Finance Commission – Issues related to devolution of resources

In difficult times, Fifteenth Finance Commission rose to the challenge


From UPSC perspective, the following things are important :

Prelims level : Finance Commission

Mains level : Paper 2- Recommendations of Fifteenth Finance Commission

The article analyses the various recommendations of the Fifteenth Finance Commission and their impact.

Unique challenges

  • Many new and unique demands were placed on the 15th Finance Commission.
  • The major challenge being addressing the issue of the 2011 population census evoking a sharp response from the southern states.
  • Other issues include the non-lapsable defence fund and the use of certain parameters for performance incentives.
  • The Commission was also required to perform the task of assessing and projecting the fiscal roadmap for the Union and state amid an uncertain domestic environment due to shortfall in the GST collection, further accentuated in the year 2020 by the global pandemic.

Key recommendations

The Commission, in its final report, recommended vertical devolution at 41 per cent, adjusting 1 per cent for the erstwhile state of Jammu and Kashmir.

1) Horizontal distribution

  • For horizontal distribution, the commission has tried to harmonise the principles of expenditure needs, equity and performance.
  • This is achieved by the introduction of efficiency criteria of tax and fiscal efforts and by assigning 12.5 per cent weight to demographic performance.
  • Consideration of demographic performance will help in resolving the demographic debate and incentivising states in moving towards the replacement rate of population growth.

2) Principles governing grant-in-aid

  • Grants are important as they are more directly targeted and equalise the standards of basic social services to some extent.
  • The Commission has recommended a total grant of Rs 10,33,062 crore during 2021-26.
  • Grant is broadly characterised into: (a) revenue deficit grants (b) grants for local governments (c) grants for disaster management (d) sector-specific grants and (e) state-specific grants.
  • Many of these grants are linked with performance-based criteria, thereby promoting principles of transparency, accountability, and leading to better monitoring of expenditures.
  • However, the Commission was asked to examine whether revenue deficit grants should be provided at all to the states.
  • Some states stressed that revenue deficit grants have serious disincentives for tax efforts and prudence in expenditure and, hence, these should be discontinued.
  • Fiscally stressed states of Kerala, West Bengal and Punjab are regular recipients of these grants due to high debt legacy.

3) Conditional grants to local bodies

  • This Commission’s grant for local government is different from that of its predecessors for the set of entry-level conditions:
  • (a) Constitution of State Finance Commissions.
  • (b) Timely auditing and online availability of accounts for rural local bodies coupled with
  • (c) Notifying consistent growth rate for property tax revenue for urban local bodies.
  • Secondly, the recommendations are in alignment with the national programmes of Swachch Bharat Mission and Jal Jeewan Mission.

4) Incubation of new cities and urban grants

  • It is for the first time that a Finance Commission has recommended Rs 8,000 crore to states for incubation of new cities, granting Rs 1,000 crore each for eight new cities.
  • The focus of urban grants for million-plus cities is improvement in air quality and meeting the service level benchmark of solid waste management and sanitation.

5) Grants for health and setting up of disaster mitigation fund

  • The commission recommended channelising the health grant of Rs 70,051 crore through local bodies, addressing the gaps in primary health infrastructure.
  • The Commission’s recommendation for setting up the state and national level Disaster Risk Mitigation Fund (SDRMF), in line with the provisions of the Disaster Management Act, is both well-timed and necessary.
  • For the first time, the Finance Commission has introduced a 10-25 per cent graded cost-sharing basis by the states for the NDRF and NDMF which has not been appreciated by the states.

6) Non-lapsable fund for defence

  • The Commission has recommended setting up of a dedicated non-lapsable fund, the Modernisation Fund for Defence and Internal Security (MFDIS).
  • Objective of the fund is to bridge the gap between projected budgetary requirements and budget allocation for defence and internal security and to provide greater predictability for enabling critical defence capital expenditure.
  • The fund will have four specific sources: (a) Transfers from the Consolidated Fund of India, (b) disinvestment proceeds of DPSEs, (c) proceeds from the monetisation of surplus defence land and (d) proceeds of receipts from defence land likely to be transferred to state governments and for public projects in the future.
  • The total indicative size of the proposed MFDIS over the period 2021-26 is Rs 2,38,354 crore.
  • The Union government has accepted this recommendation in principle.

Consider the question “Examine the various principles on which the Fifteenth Finance Commission based the horizontal distribution of states share.”


The report starts with the famous quote of Mahatma Gandhi: “The future depends on what we do in the present”. It would be interesting to see the impact of these overarching and revolutionary recommendations in the times ahead.

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