Revenue incentives at the third tier

Given the poor level of exploitation in most states of even such sources of revenue as have been legislatively assigned to the fiscal domain of panchayati raj institutions, the most important issue is that of incentives for own revenue collection. Incentives can be built into the design of State-local transfers by deducting local revenue potential from closed-ended grant entitlements, thus deeming local collections as having been realised (upto some stipulated fraction of potential if need be). Such a system can work only if the assessment of revenue potential across panchayat jurisdictions is perceived as cross-sectionally fair, and if it carries minimal costs of assessment for the State government. The jurisdiction-specific indicator must also not carry policy endogeneity, with adverse incentives for provision of public services by PRIs. The paper examines these issues and suggests a way by which the revenue potential can be quantified in an operationally useful way, without adverse incentives. The paper also examines whether State governments should be incentivised by the Centre to implement decentralisation and encourage own revenue generation by PRIs.