Finance Commission – Issues related to devolution of resources

Mar, 29, 2019

Time to have institutional mechanism like Fiscal Council to enforce rules: NK Singh

Note4students

Mains Paper 2: Polity | Appointment to various Constitutional posts, powers, functions and responsibilities of various Constitutional Bodies

From UPSC perspective, the following things are important:

Prelims level: Fiscal Council

Mains level: Mandate of the finance commission


News

  • Stressing on the need to have uniform rules for fiscal consolidation of States and Centre 15th Finance Commission’s Chairman NK Singh called for institutional mechanism like a ‘Fiscal Council’ to enforce fiscal rules and keep a check on Centre’s fiscal consolidation.

A check over borrowings

  • For state government liabilities, Article 293 (3) provides a constitutional check over borrowings.
  • But there is no such restriction on the Centre.
  • It is time we have an alternative institutional mechanism like Fiscal Council to enforce fiscal rules and keep a check on Centre’s fiscal consolidation.
  • Singh had earlier proposed creation of an autonomous Fiscal Council with representatives from both states and Centre, but the recommendation was not implemented.

Why need Fiscal Council?

  • Various cesses and surcharges are becoming disproportionate proportion of overall divisible revenue.
  • There should be some mechanism to ensure that the basic spirit of the devolution process should not be undercut by clever financial engineering or taking recourse to traditions.
  • There is a need for coordination between the finance commission as well as the GST Council, which he termed as the only federal institution in the country.
  • There’s need for coordination between Finance Commission and GST council.
  • GST Council has no clue of what the Finance Commission is doing and Finance Commission has even lesser clue of what the GST Council is doing.

The municipal example

  • It is very clear that successful economic growth, successful good quality employment depends on agglomerations that work.
  • That in turn is going to depend on whether municipalities have enough revenue.
  • What the municipalities get today in terms of revenue is one per cent of GDP whereas on comparative basis, looking at other emerging market countries, it really ought to be 5 per cent of GDP.
Mar, 25, 2019

[op-ed snap] Another look at fiscal transfers

Note4students

Mains Paper 2: Polity | Functions & responsibilities of the Union & the States, issues & challenges pertaining to the federal structure

From UPSC perspective, the following things are important:

Prelims level: State Finance Commission (SFC)

Mains level: Role of finance commissions in fiscal federalism and changes proposed


NEWS

CONTEXT

Concept of federalism

  • Federalism is an old concept.
  • It is well known that the efficiency of a government depends on, among other factors, its structure.
  • In large countries, it has been felt that only a federal structure can efficiently meet the requirements of people from different regions.

The reason behind the existence of the present form of federalism

  • In our country during the independence struggle, provincial autonomy was regarded as an integral part of the freedom movement.
  • However, after Independence, several compulsions, which included defence and internal security, led to a scheme of federalism in which the Centre assumed greater importance.
  • Also in the immediate period following Independence, when the Centre and all States were ruled by the same party and when many of the powerful provincial leaders migrated to the Centre, the process of centralisation gathered further momentum.
  • Economic planning at a nation-wide level helped this centralising process.

What is Fiscal Federalism?

  • Fiscal federalism is the economic counterpart to political federalism.
  • Fiscal federalism is concerned with the assignment on the one hand of functions to different levels of government, and with appropriate fiscal instruments for carrying out these functions on the other.
  • The Central government must provide national public goods that render services to the entire population.
  • A typical example cited is defence.
  • Sub-national governments are expected to provide goods and services whose consumption is limited to their own jurisdictions.

Determinations of Raising of Taxes by different units of government

  • An equally important question in fiscal federalism is the determination of the specific fiscal instruments that would enable the different levels of government to carry out their functions.
  • This is the ‘tax-assignment problem’ .
  • In determining the taxes that are best suited for use at different levels of government, one basic consideration is in relation to the mobility of economic agents, goods and resources.
  • It is generally argued that the de-centralised levels of government should avoid non-benefit taxes and taxes on mobile units.
  • This implies that the Central government should have the responsibility to levy non-benefit taxes and taxes on mobile units or resources.

Problems in assigning different  taxing responsibilities  to different levels of government

  • Different Constitutions interpret differently what is mobile and what is purely a benefit tax.
  • For example, in the United States and Canada, both Federal and State governments have concurrent powers to levy income tax.
  • On the contrary, in India, income tax is levied only by the Central government though shared with the States.
  • Recognising the possibility of imbalance between resources and responsibilities, many countries have a system of inter-governmental transfers.

