BABBA – Sem 7 (2022)

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Financial Commission

The Finance Commission is a Constitutionally mandated body that is at the centre of fiscal
federalism.

Set up under Article 280 of the Constitution, its core responsibility is to evaluate the state of
finances of the Union and State Governments, recommend the sharing of taxes between
them, lay down the principles determining the distribution of these taxes among States.

Article 280 of the Indian Constitution

 President after two years of the commencement of Indian Constitution and thereafter
every 5 years, has to constitute a Finance Commission of India.
 It shall be the duty of the Commission to make recommendations to the President in
relation to the:

o the distribution between the Union and the States of the net proceeds of taxes
which are to be, or maybe, divided between them and the allocation between
the States of the respective shares of such proceeds;

o the principles which should govern the grants in aid of the revenues of the
States out of the Consolidated Fund of India;

o any other matter referred to the Commission by the President in the interests
of sound finance

o The Commission shall determine their procedure and shall have such powers
in the performance of their functions as Parliament may by law confer on
them

Article 281 of the Indian Constitution

 It is related to the recommendations of the Finance Commission:

o The President has to lay the recommendation made by Finance Commission

and its explanatory memorandum before each house of Parliament
Two distinctive features of the Commission’s work involve redressing the vertical
imbalances between the taxation powers and expenditure responsibilities of the centre and
the States respectively and equalization of all public services across the States.

President of India constitutes the Finance Commission every five years or on time
considered necessary by him.
Composition

 Chairman: Heads the Commission and presides over the activities. He should have
had public affairs experience.
 Four Members.
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 The Parliament determines legally the qualifications of the members of the

Commission and their selection methods.

Qualification and Chairman and Members

 The 4 members should be or have been qualified as High Court judges, or be

knowledgeable in finance or experienced in financial matters and are in
administration, or possess knowledge in economics.
 All the appointments are made by the President of the country.
 Grounds of disqualification of members:
 found to be of unsound mind, involved in a vile act, if there is a conflict of interest
 The tenure of the office of the Member of the Finance Commission is specified by the
President of India and in some cases, the members are also re-appointed.
 The members shall give part-time or service to the Commission as scheduled by the
President.
 The salary of the members is as per the provisions laid down by the Constitution.

Functions of Finance Commission

The Finance Commission makes recommendations to the president of India on the following
issues:

 The net tax proceeds distribution to be divided between the Centre and the states,
and the allocation of the same between states.
 The principles governing the grants-in-aid to the states by the Centre out of the
consolidated fund of India.
 The steps required to extend the consolidated fund of a state to boost the resources of
the panchayats and the municipalities of the state on the basis of the
recommendations made by the state Finance Commission.
 Any other matter referred to it by the president in the interests of sound finance.
 The Commission decides the basis for sharing the divisible taxes by the centre and
the states and the principles that govern the grants-in-aid to the states every five
years.
 Any matter in the interest of sound finance may be referred to the Commission by
the President.
 The Commission’s recommendations along with an explanatory memorandum with
regard to the actions done by the government on them are laid before the Houses of
the Parliament.
 The FC evaluates the rise in the Consolidated Fund of a state in order to affix the
resources of the state Panchayats and Municipalities.
 The FC has sufficient powers to exercise its functions within its activity domain.
 As per the Code of Civil Procedure 1908, the FC has all the powers of a Civil Court. It
can call witnesses, ask for the production of a public document or record from any
office or court.

Advisory Role of Finance Commission

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The recommendations made by the Finance Commission are of an advisory nature only and
therefore, not binding upon the government. It is up to the Government to implement its
recommendations on granting money to the states. To put it in other words, ‘It is nowhere
laid down in the Constitution that the recommendations of the commission shall be binding
upon the Government of India or that it would amount to a legal right favouring the
recipient states to receive the money recommended to be provided to them by the
Commission.
Why is there a need for a Finance Commission?
The Indian federal system allows for the division of power and responsibilities between the
centre and states.  Correspondingly, the taxation powers are also broadly divided between
the centre and states.  State legislatures may devolve some of their taxation powers to local
bodies.
Its working is characterised by extensive and intensive consultations with all levels of
governments, thus strengthening the principle of cooperative federalism.

Its recommendations are also geared towards improving the quality of public spending and
promoting fiscal stability.

Finance Commission List

The first Finance Commission was set up in 1951 and there have been fifteen so far. Each of
them has faced its own unique set of challenges.
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Formula used for distribution:

The share in central taxes is distributed among states based on a formula.  Previous Finance
Commissions have considered various factors to determine the criteria such as the
population and income needs of states, their area and infrastructure, etc.  Further, the
weightage assigned to each criterion has varied with each Finance Commission.

