Financial Framework of Panchayati Raj Institutions

Panchayati Raj Institutions (PRIs) form the constitutional backbone of grassroots governance across rural India. With over 2.55 lakh Gram Panchayats, more than 6,700 block-level bodies, and around 665 Zila Parishads functioning today, the scale of local self-governance is enormous. Yet, for these institutions to actually deliver roads, drinking water, sanitation, and local development, one question becomes critical: where does the money come from? The financial framework of PRIs is layered, contested, and far from straightforward. Understanding it is essential to appreciating why local governance in India works well in some places – and struggles in others.

The constitutional foundation of PRI finances
Sources of revenue: how PRIs are supposed to fund themselves
Own source revenue
Revenue from government grants
State Finance Commissions: the institutional mechanism
The functioning gap: how SFCs have underperformed
Why own source revenue remains so low
Weak tax base and missing rules
Untapped community assets
Political resistance to taxation
The grant dependency trap
Challenges in ensuring timely and adequate funding
Recent reforms and the road ahead
What do you think?

The constitutional foundation of PRI finances

The 73rd Constitutional Amendment Act of 1992 was a turning point. It did not just give Panchayats a democratic structure – it created a constitutional basis for their financial empowerment. Article 243H authorises state legislatures to empower Panchayats to levy, collect, and appropriate taxes, duties, tolls, and fees. Article 243-I mandates that the Governor of each state constitute a State Finance Commission every five years to review the financial position of Panchayats and recommend principles for resource allocation. Article 280(3)(bb) further empowers the Central Finance Commission to recommend grants to supplement PRI resources through augmentation of the Consolidated Fund of the State.

These provisions collectively establish three pillars of PRI finance: own source revenue, transfers from state governments through State Finance Commissions, and grants from the Central Finance Commission. In practice, the balance between these three pillars is heavily skewed – and that imbalance defines the central challenge of PRI finances today.

Sources of revenue: how PRIs are supposed to fund themselves

The financial architecture of PRIs draws from both internal and external sources. Internally, Panchayats can generate their own revenue. Externally, they depend on grants from higher levels of government. The mix – or rather, the mismatch – between these sources tells a revealing story about the state of fiscal decentralisation in India.

Own source revenue

Own Source Revenue (OSR) refers to the income a Panchayat generates from its own resources, independent of transfers from higher tiers of government. Under Article 243-H, Panchayats may collect property taxes, professional taxes, water charges, license fees, and fees from markets and fairs. Non-tax revenue can come from leasing community assets such as ponds, tanks, grazing lands, and common lands – collectively called Common Property Resources (CPRs).

The potential is real. In Telangana’s Velpur Gram Panchayat, for instance, income from auctioning a local market and leasing village ponds contributed meaningfully to the body’s financial health, enabling it to provide services like roads, drainage, and street lighting. Research from the National Institute of Public Finance and Policy (NIPFP) confirms that Panchayats which generate more OSR also tend to provide better services – and when good services are available, residents are more willing to pay taxes.

However, the national picture remains stark. Between 2017 and 2022, OSR across all gram panchayats averaged just ₹59 per capita, according to Ministry of Panchayati Raj data. In the fiscal year 2022-23, out of a total PRI revenue of ₹35,354 crore, only ₹737 crore came from own tax revenue – barely 2% of total income. Even more telling, only 18% of gram panchayats actively utilise Common Property Resources as a revenue stream. States like Goa and Puducherry perform much better in per capita OSR collection, while states like Bihar, Jharkhand, and Uttar Pradesh lag considerably.

Revenue from government grants

The bulk of PRI income comes from grants provided by the Centre and state governments. Data from the Reserve Bank of India indicates that around 80% of PRI revenue comes from Central government grants, while roughly 15% comes from state government grants. In the worst-performing cases, grants account for as much as 95% of a panchayat’s total income – giving rise to what researchers have called a “dependency trap.”

Central Finance Commission grants flow to Rural Local Bodies (RLBs) in two forms. Tied grants (60% of the total) can only be used for specific purposes – sanitation and the supply of drinking water – while untied or basic grants (40%) can be used for local needs at the Panchayat’s discretion. Under the 15th Finance Commission (2021-26), the total grant allocation to rural local bodies stood at approximately ₹2.36 lakh crore, with a fund release efficiency of nearly 95% – a significant improvement over previous commissions.

The tied-untied grant structure, while designed to ensure minimum service standards, has been criticised for its rigidity. The Standing Committee on Rural Development and Panchayati Raj noted that when a panchayat has already achieved saturation in sanitation or drinking water infrastructure, tied grants cannot be reallocated and are therefore not released at all – leaving the panchayat without funds it could otherwise use productively. The committee recommended a reallocation mechanism to convert unused tied grants into untied grants for better fund utilisation.

State Finance Commissions: the institutional mechanism

One of the most significant institutional innovations introduced by the 73rd Amendment was the mandatory creation of State Finance Commissions (SFCs). Under Article 243-I, the Governor of each state is required to constitute an SFC every five years. These commissions function much like the Central Finance Commission but at the state level – reviewing the financial health of Panchayats and recommending principles for distributing tax proceeds, duties, fees, and grants between the state government and its PRIs across all three tiers: village, block, and district.

Specifically, SFCs make recommendations on the distribution of state tax proceeds between the state and panchayats, the determination of taxes that panchayats may levy themselves, the grants-in-aid payable to PRIs from the Consolidated Fund of the State, and measures to improve the overall financial position of panchayats.

In states where SFCs have functioned well, such as Kerala and Karnataka, the results have been visible: better-resourced panchayats, more regular grant disbursements, and stronger local governance. Karnataka, for example, is consistently ranked high on the Ministry of Panchayati Raj’s Panchayat Devolution Index for assigning functions to panchayats, releasing SFC grants on time, and maintaining adequate staffing capacity.