The provision in Indian Constitution regarding the division of taxes

  • The Indian Constitution lays down the functions as well as taxing powers of the Centre and States.
  • It is against this background that the issues relating to the correction of vertical and horizontal imbalances have been addressed by every Finance Commission, taking into account the prevailing set of circumstances.
  • However, Central transfers to States are not confined to the recommendations of the Finance Commissions.
  • There are other channels such as those through the Planning Commission until recently as well the discretionary grants of the Central government.

Recent changes in the division of tax proceeds

  • The Fourteenth Finance Commission has broken new ground in terms of allocation of resources.
  • One of its major recommendations has been to increase the share of tax devolution to 42% of the divisible pool.
  • This is a substantial increase by almost 10 percentage points.
  • The commission has argued that this does not necessarily affect the overall transfers but only enhances the share of unconditional transfers.
  • Over years, the performance of the Central government is judged not only on the basis of actions taken which fall strictly in its jurisdiction but also on initiatives undertaken in the areas which fall in the Concurrent and even State lists.
  • Today, the Central government is held responsible for everything that happens, including, for example, agrarian distress.
  • The Planning Commission was replaced by the NITI Aayog, which was simply a think-tank with no powers of resource allocation.

Way Forward

  • The Constitution should be amended and the proportion of shareable taxes that should go to the States fixed at the desired level.
  • The shareable tax pool must also include cesses and surcharges as these have sharply increased in recent years.
  • Fixing the ratio at 42% of shareable taxes, including cesses and surcharges, seems appropriate.
  • Another possible route is to follow the practice in the U.S. and Canada: of allowing the States to levy tax on personal income, with some limitations.
  • Also once this power is given to the States, the transfers from the Centre need adjustment.
  • There are issues relating to horizontal distribution. An appropriate balancing of criteria is needed particularly in the context of the rise in unconditional transfers.
Mar, 20, 2019

RBI governor bats for permanent status to Finance Commission

Note4students

Mains Paper 2: Polity | Functions & responsibilities of the Union & the States, issues & challenges pertaining to the federal structure

From UPSC perspective, the following things are important:

Prelims level: Finance Commission

Mains level: Read the attached story


News

  • The 15th Finance Commission, constituted in November 2017, will give recommendations for devolution of taxes and other fiscal matters for five fiscal years, commencing April 1, 2020.
  • RBI Governor Shaktikanta Das has said increasingly it is felt that there is a need to give permanent status to the Finance Commission and constitution of State Finance Commissions every five years.

Addressing various challenges

  • According to Das, there is now general agreement in the country about the importance of fiscal consolidation roadmap both at national and sub-national levels.
  • Successive finance commissions have made efforts to address the emerging issues and challenges, but in a democracy like India, the debate goes on.
  • Geopolitical risks have necessitated higher expenditure on defence and internal security.
  • Natural calamities and disasters have called for higher expenditure on relief and rehabilitation.
  • In parallel, aspirations of people and the country as a whole have required that the government spends more on developmental programmes.

Why such move?

  • The Commission can function as a leaner entity in the intervening period till the next Finance Commission is set up in a full-fledged manner.
  • Over past several decades, Finance Commissions have adopted different approaches with regard to principles of tax devolution, grants to be given to states and fiscal consolidation issues.
  • There is a need to ensure broad consistency between Finance Commissions so that there is some degree of certainty in the flow of funds, especially to the states.
  • This has become even more critical in the post GST scenario.

Imbibing Continuity

  • According to Das, finance commissions have over the past several decades adopted different approaches with regard to principles of tax devolution, grants to be given to states and fiscal consolidation issues.
  • In other words, there has to be continuity and change between finance commissions.
  • Increasingly, therefore, it is felt that there is a need to give permanent status to the finance commission.
  • A commission can function lean till the next finance commission is set up in a full-fledged manner.
  • During the intervening period, it can also address issues arising from implementation of the recommendations of the finance commission.

Other recommendations

  • The principle of decentralisation works better when powers and functions are delegated based on which tier of governance is best suited to fulfill that responsibility.
  • The constitution has already provided for delegation of certain functions to the urban and rural local bodies; but it is seen that there is still good distance to traverse when it comes to devolution of funds to these local bodies.
  • It is essential that State Finance Commissions are constituted every five years as per the mandate in Article 243I of the Constitution and arrangements are made for their robust functioning.

