Finance Commission – Issues related to devolution of resources

Finance Commission


From UPSC perspective, the following things are important :

Prelims level: Finance Commission

Mains level: Finance Commission, Its evolving role in fiscal federalism

  • The report of the Fifteenth Finance Commission, along with an Action Taken Report, was tabled in Parliament.
  • The Commission, headed by N K Singh, had submitted its Report to the President in December 2019.
  • The government had accepted the recommendations of the Commission “in substantial measure a/c to FM.

The Finance Commission and its purpose

  • Article 280 of the Constitution requires that a Finance Commission be constituted to recommend the distribution of the net proceeds of taxes between the Centre and states, and among the states.
  • Much has changed since the First Commission was set up in November 1951 under the Chairmanship of K C Neogy, a former member of the Constituent Assembly and diwan of a princely state.
  • The President has appointed 14 more Commissions since then.

Why need Finance Commission?

  • The framers of the Constitution were seeking to address the vertical imbalance between the taxation powers and expenditure and responsibilities of the federal government and the states, and the horizontal imbalance, or inequality, between states that were at different stages of development.
  • Ensuring inclusiveness is, therefore, a key mandate of the Finance Commission.
  • That means assigning weights to things like population, the fiscal distance between the top ranked states and the others, etc.
  • It is not that the best-performing state will be allocated the highest share — even if delivery execution and governance are better — rather, the effort will be to narrow the development gap between states.

Constitution of the Finance Commission

  • The Finance Commission Rules, 1951, lay down the criteria for being members of the constitutional body.
  • Members:
  1. those having special knowledge of finance and accounts of government with wide knowledge and experience in financial matters and in administration,
  2. or with special knowledge of economics, and
  3. those who have been qualified to be appointed as a judge of a High Court

Notable members

  • In the years following the reforms of the 1990s, Commissions have been headed by reputed economists and administrators — from A M Khusro, who headed the Eleventh Finance Commission, to Chakravarthi Rangarajan, Vijay Kelkar, and Y V Reddy, who were Chairmen of subsequent Commissions.
  • Senior politicians like K Brahmananda Reddy, Y B Chavan and N K P Salve had helmed earlier Commissions.
  • Before N K Singh, an economist and career administrator who subsequently joined politics, the last politician in this role was K C Pant, who then went on to be Deputy Chairman of the Planning Commission.

Changing role of the Finance Commission

  • What has changed dramatically since the 1950s, when the First Commission presented its recommendations on the transfer of resources between the Centre and the states, is the scale of distribution of tax proceeds.
  • From 10% of the total tax receipts of the Centre in 1950, it rose to a record 42% after the recommendations of the Fourteenth FC headed by Y V Reddy — a share that made previous awards look conservative, and sat well with the spirit of cooperative federalism.
  • The Fifteenth FC has recommended that this allocation be reduced by a percentage point to 41% in order to meet the security and special needs of the erstwhile state of Jammu and Kashmir.
  • The other significant change has been in the equation between the central and state governments as a result of the recommendations of the Twelfth FC which reshaped lending by the federal government to states.
  • The Fourteenth Commission recommended the creation of a Fiscal Council; the Thirteenth had set out detailed measures on implementing GST with a grand bargain for states.

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