Contents How to read this report We suggest you read either the short summary (Overview) or the long summary (Executive Summary). The chapters of the report are self-contained, and can be read separately. OVERVIEW Xill EXECUTIVE SUMMARY XV11 1. THE STATE-LEVEL FISCAL CRISIS OF THE LATE 1990s 1 India's States 1 Genesis of the Fiscal Crisis 3 Impact of the Fiscal Crisis 7 The State-level Reform Effort 11 Challenges Before the States 14 2. EXPENDITURE REFORMS 20 Overview 20 Salaries and Pensions 20 Subsidies 26 Public Enterprise Reforms 32 Reforms to Improve the Quality of Spending 34 3. REVENUE POLICY AND ADMINISTRATION 40 State's Own-Revenue: Structure and Reforms 41 Reforms to Tax Institutions 53 4. FISCAL FEDERALISM AND THE INCENTIVE FRAMEWORK FOR STATE REFORMS 58 Borrowing Regime . 60 Revenue Transfers (Tax Sharing and Grants) 68 Institutional Issues and External Funding Agencies 77 5. CONCLUSIONS AND PROSPECTS 79 Summary of Recommendations 79 Modelling the Impact of Reform 82 Risks 85 ANNEXES 87 REFERENCES 107 Annexes India's Special Category States, Small States and Union Territories 89 Case Studies in Reforms to Improve Expenditure Quality 91 Case 1: E-governance: a mixed bag 91 Case 2: Right to information: an effective tool for promoting performance? 92 Case 3: Successful health care initiatives: with and without private sector participation 92 Case 4. The Bangalore service delivery turnaround 93 Case 5: How to beat corruption in drugs procurement, and thereby improve rural health service delivery: The Tamil Nadu Medical Services Corporation 94 Case 6: Karnataka's Ombudsman 95 Case 7: Some reforms to improve expenditure management 95 Case 8: The USAID-financed India REFORM Project: helping states develop fiscal reform capacity 96 Selected Issues in VAT Introduction at the State Level in India 98 A.Haryana's experience with VAT: going it alone 98 B.International experience with value-added taxes in a federation: lessons for India 98 C.Mechanisms for handling interstate trade in a VAT regime 100 Institutions for Revenue Coordination Schemes to Promote Good Fiscal Performance 104 A. Fiscal Reform Facility (FRF) 104 B.World Bank sub-national adjustment lending (SALs) 105