Back2Basics

Finance Commission

Finance Commission of India: Powers, Functions and Responsibilities

Aug, 22, 2018

[op-ed snap] Strengthening the federal link

Note4students

Mains Paper 2: Polity | Functions & responsibilities of the Union & the States, issues & challenges pertaining to the federal structure

From UPSC perspective, the following things are important:

Prelims level: State Finance Commission (SFC), 73rd and 74th Constitutional Amendments (CAs), Article 243I of the Constitution,

Mains level: Role of finance commissions in fiscal federalism


Context

State finance commissions

  1. The State Finance Commission (SFC) is a unique institution created by the 73rd and 74th Constitutional Amendments (CAs) to rationalise and systematise State/sub-State-level fiscal relations in India
  2. Its primary task is to rectify growing horizontal imbalances in the delivery of essential public services to citizens
  3. But there has been inadequate appreciation of the significance of this institution by the Union, States as well as the professional community

Delays in the formation of SFCs

  1. Article 243I of the Constitution mandated the State Governor to constitute a Finance Commission within one year of the CAs (before April 24, 1994) and thereafter every five years
  2. This means fifth generation SFCs ought to have submitted reports by now but till date, only Assam, Himachal Pradesh, Tamil Nadu and Kerala have submitted their fifth SFC reports
  3. Many States are yet to cross the third SFC stage
  4. The seriousness, regularity, acceptance of recommendations and their implementation which characterise the Union Finance Commissions (UFCs) are conspicuously absent when it comes to SFCs

Problems being faced by SFCs

  • For historical reasons, UFCs, particularly from the third, have chosen a restrictive role of staying away from plan and investment allocations
  1. SFCs normally could not do this although some have chosen the UFC path
  2. Now that the Planning Commission has been dismantled, the 15th UFC has to spell out its decision-making domain
  • It is important to disabuse the notion among several politicians, policymakers and even experts that SFCs and the local governments they deal with have an inferior constitutional status when compared to the UFC
  1. The SFC is undoubtedly modelled on the UFC created under Article 280 and exemplified in Articles 243I and 243Y
  2. While the UFC is tasked with rectifying vertical and horizontal imbalances at the Union-State level, the SFC has to perform the same with reference to State/sub-State-level institutions
  3. The Constitution treats a local government on a par with a State government, especially when it comes to sharing of financial resources
  • SFCs face a crucial problem of reliable data
  1. The financial reporting system of the Union and States is well laid down
  2. On the other hand, local governments with no proper budgetary system are in deep disarray

Importance of SFCs

  • The task of the SFC to correct horizontal imbalances is extremely onerous when compared with the UFC as SFCs have to consider nearly 2.5 lakh local governments to promote minimum essential services in rural and urban areas
  1.  An SFC is the institutional agency to implement the golden rule of cooperative federalism that every citizen should be assured minimum public goods irrespective of her choice of residence
  • Article 280(3) has been amended to add clauses (bb) and (c) in order to take measures to augment the resources of panchayats and municipalities on the basis of the recommendations “made by the finance commission of the state”
  1. These sub-clauses affirm the organic link between local governments and SFCs to fiscal federalism
  • The federalist development state of India can grow only through a process of evolutionary policy making which works towards cherished goals
  1. Articles 243G and 243W give mandate of planning “for economic development and social justice”

Failure of UFC to address local level challenges

  1. UFCs have failed to play a hand-holding role in placing decentralised governance properly in the cooperative federal map of India
  2. No UFC has done its homework in reading and analysing SFC reports
  3. Without presenting a consolidated account of the reality at the sub-State level or highlighting which report went wrong, no UFC can legitimately guide States or contribute to improving the goals of constitutional amendments

Way Forward

  1. SFCs have not been provided with the necessary environment to play their rightful role in Indian fiscal federalism
  2. A great opportunity to build regional equity in India has been undermined
May, 11, 2018

Row over terms of reference: 15th Finance Commission forms panel to quell controversy

Note4students

Mains Paper 2: Polity | Appointment to various Constitutional posts, powers, functions and responsibilities of various Constitutional Bodies

From UPSC perspective, the following things are important:

Prelims level: Particulars of the Finance Commission

Mains level: Complement this newscard with our previous newscards on the same issue.


