Finance Commission
Article 280 of the Constitution of India provides for a Finance Commission as a quasi-judicial body. It is constituted by the president of India every 5th year or at such earlier time as he considers necessary. The primary role of Finance Commission is to ensure a fair allocation of financial resources balancing the fiscal needs of both the Centre and the states.
Recently, the 16th Finance Commission led by former Niti Aayog Vice Chairman Arvind Panagariya has started seeking public suggestions on its mandate.
Role of the Finance Commission
- Distribution of Tax Revenue: The Finance Commission advises on the division of net proceeds of taxes between the Centre and the States (vertical devolution) and among the States (horizontal devolution). It aims to ensure that States have adequate funds to fulfill their responsibilities.
- Principles Governing Grants-in-Aid: The Commission suggests principles that should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India. These grants are provided to help States manage fiscal deficits and undertake specific development projects.
- Augmenting Local Bodies’ Resources: The Finance Commission also recommends measures to augment the revenues of municipalities and panchayats. This is crucial for ensuring that local bodies have sufficient funds to carry out their functions effectively.
- Additional Financial Recommendations: It may also be tasked with other financial matters referred to it by the President of India, such as suggesting measures to improve the fiscal health of the States.
- Decision on Horizontal Devolution: The horizontal devolution, or the distribution of funds among States is determined by a formula devised by the Finance Commission. This formula takes into account various factors, including:
- Population: A State’s population is a significant factor in determining its share of the tax revenue.
- Income Levels: The per capita income and overall economic condition of a State are considered to ensure equitable distribution.
- Geographical Area: The size of the State is factored in to address regional disparities.
- Fiscal Discipline: States demonstrating better fiscal management may receive additional incentives.
- Duration of Recommendations: The recommendations of the Finance Commission are typically valid for five years.
Criteria for Devolution:
| Criteria | 14th FC (2015-20) | 15th FC (2020-21) | 15th FC (2021-26) |
| Income Distance | 50.0 | 45.0 | 45.0 |
| Area | 15.0 | 15.0 | 15.0 |
| Population (1971) | 17.5 | – | – |
| Population (2011)# | 10.0 | 15.0 | 15.0 |
| Demographic Performance | – | 12.5 | 12.5 |
| Forest Cover | 7.5 | – | – |
| Forest and Ecology | – | 10.0 | 10.0 |
| Tax and fiscal efforts* | – | 2.5 | 2.5 |
| Total | 100 | 100 | 100 |
Major Terms of reference for 16th Finance Commission:
- Division of Tax Proceeds: Recommending the distribution of taxes between the Union Government and the States under Chapter I, Part XII of the Constitution.
- This includes the allocation of shares among the States from these tax proceeds.
- Principles for Grants-in-Aid: Establishing the principles governing grants-in-aid to the States from the Consolidated Fund of India.
- This encompasses determining the amounts to be provided to the States as grants-in-aid, specifically under Article 275 of the Constitution, for purposes beyond those outlined in the provisos to clause (1) of that article.
- Enhancing State Funds for Local Bodies: Identifying measures to enhance the Consolidated Fund of a State.
- This is aimed at supplementing the resources available to Panchayats and Municipalities within the State, based on recommendations made by the State’s own Finance Commission.
- Evaluation of Disaster Management Financing: The Commission may review the current financing structures related to Disaster Management initiatives.
- This involves examining the funds created under the Disaster Management Act, 2005, and presenting suitable recommendations for improvements or alterations.
Issues with Finance Commission:
Hari Krishna Dwivedi and Achin Chakraborty in Economic & Political Weekly (2022) argue that the appointment procedure of Finance Commission has inherent biases. They are appointed by the centre, hence may not be fully independent and immune from political influence.
Kalaiyarasan A. argues that Finance Commission became a politicized institution with arbitrariness and inherent bias towards the union government. In today’s fiscal policy and Finance Commission, the concerns of the founding fathers- addressing socio economic inequities- are being forgotten.
There are suggestions to make Finance Commission a permanent body as well as allowing Finance Commission to determine even discretionary grants. In order to achieve the goal of cooperative fiscal federalism, the Finance Commission’s Chairman and members should be appointed through broad based consultation which must involve states.
Conclusion
The Finance Commission of India plays a pivotal role in fostering fiscal federalism by ensuring equitable resource distribution between the Centre and the States. While it has significantly contributed to balancing financial needs, challenges such as political influence and limited independence highlight the need for reforms. Making the Finance Commission a permanent and more autonomous institution could strengthen its capacity to address fiscal imbalances and promote cooperative federalism effectively.
Preferred UPSC Questions
GS Paper II (Governance, Constitution, Polity):
- Discuss the constitutional provisions related to the Finance Commission and its role in fostering fiscal federalism.
- Critically evaluate the challenges faced by the Finance Commission in ensuring equitable resource allocation.
- How does the Finance Commission’s mandate align with the principles of cooperative federalism?
GS Paper I (Society):
- Examine the societal implications of equitable resource distribution through the Finance Commission’s recommendations.
- How does the Finance Commission impact socio-economic development at the local level?
GS Paper III (Economy):
- Analyze the role of the Finance Commission in addressing fiscal imbalances between the Centre and the States.
- Discuss the significance of horizontal and vertical devolution in the context of India’s fiscal federal structure.
GS Paper IV (Ethics, Integrity, and Aptitude):
- Highlight the ethical challenges faced by the Finance Commission in maintaining impartiality amidst political pressures.
- Discuss the importance of transparency and accountability in the Finance Commission’s functioning to uphold fiscal fairness.
