundation at TIDE Bangalore in 1995. He has worked with the UNDP, the World Bank and other agencies in a number of developmental projects. At present he heads The Centre for Budget and policy Studies, Bangalore.

Kriti Toshniwal is a Research Assistant at The Center for Budget and Policy Studies, Bangalore. She has a masters deegre in economics from the Madras School of Economics and also teaches econometrics at Mount Carmels College, Bangalore.


If Karnataka is a good example of how fiscal performance has been improved through 'political will', it also provides an illustration of how this is achieved at the expense of development. Health and education are key areas but the results of this study show that expenditure has been taken up by salary payments which are hardly 'developmental'. Spending in irrigation has also been large in certain years only due to debt-servicing. The question that begs asking if improving the fiscal position by the government can be worth much if this is at the expense of what the government is elected to do. Is the State raising money in order to maintain itself in a position of financial comfort?

Editor