Finance Commission – Issues related to devolution of resources

Need for fiscal decentralisation


From UPSC perspective, the following things are important :

Prelims level: Finance Commission and its role

Mains level: Paper 2- Fiscal decentralisation.

Covid pandemic has turned the fiscal health of states from bad to worse. This article highlights the role of the Finance Commission as a neutral arbiter in the Centre-state relation in achieving the delicate balance. It has highlighted certain issues that the commission has to consider when it submits its report. So, what are those issues? Read to know…

Disruption in fiscal consolidation and impact on Centre-state relations

  • Due to COVID, there is a  collapse in general government revenues and the consequent rise in the deficit levels.
  • It has disrupted the glide path of fiscal consolidation.
  • But it has also deepened the faultlines in Centre-state fiscal relations. 
  • The Centre is trying to claw back the fiscal space ceded to the states and assert its dominance over the country’s fiscal architecture.
  • This coupled with the fiscal constraints exposed by the pandemic have made it harder to maintain the delicate balance needed to manage the contesting claims of the Centre and the states

Why the 15th Finance Commission report is critical for decentralisation

  • It will be ironic if the ongoing health crisis that has ended up exposing the limitations of a centralised approach, ends up reversing the trend towards fiscal decentralisation.
  • The Commission’s report will be critical on two counts:
  • First, it will determine how India’s fiscal architecture is reshaped.
  • Second, how Centre-state relations are reset as the country attempts to recover from the COVID-19 shock.

1. Will the burden of reducing debt/gdp  fall equally on Centre and state?

  • The glide path of fiscal consolidation laid out by the FRBM review committee had envisaged bringing down general government debt to 60 per cent of GDP by 2022.
  • This is unlikely to materialise now.
  • Factoring in the additional borrowings, the debt-to-GDP ratio may well be over 80 per cent this year.
  • Thus the fiscal consolidation roadmap will have to be reworked.
  •  As per its terms of reference, the Finance Commission will lay out the new path to be followed by both Centre and states.
  • But the question is: Will the burden of debt reduction fall equally upon the Centre and states?
  • Or will the Commission allow the Centre to have greater leeway when it comes to fiscal consolidation?

2. Will the conditional extension of borrowing limit be formalised?

  •  Recently, the Centre eased the states’ budget constraint, allowing them to borrow more this year.
  • But this extra borrowing was conditional upon states implementing reforms in line with the Centre’s priorities.
  • Despite protests, most states are likely to comply with the conditions, to varying degrees.
  • But the issue is: As the hit from the ongoing crisis spreads over multiple years, state governments may want to maintain their expansionary fiscal stance next year as well.
  • Then, will the Finance Commission, in line with its terms of reference, go along with the Centre’s stance and recommend imposing conditions on additional borrowing and formalise this arrangement?
  • It is difficult to see such an arrangement being rolled back once formalised.

3. GST compensation cess

  • The GST council, in which the Centre effectively has a veto, is yet to clearly spell out its views on the extension of the compensation cess to offset states losses beyond the five-year period.
  • The Commission will have to weigh in on this too.
  • At this time the Centre is struggling to fulfil its promise of assuring states their GST revenues.
  • In such situation, will the Commission argue in favour of extending the compensation period, as states desire, but, perhaps, lowering the assured 14 per cent growth in compensation and linking it to nominal GDP growth?
  • As GST revenue accounts for a significant share of states’ income, how this plays out will also have a bearing on their ability to bring down their debt levels.

4. Issue of tax devolution

  • In some sense, accepting the recommendations of the 14th Finance Commission was a fait accompli.
  • The terms of reference of the 15th Finance Commission points to the present government’s desire to claw back the fiscal space offered to the states.
  • But is clawing back fiscal space now a prudent approach?
  • A cash-strapped Centre will surely welcome greater say over the diminished resources.
  • And there a strong argument for the Centre to have far greater fiscal space than it currently enjoys.
  • This is partly because the fiscal multiplier of central government capital spending is greater than that by the states.
  • But also the nature of politics may well push in that direction.
  • Centralisation of political power may well lead to demands for centralisation of resources.
  • However, surely fiscal space can be created by a review of the Centre’s own spending programme.

Need to relook at the Centre’s expenditure priorities

  • Over the past decades, there has been a substantial increase in the Centre’s spending on items on the state and concurrent list.
  •  This shift has occurred even as grants by the Centre to states exceed the former’s revenue deficit.
  • This, as some have pointed out, effectively means that the Centre is borrowing to transfer to states.
  • Surely, a relook at the Centre’s expenditure priorities would create greater fiscal space for it.

What the Finance Commission can do?

  • Any attempt to shift the uneasy balance in favour of the Centre will strengthen the argument that this government’s talk of cooperative federalism serves as a useful mask to hide its centralising tendencies.
  • As a neutral arbiter of Centre-state relations, the Finance Commission should seek to maintain the delicate balance in deciding on contesting claims.
  • This may well require giveaways especially if states are to be incentivised to push through legislation on items on the state and concurrent list.
  • The fiscal stress at various levels of the government necessitates a realistic assessment of the country’s macro-economic situation, the preparation of a medium-term roadmap, as well as careful calibration of the framework that governs Centre-state relations.
  • At this critical juncture, the Finance Commission should present the broad contours of the roadmap.
  • Though it could request for another year’s extension to present its full five-year report citing the prevailing uncertainty.

Consider the question “COVID pandemic has put the States in the dire fiscal position. What we need is more of the fiscal decentralisation now.” In light of this, along with other factors, elaborate on the role 15th Finance Commission could play in this regard.


Finance Commission has to play an important role in achieving the delicate balance in the conflicting domain of finance by addressing the concerns of both the players.

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