News

15th Finance Commission (FC) is seeking to quell the controversy

  1. The commission has set up a six-member council to “advise and assist” it on the ToR and “help in broadening the commission’s ambit and understanding”

More about the panel

  1. It will help prepare any research study which would enhance the commission’s understanding on the issues containing in its ToR;
  2. and to help broaden the commission’s ambit and understanding to seek best national and international practices on matters pertaining to fiscal devolution and improve the quality, reach and enforcement of its recommendations.
  3. The council’s role is advisory in nature, and it can’t tweak on its own the ToR of the commission
  4. Any change in the ToR has to be made by the Centre with the assent of the President
  5. The setting up of the council by the commission will also serve to ease pressure on the Centre, which has been accused of sabotaging cooperative federalism through “faulty” ToR

Bacground

  1. Some states have claimed that the progressive ones stand to lose if the commission follows its ToR
  2. and takes the 2011 census as the basis for the devolution of central funds, instead of 1971, that was adopted earlier
May, 05, 2018

[op-ed snap] The southern alliance and the 15th Finance Commission

Note4students

Mains Paper 2: Polity | Appointment to various Constitutional posts, powers, functions and responsibilities of various Constitutional Bodies

From UPSC perspective, the following things are important:

Prelims level: Particulars of the Finance Commission

Mains level: Complement this newscard with our previous newscards on the same issue.


News

Context

  1. The finance ministers of three southern states and Puducherry (a Union territory) met at Thiruvananthapuram to protest the terms of reference (ToR) of the 15th Finance Commission (FC-15)
  2. Southern states are finalizing a formal protest to be lodged with the president of India, who appoints every finance commission
  3. The principal concern centres on the direction in the ToR to use population figures from the 2011 census in place of the 1971 census in the formula for determining state shares

Some of the contentious issues

  1. First, the state shares of a divisible pool has risen from roughly 24% of the Centre’s tax revenue at the start of reform in 1991, to a peak of 42% prescribed by FC-14 for the period 2015-20
  2. The suggestion in the ToR that FC-15 might consider a reduction of this divisible pool has led to widespread state disaffection, and not just in the south
  3. Second, to prevent population size from becoming a perverse incentive for states to neglect population control, seven finance commissions over a span of 35 years were explicitly directed in their ToR to freeze population shares of states at the 1971 census levels
  4. But FC-15 is re-considering it now

How can the GST help?

  1. With the GST, we now have for the first time a closer approximation to the true relative taxable base in different states
  2. Since the coverage of the GST tax base is uniform across states, and since the GST can be presumed to have imposed a uniform tax effort across states within its coverage,
  3. state-wise collections give us a better handle on the relative taxable capacity of states than the domestic product proxy that has been used until now
    (Background:  A common tax effort percentage is currently being applied to variations in state domestic product per capita, which is used to proxy differences across states in the taxable base)

What is the main issue with the southern states?

  1. A legitimate grievance of the southern states, however, is population migration to these states from the slower growing states of the north
  2. In the Economic Survey (ES) for 2016-17, an excellent chapter estimated inter-state economic migration between the censuses of 2001 and 2011 at roughly 5.5 million per year

No cause of worry for Kerala

  1. Kerala may be a host state for domestic migration, but it has been an exporter of prized manpower to the rest of the world
  2. As a major recipient of international remittances, the income accruing to Kerala far outpaces the income originating in the state
  3. Since finance commissions have so far been compelled to use state domestic product as a measure of relative tax capacity, which excludes remittance income,\
  4. Kerala has on that account actually been getting a top-up higher than was due
Apr, 16, 2018

[op-ed snap] Mandate and allocations: The 15th Finance Commission

Image Source

Note4students

Mains Paper 2: Polity | Appointment to various Constitutional posts, powers, functions and responsibilities of various Constitutional Bodies

Prelims level: Various article so the constitution discussed in the newscard and particulars of the finance commission.

Mains level: Many states have raised questions against the directive to use population data of the 2011 Census. The newscard discusses some important points related to it.