Formula used for distribution:

Population is an indicator of the expenditure needs of a state. Over the years, Finance
Commissions have used population data of the 1971 Census.  The 14th Finance Commission
used the 2011 population data, in addition to the 1971 data.  The 15th Finance Commission
has been mandated to use data from the 2011 Census.
Area is used as a criterion as a state with larger area has to incur additional administrative
costs to deliver services.
Income distance is the difference between the per capita income of a state with the average
per capita income of all states. States with lower per capita income may be given a higher
share to maintain equity among states.
Forest cover indicates that states with large forest covers bear the cost of not having area
available for other economic activities. Therefore, the rationale is that these states may be
given a higher share.

Grants-in-Aid:
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Besides the taxes devolved to states, another source of transfers from the centre to states is
grants-in-aid. As per the recommendations of the 14th Finance Commission, grants-in-aid
constitute 12% of the central transfers to states. The 14th Finance Commission had
recommended grants to states for three purposes: (i) disaster relief, (ii) local bodies, and (iii)
revenue deficit

The Fifteenth Finance Commission was constituted on 27 November 2017 against the
backdrop of the abolition of Planning Commission (as also of the distinction between Plan
and non-Plan expenditure) and the introduction of the goods and services tax (GST), which
has fundamentally redefined federal fiscal relations.

The Terms of Reference of the current Commission have some distinctive features, including
recommending monitorable performance criteria for important national flagship
programmes and examining the possibility of setting up a permanent non lapsable funding
for India’s defence needs. The reorganisation of the State of Jammu and Kashmir into two
Union Territories – one of Jammu and Kashmir and one of Ladakh – presents a new
dynamic. On the whole the Finance Commission faces new challenges in the process of the
evolution of our federal polity. As an important Constitutional entity, the Commission is
committed to balancing competing claims and priorities among all three tiers of government
in a credible manner.

The 15th Finance Commission is chaired by Mr. N.K. Singh was constituted by the President
in November 2017. The Commission has a very wide range of recommendations for states in
various sectors like power and waste management etc. The 15th Finance Commission was
required to submit two reports – this first report consisting of recommendations for the
financial year 2020-21 and the second report with recommendations for the 2021-26 period.

The report of the 15th Finance Commission is divided into four volumes – 

 Volume 1 and 2 contain annexes and the main report.

 Volume 3 deals with the Union Government and its departments and also deals
with challenges between the period and the roadmap ahead.
 Volume 4 deals with states and in that analysis of the states, it addresses all the
key challenges which are faced by the states.

Vertical and horizontal devolution

Vertical devolution

It is also known as the devolution of the taxes of the Union to States. For the period of 2021-
26, the share of states is recommended to be 41% in the central taxes which is the same as
that of 2020-2021. However, this is less than the 14th Finance Commission share which was
42%. The Commission has said that the grants from Central resources to the states were
reduced because they have to adjust that 1% for the newly formed union territories of
Jammu Kashmir and Ladakh. It was done to maintain stability among the resources during
this pandemic.
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Horizontal devolution

It is also termed as allocation between the states. The horizontal devolution is categorized
into various heads for different areas and the weightage is given accordingly.

The criteria are given as follows maximum weightage is given to the income factor which is
45% of the share, next is given to population and area which is 15% for each, next head is of
demographic performance which is given a share of 12.5%, next 10% share is given to forest
and ecology and at last 2.5% to tax and fiscal affairs and this all heads combine of 100%. This
is how the share is allotted between the states. This is the same as of the year 2020-21 we can
see this in the table mentioned below also it covers the difference from 14th Finance
Commission. 

Grants to be provided from centre’s resources

Following are the grants mentioned which will be provided from centre’s resources: 

Revenue deficit grants

The 15th Finance Commission will provide an amount of Rs 2.9 lakh crore to 17 states to
eliminate the revenue deficit.

State-specific grants

States will get a grant of Rs 1.3 lakh crore for 8 sectors which are health, school education,
higher education, implementation of agricultural reforms, maintenance of PMGSY roads,
judiciary, statics, and aspirational districts and blocks. Also, the commission has kept a
portion for the performance-linked incentives in the grant.
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A state-specific grant of Rs 49,599 crore is recommended by the commission and it should be

given in the areas of social need, administrative governments, infrastructure, water, and
sanitation, preservation of cultural-historical monuments, high-cost physical instruction
structure, and tourism. A high-level committee should be established to review and monitor
how the state-specific grounds are utilized as recommended by the Commission.

Grants to local bodies

The total grant provided for local bodies is Rs 4.36 lakh crore which is divided into various
categories of the local bodies like 2.4 lakh crore for rural local bodies, 1.2 lakh crore to urban
local bodies, and 70 thousand crores for health grants from local governments. The health
grants will also be provided to convert rural centres and primary health care centres to
health and wellness centres which will also support diagnostic infrastructure.

