Constitutional Bodies

Mains Marks Booster 29th July 2023

Download PDF (English)

Finance Commission (Article 280):

Introduction

Article 280 of the Constitution established the Finance Commission to manage the distribution of tax revenues between the union and states, as well as among states, in order to address vertical and horizontal imbalances.

Functions:

Role of Finance Commission	Example
Distribution of tax revenues between the union and states	Allocating a portion of central tax revenue to states based on their population and fiscal needs
Allocation of tax revenues among states	Determining the share of tax revenues each state receives based on factors like population, area, and fiscal capacity
Recommendations on grants-in-aid to states	Suggesting financial assistance to states for specific purposes such as infrastructure development or social welfare programs
Assessing fiscal imbalances	Analyzing disparities in revenue and expenditure patterns among states to address vertical and horizontal imbalances
Reviewing fiscal performance	Evaluating the financial management practices of states and making recommendations for improvement
Providing guidelines on fiscal matters	Offering guidance on matters related to taxation, public debt, and fiscal discipline
Ensuring cooperative federalism	Facilitating cooperation and coordination between the union and states in financial matters for balanced economic growth
Periodic review and revision	Conducting regular reviews and revising the sharing of tax revenues and grants-in-aid based on changing economic and fiscal conditions

Composition:

Chairman: He oversees the Commission's operations as its chairperson. He should have prior public affairs experience.

Members, there are four members total, excluding the chairman.

Both the qualifications and the standards for the Commission members are mandated by statute and set by Parliament.

Membership qualifications as per the constitution:

Judge of HC or qualified to be one.
Special knowledge in finance and administration.
Special knowledge and experience in government accounts and finance.
Person with special knowledge of economics.

Significance

The Finance Commission contributes to the upkeep of fiscal federalism in India by carrying out the following duties:

the allocation of the Union's and the States' respective parts of the net profits of taxes that must be shared between them as well as the distribution of these proceeds among the States.
determining the guidelines and number of grants-in-aid to be given to States who require such help.
On the basis of the suggestions given by the state's finance commission, actions are required to increase a state's consolidated fund in order to complement the resources of its panchayats and municipalities.

Key Recommendation of the 14th Finance Commission:

The commission recommended an increase in the states' share in the Union tax revenues from 32% to 42%, the largest ever increase.
It removed the distinction between plan and non-plan expenditures for a holistic development process.
Grants-in-aid for states were divided into two categories – revenue deficit grant and local bodies grant.
For local bodies, the commission recommended a basic grant and a performance grant.

Key Recommendations of the 15th Finance Commission:

Vertical Devolution: The 15th Finance Commission maintained vertical devolution at 41%, similar to the 14th Commission's 42%, adjusted due to the changed status of Jammu and Kashmir into Union Territories.
Horizontal Devolution: Allocation between states considered factors like demographic performance, income, population, area, forest and ecology, and tax and fiscal efforts with different weights.
Revenue Deficit Grants: Recommended grants amounting to about Rs. 3 trillion over five years, with the number of qualifying states decreasing from 17 in FY22 to 6 in FY26.
Performance-Based Incentives and Grants: These revolve around four main themes - social sector (health, education), rural economy (agriculture, rural roads), governance/administrative reforms, and power sector, providing additional borrowing windows for states.
Grants to Local Governments and Fiscal Space for Centre: Proposed both basic and performance-based grants for local bodies, with a special focus on urban services, incubation of new cities, and health grants. Ensured sufficient fiscal space for the Union to meet its obligations and national development priorities.

Criticism of the 15th Finance Commission:

Performance-based incentives could potentially limit states' independent decision-making.
Imposing conditions on states' borrowing capacity may negatively impact state expenditure, particularly in the realm of development.
This approach could potentially challenge the principle of cooperative fiscal federalism.
The system does not sufficiently require the Union government to exercise fiscal prudence.
The mutual fiscal responsibility shared between the Union and the States might be diluted under such a system.

Comparative analysis of the 14th and 15th Finance Commission with reference to Municipal Governance:

Parameters	14th Finance Commission	15th Finance Commission
Increment of funds to cities	Local governments received 4.31 percent of the distributable pool from the 14th FC, of which 30% were given to municipalities.	Local governments received 4.15 percent of the divisible pool from the 15th FC, of which 40% were given to municipalities.
Metropolitan Governance	About 20% of the 14th FC's allotments were designated as performance grants. These funds were contingent upon increased income, audited financial statements, and the publication of service-level standards.	The 15th FC has rewarded the metropolitan government by tying 100% of financing to results.
Transparency in Municipal finances	It maintained much-needed policy consistency but did not always result in better data or more openness. The 14th FC had made the disclosure of service level benchmarks a requirement for performance grants.	The 15th FC has also stressed the necessity of digitizing municipal accounting and of having a comprehensive understanding of the finances of the municipal sector at the state and union levels.

Conclusion

The Finance Commission has performed a valuable purpose and met a big demand as an independent entity. It served as a specialist in cooperative energy for the efficient operation of a federal system in a difficult and complicated country like India.