News

Context

  1. The presidential terms of reference (ToR) of the Fifteenth Finance Commission have raised questions
  2. Why: The concerns are over the directive to use population data in the ToR from the 2011 Census, and not the 1971 Census that was used earlier, is an exaggeration
  3. For the southern States the issue of population is a point of concern
    (ToR: Terms of reference (TOR) define the purpose and structures of a project, committee, meeting, negotiation, or any similar collection of people who have agreed to work together to accomplish a shared goal)

Some important contentious issues
States need to debate a number of contentious issues in the ToR which affect the very structure of fiscal federalism
These include: asking the Commission

  1. “to examine whether revenue deficit grants be provided at all”;
  2. considering “the impact of [the] fiscal situation of the Union government of substantially enhanced devolution by the Fourteenth Finance Commission, coupled with continuing imperative of the national development programme including New India 2022”;
  3. looking at the conditions that may be imposed by the Central government while providing consent to States when they borrow under Article 293(3);
  4. asking the Commission to propose measurable performance-based incentives to States
  5. and finally, promoting ease of doing business

 The ToR of the Fifteenth Commission raise questions about constitutional propriety 

  1. Take, for example, the suggestion that the Commission may examine whether the revenue deficit grants should be given at all
  2. The very objective of Article 275 is to enable the Commission to give grants to offset post-devolution gaps between normatively assessed revenues and expenditures
  3. If the Commission takes this suggestion seriously, it will have serious ramifications for States with genuinely large resource gaps
  4. The ToR seek to reduce the role of Article 275, which is a legitimate channel for grants,
  5. and asks the Commission to leave it more fiscal space to expand grants under Article 282, which is questionable

Central government is interfering with the state subjects

  1. Asking the Commission to take into account the performances in implementation of various Central schemes is equally contentious
  2. The Seventh Schedule of the Constitution assigns the respective functions in terms of Union, State and Concurrent subjects
  3. It is ironical that the Union government has been intruding into State subjects through Central schemes by forcibly using fiscal space
  4. Performances must be built into the implementation of schemes and not into the tax devolution formula
  5. It must be noted that devolution of taxes to States is not a charity; it is their right

The way forward

  1. The ToR of the present Commission raise serious issues of constitutional propriety
  2. Hopefully, States will safeguard their turf to preserve the federal fabric of the country

Back2basics

Finance commission

  1. The first Finance Commission was established by the President of India in 1951 under Article 280 of the Indian Constitution
  2. It was formed to define the financial relations between the central government of India and the individual state governments
  3. 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
  4. As per the Constitution, the Commission is appointed every five years and consists of a chairman and four other members
  5. Since the institution of the first finance commission, stark changes in the macroeconomic situation of the Indian economy have led to major changes in the finance commission’s recommendations over the years
  6. There have been fifteen commissions to date
  7. The most recent was constituted in 2017 and is chaired by N. K.Singh, a former member of the Planning Commission
Apr, 10, 2018

15th Finance Commission: Is it just a South India vs North India debate?

Note4students

Mains Paper 3: Economy | Indian Economy Issues relating to planning

From UPSC perspective, the following things are important:

Prelims level: Fifteenth Finance Commission, Article 270 of the Indian Constitution

Mains level: Debate on the effect of 15th Finance commission’s changed terms of reference


Context

Fifteenth Finance Commission’s terms of reference (ToR)

  1. The Fifteenth Finance Commission’s terms of reference (ToR) have evoked a sharp response from southern states
  2. The ToR mandates the Commission to use 2011 population for tax sharing and devolution of resources instead of 1971 population as was the practice in the past
  3. Between 1971 and 2011, except Telangana, population shares of four southern states in total declined from 22.01% to 18.16%
  4. Use of 2011 population for sharing resources means a decline in the flow of resources to these states

Beyond southern states

  1. Between 1971 and 2011, population share has declined in 10 states other than the four southern states
  2. These are Assam, Goa, Himachal Pradesh, Odisha, Punjab and West Bengal
  3. Thus, use of 2011 population would also affect economically less prosperous states like Assam, Odisha and West Bengal

Tax-sharing formula

  1. In the past, the tax-sharing formula was a combination of factors reflecting equity, need and efficiency
  2. Population being a neutral indicator of need has been used by all 14 finance commissions

Fundamental question about the use of population

  1. Any finance commission is required to assess fiscal needs of states for tax sharing and grants
  2. Binding Commission’s work to a particular reference population is arbitrary and unfair to all the stakeholders including the Commission

Policy on resource sharing

  1. The policy on resource sharing needs to make a distinction between tax sharing and grants
  2. Tax sharing is to correct the vertical and horizontal imbalances arising due to constitutional assignment of tax powers and expenditure responsibilities between the Union and states
  3. Also, as per the Article 270 of the Indian Constitution, tax share recommended by the Finance Commission does not form part of the consolidated fund of the Union government, implying this is not a component of Union budget