The grants to local bodies will be distributed based on the population and area of the states
with a 9:1 ratio respectively; these grants are other than the health grants. The commission
has fixed some conditions for availing these grants. The entry-level criteria include (i) the
publication of preliminary and audited accounts in the public domain, and (ii) the
establishment of minimum property tax floor rates by states, as well as improvements in
property tax collection. If the state on the recommendation does not constitute a State
Finance Commission then no grants will be given to local bodies after March 2024.

Disaster risk management 

Disaster management will have a total of Rs 1.6 lakh crores of funds in which the Centre’s
share will be Rs 1.2 lakh crore. The  Commission also recommended that the fund should be
divided in the existing pattern, that is the Centre to state ratio for the northeastern and
Himalayan states will be 90:10 and for the other states, it will be 75:25.

Defence and internal security

The Modernisation Fund for Defence and Internal Security (MFDIS) would be established as
a special non-lapsable fund to fill the gap between budgetary requirements and capital
spending in defence and internal security. Over the next five years, the fund is expected to
have a corpus of Rs 2.4 lakh crore (2021-26). From the Consolidated Fund of India, Rs 1.5
lakh crore would be transferred. The remaining funds will come from actions like
disinvestment in defence public sector businesses and the monetisation of defence lands.

Performance initiatives and grants

The 15th Finance Commission has recommended a grant of Rs 4,800 crores for the states to
enhance educational outcomes, Rs 6,143 crores for online learning and development of
professional courses, and Rs 45,000 crores to get at performance-based initiative for all the
carrying out agriculture.
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Recommendations for the health sector

The 15th Finance Commission has recommended states increase their spending on health
and make it more than 8% of their whole budget by the year 2022. The primary healthcare
expenditure should be two-third of the total health expenditure by 2022, making it easy for
the states to adapt and innovate the centrally-sponsored schemes. All Indian Medical and
Health Services should be established. A total grant of Rs 1,06,606 crore which is 10.3% of
the total grant will support the health sector.

Fiscal roadmap

Fiscal deficit and debt levels

The Commission recommended that the fiscal deficit should be brought down to 4% GDP by
the Centre. It recommends the fiscal deficits for every year like 4% in 2021-22, 3.5% in 2022-
23, 3% in 2023-24. If the state is unable to utilise the amount in 2021-25 then it can utilise that
amount by 2026. During the first four years (2021-2025), states will be allowed to borrow an
additional 0.5 per cent of GSDP if they implement power sector reforms that include (i)
reducing operational losses, (ii) reducing revenue gaps, (iii) reducing cash subsidy payments
by adopting direct benefit transfer, and (iv) reducing tariff subsidy as a percentage of
revenue.

Revenue mobilisation

Taxation based on income and assets should be tightened. The coverage of measures relating
to tax deduction and collection at source (TDS/TCS) should be increased to avoid excessive
reliance on income tax on salaried incomes. State-level stamp duty and registration fees have
a lot of untapped potentials. Property records should be computerised and connected with
transaction registration, as well as the market value of properties. The property valuation
process should be streamlined by state governments.

GST

The inputs and outputs intermediating with the inverted duty structure should be resolved.
Revenue neutrality which is compromised by the multiple rate structure and several towns
and adjustment on the GST rate should be restored. Also, it should be rationalized by
merging the rates of 12% and 18%. For expanding the GST scope, the states need to step up
and look into it.

Criticism

It absolves the Union administration of responsibility for its budgetary restraint and dilutes
the Union’s and States’ shared accountability. The commission should have provided
performance-based initiatives to the states to perform better in the population control
reform. It should have also included the population census of 1971. Fiscal federalism will be
affected and weakened if there are any restrictions imposed on states’ capacity to borrow
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and it will have a negative impact on state spending, particularly on development

investment.

Conclusion

When we see any of the Financial Commission reports, there are some drawbacks in it.
There are certain crucial points which we always have to see how it affects the country.
There were many challenges faced in the recommendations made by the commission like
global economic slowdown, lower tax revenues etc. The disturbance in the economy was
created by the coronavirus pandemic due to which many new reforms were made by the
Finance Commission in concern to the health sector. Many policies like GST, direct tax code,
and improving expenditure outcomes will need to have a special focus from the government
in the future from the Finance Commission. From the report, we can easily see that the
health sector has to improve and this is why the commission has higher grants for it. 

References

1. https://byjus.com/free-ias-prep/finance-commission-of-india/
2. https://www.insightsonindia.com/2019/03/02/finance-commission-of-
india-2/
3. https://blog.ipleaders.in/analyzing-15th-finance-commission-report/
4. https://www.drishtiias.com/daily-updates/daily-news-analysis/15th-finance-
commission-recommendations-resource-allocation
5. https://prsindia.org/policy/report-summaries/report-15th-finance-commission-
2021-26
6. https://fincomindia.nic.in/
7. https://pib.gov.in/PressReleasePage.aspx?PRID=1693868
8. https://fincomindia.nic.in/writereaddata/html_en_files/fincom15/
TermsofReference_XVFC.pdf