Finance Commission – Issues related to devolution of resources

15th Finance Commission submits report to President


From UPSC perspective, the following things are important :

Prelims level: Finance Commission

Mains level: Mandate of the Finance Commission

The 15th Finance Commission, chaired by NK Singh, on Monday submitted its final report for 2021-22 to 2025-26 to the President.

Try this PYQ:

With reference to the Finance Commission of India, which of the following statements is correct?

(a) It encourages the inflow of foreign capital for infrastructure development

(b) It facilitates the proper distribution of finances among the Public Sector Undertakings

(c) It ensures transparency in financial administration

(d) None of the statements (a), (b) and (c) given above is correct in this context

Key recommendations that would feature in its final report:

  • A separate defence and national security: The viability of creating a separate defence and national security fund as suggested by the Centre.
    • States would keenly await these recommendations as it may translate into a lower share of funds for them.
  • GST compensation dues to States: The panel is also expected to factor in unpaid GST compensation dues to States for this year, while working out State’s revenue flow calculations for the years beyond 2022.

Formula that decides a State’s share:

Weight in 15th FC Parameters Weight in 14th FC
15 (2011 Census) Population 27.5 (17.5 – 1972, 10 – 2011 Census)
15 Area 15
10 Forest and Ecology 7.5
45 Income Distance 50
12.5 Demographic Performance
2.5 Tax Effort

What is the Finance Commission?

  • The Finance Commission (FC) was established by the President of India in 1951 under Article 280 of the Indian Constitution.
  • It was formed to define the financial relations between the central government of India and the individual state governments.
  • The Finance Commission (Miscellaneous Provisions) Act, 1951 additionally defines the terms of qualification, appointment and disqualification, the term, eligibility and powers of the Finance Commission.
  • As per the Constitution, the FC is appointed every five years and consists of a chairman and four other members.
  • Since the institution of the First FC, stark changes in the macroeconomic situation of the Indian economy have led to major changes in the FC’s recommendations over the years.

Constitutional Provisions

Several provisions to bridge the fiscal gap between the Centre and the States were already enshrined in the Constitution of India, including Article 268, which facilitates levy of duties by the Centre but equips the States to collect and retain the same.

Article 280 of the Indian Constitution defines the scope of the commission:

  1. The President will constitute a finance commission within two years from the commencement of the Constitution and thereafter at the end of every fifth year or earlier, as the deemed necessary by him/her, which shall include a chairman and four other members.
  2. Parliament may by law determine the requisite qualifications for appointment as members of the commission and the procedure of selection.
  3. The commission is constituted to make recommendations to the president about the distribution of the net proceeds of taxes between the Union and States and also the allocation of the same among the States themselves. It is also under the ambit of the finance commission to define the financial relations between the Union and the States. They also deal with the devolution of unplanned revenue resources.

Why need the Finance Commission?

  • As a federal nation, India suffers from both vertical and horizontal fiscal imbalances.
  • Vertical imbalances between the central and state governments result from states incurring expenditures disproportionate to their sources of revenue, in the process of fulfilling their responsibilities.
  • However, states are better able to gauge the needs and concerns of their inhabitants and therefore more efficient at addressing them.
  • Horizontal imbalances among state governments result from differing historical backgrounds or resource endowments and can widen over time.
  • The first FC was established in 1951 by Dr B.R. Ambedkar, the then-incumbent law minister, to address these imbalances.

Important functions

  • Distribution of net proceeds of taxes between Center and the States, to be divided as per their respective contributions to the taxes.
  • Determine factors governing Grants-in-Aid to the states and the magnitude of the same.
  • To make recommendations to the president as to the measures needed to augment the Fund of a State to supplement the resources of the panchayats and municipalities in the state on the basis of the recommendations made by the finance commission of the state.
  • Any other matter related to it by the president in the interest of sound finance.

Members of the Finance Commission

  • The Finance Commission (Miscellaneous Provisions) Act, 1951 was passed to give a structured format to the finance commission and to bring it to par with world standards.
  • It laid down rules for the qualification and disqualification of members of the commission, and for their appointment, term, eligibility and powers.
  • The Chairman of a finance commission is selected from people with experience of public affairs. The other four members are selected from people who:
  1. Are, or have been, or are qualified, as judges of a high court,
  2. Have knowledge of government finances or accounts, or
  3. Have had experience in administration and financial expertise; or
  4. Have special knowledge of economics

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