The functioning gap: how SFCs have underperformed

Despite their constitutional mandate, SFCs have been one of the weakest links in the PRI financial chain. As of 2025, only 25 out of 28 states had even constituted their State Finance Commissions, and the quality of their functioning has been uneven. From 2024-25 onwards, establishing an SFC has been made a mandatory condition for accessing certain central grants, signalling the government’s attempt to enforce compliance through financial incentives.

The problems run deeper than non-constitution. SFCs are frequently described as “almost defunct bodies” – often not constituted on time and struggling with inadequate infrastructure, limited operational capacity, and poor data collection. Jharkhand, for instance, released its first SFC report only recently, even though the fifth SFC was due across the country by 2014-15. Where SFC reports have been submitted, state governments have not always implemented the recommendations. Research on Odisha’s SFCs found that while successive commissions have recommended measures to strengthen panchayat finances, the state government has not always effectively implemented those recommendations.

Why own source revenue remains so low

The failure to develop robust OSR is not simply a matter of political will. It is a structural problem with multiple reinforcing causes.

Weak tax base and missing rules

PRIs face a limited tax base, a shortage of trained staff, inadequate infrastructure, and a lack of clear guidelines for introducing new taxes. In many states, even where Panchayati Raj Acts list permissible taxes, the rules for actual collection have not been framed. Madhya Pradesh, for instance, has directives for tax collection but uses rates that are decades out of date, significantly limiting revenue potential.

Untapped community assets

Although gram panchayats are authorised to collect revenue from Common Property Resources such as fisheries, grazing lands, and ponds, the actual levy remains abysmally low due to political resistance, administrative inefficiencies, and lack of enforcement mechanisms. Vested interests and local conflicts also play a role – local elected representatives are often reluctant to impose taxes on community members who vote for them, creating a structural disincentive for OSR mobilisation.

Political resistance to taxation

Local elected representatives are acutely sensitive to the political costs of tax collection. Collecting property taxes or user charges from neighbours and constituents is not an easy ask, especially in low-income rural settings. This has made many panchayats passive recipients of grants rather than active revenue mobilisers – a posture that the 73rd Amendment was explicitly designed to change.

The grant dependency trap

Ironically, panchayats that receive more grants tend to generate more OSR – because better services encourage willingness to pay. But for panchayats already trapped in a low-service, low-revenue equilibrium, the grant dependency reinforces itself. Reliance on grants tends to stifle local accountability and innovation in financial management, reinforcing the very “dependency trap” that fiscal decentralisation was meant to break.

Challenges in ensuring timely and adequate funding

Even setting aside the OSR problem, panchayats face serious difficulties in accessing the grants they are entitled to. Panchayats are required to prepare Gram Panchayat Development Plans (GPDPs) and upload them to the eGramSwaraj portal as a condition for receiving Central Finance Commission grants. Some states have either not uploaded GPDPs or uploaded fewer than the required number, leading to the withholding of funds.

Delayed release of funds by state governments sometimes forces panchayats to dip into their own limited reserves or defer development projects. In some cases, funds earmarked under central schemes do not reach the intended panchayats at all. The Standing Committee on Rural Development and Panchayati Raj reported that 19 out of 34 States/UTs received no funds under the Rashtriya Gram Swaraj Abhiyan scheme in the 2022-23 financial year.

Performance grants add another layer of complexity. These grants are awarded to well-performing panchayats but many are unable to access them due to non-fulfilment of eligibility conditions, while others submitted misleading information to qualify. The ranking system for performance grants has itself been flagged as needing reform to ensure transparency and avoid rewarding panchayats that game the criteria rather than those that genuinely perform.

Recent reforms and the road ahead

The central government has taken several steps to strengthen PRI finances in recent years. The Ministry of Panchayati Raj, in collaboration with IIM Ahmedabad, has developed a training module on Own Source Revenue generation to strengthen the financial self-reliance of Gram Panchayats. In 2025, the ministry also launched the Atma Nirbhar Panchayat Special Award (ANPSA) to recognise panchayats that demonstrate excellence in OSR mobilisation – a move designed to create positive incentives for revenue generation.

The SVAMITVA scheme, which maps rural property through drone surveys and issues property cards to village residents, is also expected to bolster property tax collection by giving panchayats accurate, updated land records for the first time. Technology-driven tools for digitising assessment and collection are increasingly being seen as a practical lever for OSR growth.

The Ministry of Panchayati Raj has consistently advocated for states to fully implement the 73rd Amendment’s provisions on the three Fs – functions, finances, and functionaries – as the complete package needed for genuine decentralisation. Finance without functions is meaningless; functions without staff are undeliverable; and staff without finances are helpless. Progress on all three fronts is needed simultaneously.

What do you think?

What do you think? If local tax collection is politically difficult for elected panchayat members, should the power to levy and collect certain taxes be shifted to a neutral administrative authority at the block or district level – or would that defeat the purpose of local self-governance? And given that SFCs are the primary mechanism for ensuring fair financial devolution to PRIs, what structural reforms do you think are needed to make them genuinely effective rather than constitutionally compliant on paper alone?

References

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Table of Contents

The constitutional foundation of PRI finances 🔗

Sources of revenue: how PRIs are supposed to fund themselves 🔗

Own source revenue 🔗

Revenue from government grants 🔗

State Finance Commissions: the institutional mechanism 🔗

The functioning gap: how SFCs have underperformed 🔗

Why own source revenue remains so low 🔗

Weak tax base and missing rules 🔗

Untapped community assets 🔗

Political resistance to taxation 🔗

The grant dependency trap 🔗

Challenges in ensuring timely and adequate funding 🔗

Recent reforms and the road ahead 🔗

What do you think? 🔗