Way forward

  1. Any incentive or reward should be done through a grant mechanism instead of horizontal tax sharing
  2. It is too early to conclude the outcome of the use of 2011 population on resource sharing
  3. The ultimate outcome would depend on how the Commission treats various factors in the horizontal allocation of resources
Mar, 30, 2018

Why South India states are objecting to Finance Commission’s mandate

Note4students

Mains Paper 2: Polity | Functions & responsibilities of the Union & the States, issues & challenges pertaining to the federal structure

From UPSC perspective, the following things are important:

Prelims level: 15th Finance Commission

Mains level: Issues related to the distribution of resources between states


News

Opposing 15th Finance Commission

  1. A political storm is brewing in South India over the determination of how India distributes its pooled tax revenues among its many states
  2. Several chief ministers and opposition leaders of southern states have expressed vehement opposition to one particular mandate of the present Fifteenth Finance Commission: to use 2011 census population figures instead of 1971 for the purpose of tax devolution

Why such opposition

  1. The Indian union made a compact with all its states in the mid-1970s to freeze federal allocations based on population size at 1971
  2. This was done to ensure states which had managed to tackle their population growth were not penalized by way of lower allocations
  3. The growth rate in population dropped uniformly across all states, but the fall in South India was rapid, creating a distinct divergence between the number of people in the North versus the South
  4. Since the present finance commission has the mandate to use newer population figures, which brings both economic and demographic divisions into the picture, the fear among southern states is that the degree of redistribution would increase

Back2Basics

Fifteenth Finance Commission

  1. The Fifteenth Finance Commission of India is a finance commission constituted in November 2017
  2. The commission was set up to give recommendations for five fiscal years commencing on 1 April 2020
  3. The main tasks of the commission were to “strengthen cooperative federalism, improve the quality of public spending and help protect fiscal stability”
  4. Finance Commission is established by the President of India under Article 280 of the Indian Constitution
  5. 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
  6. As per the Constitution, the Commission is appointed every five years and consists of a chairman and four other members
Jan, 16, 2018

Northern states may benefit under 15th Finance Commission

Note4students

Mains Paper 2: Polity | Functions and responsibilities of the Union and the States, issues and challenges pertaining to the federal structure, devolution of powers and finances up to local levels and challenges therein.

From UPSC perspective, the following things are important:

Prelims level: Particulars of the finance commission(read with B2B)

Mains level: The decision will have a long lasting positive affect on the Economies of particular states.


News

What is the news?

  1. North Indian states like Bihar and Chhattisgarh with higher rates of population growth may get more funds under the 15th Finance Commission
  2. Why: The government is asking the commission to use the latest census data of 2011 for allocation of resources, against 1971 census data used earlier

Particulars of the 15th Finance Commission

  1. The Commission, has been asked to submit its report by 30 October 2019
  2. Its recommendations will be in force for the five years starting 1 April 2020

Why this decision?

  1. Many analysts consider the earlier practice of not referring to the current population while providing resources to the state governments was archaic and distortionary
  2. This practice was sometimes justified by some as disincentivizing states from letting their population proliferate, although there was no evidence that any state did follow such a policy
  3. However, it resulted in lower standards of services provided by the state governments to its citizens
  4. Such a static provision also did not take into account the effect of net migration on the state population

Other directions given to the Commission

  1. The Commission has also been asked to propose measurable performance-based incentives in areas such as GST
  2. And efforts and progress made in moving towards replacement rate of population growth
    (which refers to the total fertility rate that will result in a stable population without increasing or decreasing it)
  3. FFC will also consider achievements made by states in implementation of flagship central schemes and building disaster resilient infrastructure, reaching sustainable development goals, and quality of expenditure
  4. Progress made in increasing capital expenditure, improving the quality of such expenditure and promoting labour-intensive growth have also been included in the ToR(terms of reference) for the Commission

Back2basics

Finance Commission of India: Powers, Functions and Responsibilities

Nov, 02, 2017

Finance Commission’s changing roles, challenges over the years

Note4Students

Mains Paper 2: Powers, functions and responsibilities of various Constitutional Bodies.

The following things are important from UPSC perspective:

Prelims level: Finance Commission

Mains level: This article is important for mains as it talks about the challenges the upcoming Fifteenth Finance Commission will face and how has Finance Commission changed over the years. It also highlights the contribution of the Finance Commission in reshaping the Center- State relations and in giving impetus to the cooperative federalism.


