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Finance Commission of India

Article 280 of the constitution of India provides for a Finance Commission as a quasi-judicial body. It is constituted by President every fifth year or at such earlier time as he considers necessary.

Finance Commission consists of a chairman and 4 other members to be appointed by President.


Finance commission is required to make recommendations to the President of India on the following matters.
1] The distribution of the net proceeds of taxes to be shared between the Centre and the States, and the allocation between the states of the respective shares of such proceeds. (Vertical and horizontal distribution).
2] The principles that should govern the grants-in-aids to the states by Centre. (i.e. out of consolidated fund of India.
3] The measures needed to augment the consolidated fund of a state to supplement the resources of the panchayats and the municipalities in the state on the basis of recommendations made by the state finance commission.
4] Any other matter referred to it by president in the interests of sound finance.

Recommendations made by FC are only advisory in nature and hence not binding on government. However as suggested by Dr. P V Rajamannar, the Chairman of the Fourth Finance Commission, ‘Since the Finance Commission is a constitutional body, expected to be quasi-judicial, its recommendations should not be turned down by the Govt. of India unless there are very compelling reasons’.

Need of Finance Commission.

It acts as the balancing wheel of fiscal federalism in India.
It leads to rational distribution of tax revenue between Centre and states. The Indian federal system provides for division of powers and responsibilities between centre and states.  Centre collects majority of the tax revenue as it enjoys scale of economies and convenience in the collection of central taxes. But, state is responsible for delivering public goods. Sometimes, this leads to states incurring expenses higher than the revenue generated by them. Thus, comes the need of devolution of central taxes to states and hence the need of finance commission to determine the basic principles for this devolution.
Regional disparities prevent some states from generating adequate resources as compared to others. FC through its recommendation tries to ensure a sense of equality in public service across the states.
Ensuring the evolution of the devolution mechanism with changing times

Issues associated.

Constitution envisages FC as the balancing wheel of fiscal federalism in India. However its role in the Centre -State fiscal relations was undermined by erstwhile Planning Commission, a non constitutional and a non-statutory body. Dr. P V Rajamannar, the Chairman of 4th FC, had highlighted the overlapping of functions and responsibilities between FC and PC in fiscal federal transfers.
Fifteenth FC has been set up under N K Singh. There has been questions by South Indian states on working of FC. According to them, population of 2011 should not be considered as one of the criteria for fiscal transfers. It undermines the population control efforts taken by south Indian states by reducing their share of funds.
Union have also asked 15th FC to consider discontinuation of revenue deficit grants. To suggest mechanism for grants linked to performance. But the question is whether the FC is the right institution to access the performance.
More importantly, states have concern with the finance commission itself. It is entirely a Union body. Neither in the selection of the members nor in deciding terms of reference, state governments have any say.

Using 2011 Census for revenue distribution.

Southern states which have worked more effectively towards population control will end up being penalized for their population control. So, the southern states are demanding that the 1971 census be used for Finance Commission’s revenue distribution formula instead of the 2011 census.

The objective of the general-purpose transfer is to ensure comparable level of public services at comparable tax rates. Now, if comparable level of service is the aim, it is only fair that the latest population data should be used.
Using the 1971 data has not served as levers for family planning. Family planning and population are better managed through initiatives by state governments under different schemes.
Idea of punishing individuals elsewhere in the country just because these areas continue to languish on major indicators goes against the Indian Republic Spirit.
Population is not the only criteria in the horizontal devolution formula. Income distance, area, forest cover etc. were also used in 14th FC recommendation.
In fact, even after giving some weightage to 2011 census data while deciding allocation for 2015-2020 period, the FC tax devolution received by Karnataka saw a 63% jump between 2014-15 and 2015-16.
So, it is factually incorrect to say that using 2011 census data will hurt the southern states.

Revenue deficit grant should be provided or not.

By suggesting that revenue deficit grant may not be provided at all, the 15th FC is being nudged towards violating Article 275(1) and 280(3b) of the Indian constitution.
These grants are meant to correct vertical imbalances that step from the constitution – while states account for 60 percent of public expenditure, they raise only 37% of the revenue.

14th Finance Commission’s recommendation of center’s fiscal condition.

By including this in TOR (terms of reference) the FC is being nudged towards reducing the tax devolution to the states to meet requirements of the central schemes.
If this happens, state will lose their policy independence and instead will be limited to implementing central schemes. This goes against the spirit of federalism.
Further, it is being mis-stated that 14th FC made an overly generous increase in devolution from 32% to 42%. Because the 14th FC covered both planned and non-plan expenditure, in reality the increase was only from 39% to 42%.

Posted in PSIR 1B

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Your notes are very nice and almost covers the entire important things in every section, but something is missing here like- current challenges are facing by commission such as 1) use of certain parameters for performance; 2) Non-lapsable defence fund; 3) re-organisation of state of J&k into 2 UTs etc.

Last edited 3 months ago by Deepak