Finance Commission – Issues related to devolution of resources

What is on the agenda for the 16th Finance Commission?  


From UPSC perspective, the following things are important :

Prelims level: Finance Commission

Mains level: Role of Finance Commission

Why in the news? 

The 16th Finance Commission, under Article 280, focuses on devolving funds. Amendments like 73rd and 74th mandate it to bolster state funds for panchayats and municipalities.

About 16th Finance Commission

  • The 16th Finance Commission of India was constituted on December 31, 2023, with Dr. Arvind Panagariya as its Chairman.
  • The President of India appointed the Commission in pursuance of Article 280(1) of the Constitution

How do other countries devolve funds to their local governments?

  • International Comparison: Countries like South Africa, Mexico, the Philippines, and Brazil allocate significantly higher percentages of their GDP (1.6% to 5.1%) to urban local bodies compared to India’s 0.5%.
  • Importance of Intergovernmental Transfers (IGTs): IGTs make up about 40% of Urban Local Bodies (ULBs) revenue in India but suffer from unpredictability, lack of earmarking for vulnerable groups, and horizontal equity.
  • Financial Health of ULBs: Despite efforts by multiple Finance Commissions, financial devolution to cities in India remains inadequate, affecting city productivity and quality of life.

Why is the Census significant?

  • Data Dependence: The absence of the 2021 Census data makes it challenging to accurately assess urban growth and demographic changes crucial for evidence-based fiscal devolution.
  • Urban Dynamics: India has approximately 4,000 statutory towns, an equal number of Census towns, and a large number of effectively urban villages, which need accurate enumeration for effective planning and resource allocation.
  • Migration Impact: The Census data is essential to capture the significant migration to Tier-2 and Tier-3 cities, impacting their infrastructure and service needs.

What about cities and the Taxation system?

  • Impact of GST: The introduction of GST has reduced ULBs’ tax revenue (excluding property tax) significantly, impacting their financial autonomy.
  • Low IGTs: Intergovernmental transfers from States to ULBs in India are minimal (around 0.5% of GDP), much lower than other developing nations, exacerbating fiscal challenges.
  • Constitutional Provisions: Despite the 74th constitutional amendment aimed at empowering ULBs, progress has been limited over three decades, hampering urban development.
  • Parallel Agencies: The growth of parallel agencies and schemes like MP/MLA Local Area Development Schemes distort the federal structure and weaken ULBs’ financial and operational autonomy.

Way forward: 

  • Enhanced Intergovernmental Transfers (IGTs): Increase IGTs from States to Urban Local Bodies (ULBs) to at least 2% of GDP, ensuring predictability and earmarking for vulnerable groups.
  • Reform in Urban Governance and Fiscal Autonomy: Strengthen constitutional provisions to empower ULBs further, reducing dependence on parallel agencies like MP/MLA Local Area Development Schemes.

Mains PYQ: 

Q How is the Finance Commission of India constituted? What do you know about the terms of reference of the recently constituted Finance Commission? Discuss. (UPSC IAS/2018)

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