News

Context

  • The government will soon constitute the Fifteenth Finance Commission, as per normal practice, a couple of years before the end of the five-year period during which the Commission’s recommendations are valid.

The Finance Commission

    1. 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.
  • 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.
    1. 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.
  1. The First Commission was set up in November 1951 under the Chairmanship of K C Neogy.
  2. The President has appointed 13 more Commissions since then.
  3. The Finance Commission Rules, 1951, lay down the criteria for being members of the constitutional body: those having special knowledge of finance and accounts of government with wide knowledge and experience in financial matters and in administration, or with special knowledge of economics, and those who have been qualified to be appointed as a judge of a High Court.

Convention regarding composition of the Finance Commission

    1. 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.
    2. Senior politicians like K Brahmananda Reddy, Y B Chavan and N K P Salve had helmed earlier Commissions; the last politician in this role was K C Pant, who then went on to be Deputy Chairman of the Planning Commission.
    3. The approach the government adopts on the composition of the Fifteenth Finance Commission and whether it will follow what has been a convention, since the Twelfth Finance Commission (2002), of having a member of the (erstwhile) Planning Commission as a part-time member will be interesting to watch.
    4. The Planning Commission in its old structure and form has been dismantled, and has been replaced with the Niti Aayog.
  • The Twelfth Commission, had suggested to the government that it could alternate between an economist and a political figure such as a former state Finance Minister to be the Chairman.

How has responsibilities and scope of the Finance Commission increased over the years?

  1. The scale of distribution of tax proceeds has changed dramatically since the 1950s since the First Commission presented its recommendations on the transfer of resources between the Centre and the states.
  2. From 10% of the total tax receipts of the Centre in 1950, it has now risen to a record 42% after the recommendations of the Fourteenth Finance Commission, a share that makes previous awards look conservative, and sits well with the spirit of cooperative federalism.
  3. Along with these changes has been the widening of the terms of reference of the Commissionthe Thirteenth Commission was told-
  • To assess the impact of the proposed GST from April 1, 2010;
  • The need to improve the quality of public expenditure, to review the finances of both the Centre and the states;
  • To suggest measures to maintain a stable fiscal environment consistent with equitable growth;
  • To suggest a revised roadmap to maintain the gains of fiscal consolidation through 2015.
  1. Also the equation between the central and state governments has changed as a result of the recommendations of the Twelfth Finance Commission which-
    • Reshaped lending by the federal government to states that is, rather than the Centre borrowing and then lending to states, it recommended that states be allowed to borrow directly.
    • Since then, the debt obligation of states to the Centre has come down significantly, giving rise to questions over whether states that have repaid all borrowings from the Centre need to take Delhi’s approval at all for their future borrowings.
  • Also recommended that if states were to be given debt relief over and above the distribution of tax proceeds, conditions of fiscal discipline should be enforced.
  • Grants that were recommended by the Commission are however conditional  which may also have been criticised, but the counter-argument has been that it was aimed ultimately at improving governance.
  • It has also been pointed out that other federal structures too have equalisation grants.
  1. 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.

Challenges ahead of Fifteenth Finance commission

  1. As the Fifteenth Commission is set to be appointed, the criteria for distribution will be reviewed.
  2. The question is whether the commission will take into account the level of collections by each state after the roll out of the GST or not?
  3. The challenge this time will be the fact that unlike in the past, the share of net tax proceeds between the central government and states is almost equal.
  4. After the last Commission’s recommendation to distribute 42%, raising the bar on higher transfer of resources will have a much bigger impact on the federal government.
  5. The twelfth Finance Commission had suggested that it was time now to perhaps look at a Constitutional amendment to fix a ceiling on the distribution of the net tax proceeds, with the Finance Commission arbitrating on distributing tax proceeds among states.                                                                                             
  6. The Commission itself reckons that its biggest role has been to uphold the country’s federal structure, and to be an architect of fiscal restructuring – from being mainly an arbitrator between the Centre and states.
Mar, 26, 2015

How can the 14th Finance Commission advance cooperative federalism?

  1. The overall increase in the amount of financial resources will make state financially strong. Financial stability lends to a strong federation.
  2. The state will have more autonomy as there will no conditional transfers, states can decide expenditure on basis of their own priorities.
  3. Implementation of GST will also bring centre and state closer to each other on economic platform.
  4. Although, there is no clear direction on how to evaluate performance of Panchayats which is going to affect their financial stability.
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