The Finance Commission is a constitutional body established under Article 280 of the Indian Constitution. It plays a crucial role in the distribution of tax revenues between the Union and States, ensuring fiscal balance and cooperative federalism. This article explores the functions, composition, significance, key recommendations, and criticisms of the Finance Commission, along with insights into the 15th and 16th Finance Commissions.

Functions of the Finance Commission

The Finance Commission is responsible for ensuring a fair distribution of financial resources between different levels of government. Its key functions include:

1. Distribution of Tax Revenues

• Determines the share of tax revenue allocated to the Union and States.
  
  
• Ensures financial balance by addressing vertical and horizontal imbalances.
  
  

2. Allocation Among States

• Allocates tax revenues to states based on population, fiscal capacity, and economic performance.
  
  

3. Grants-in-Aid Recommendations

• Suggests financial assistance to states for specific needs like infrastructure, education, and welfare programs.
  
  

4. Fiscal Performance Review

• Assesses revenue and expenditure patterns among states.
  
  
• Provides recommendations for improving financial management.
  
  

5. Guidelines on Fiscal Matters

• Offers policy directions on taxation, debt management, and fiscal discipline.
  
  

6. Strengthening Cooperative Federalism

• Ensures Union-State cooperation in financial matters for balanced economic growth.
  
  

Composition of the Finance Commission

The Finance Commission consists of one Chairman and four members. Their qualifications are mandated by Parliament.

Qualifications for Membership

• A High Court Judge or qualified to be one.
  
  
• Expertise in finance and administration.
  
  
• Special knowledge of government accounts and finance.
  
  
• An economist with deep knowledge of financial systems.
  
  

Significance of the Finance Commission

The Finance Commission plays a key role in maintaining fiscal federalism in India by:

• Ensuring equitable tax revenue sharing between the Union and States.
  
  
• Determining grants-in-aid for financially weaker states.
  
  
• Enhancing the financial autonomy of local bodies like Panchayats and Municipalities.
  
  

Key Recommendations of the 15th Finance Commission

The 15th Finance Commission made significant recommendations, ensuring fiscal stability.

1. Vertical and Horizontal Devolution

• Retained vertical devolution at 41%, slightly lower than the 14th Finance Commission’s 42% (adjusted after Jammu and Kashmir became a Union Territory).
  
  
• Allocated state shares based on population, area, income, ecology, and fiscal performance.
  
  

2. Revenue Deficit Grants

• Recommended ₹3 trillion in revenue deficit grants over five years.
  
  
• Reduced the number of qualifying states from 17 in FY22 to 6 in FY26.
  
  

3. Performance-Based Incentives and Grants

• Focused on health, education, rural economy, governance reforms, and power sector improvements.
  
  

4. Local Government Grants

• Proposed basic and performance-based grants for urban and rural local bodies.
  
  
• Emphasized urban services, infrastructure, and digital transformation.
  
  

5. Fiscal Space for the Union

• Ensured adequate fiscal resources for national development priorities.
  
  

Criticism of the 15th Finance Commission

Despite its importance, the Finance Commission faced several criticisms:

• Performance-based incentives may limit state autonomy.
  
  
• Borrowing conditions could restrict state-level developmental expenditures.
  
  
• Imposed conditions challenge the principle of cooperative federalism.
  
  
• Did not enforce fiscal prudence on the Union government.
  
  
• Could dilute the mutual fiscal responsibility shared by the Union and States.
  
  

Comparison of the 14th and 15th Finance Commissions

16th Finance Commission Key Details

The 16th Finance Commission was constituted under Article 280(1) in 2024, with Dr. Arvind Panagariya as its Chairman.

Terms of Reference

• Tax Revenue Distribution: Determines the Union-State tax revenue split.
  
  
• Grants-in-Aid: Establishes principles for financial assistance to states.
  
  
• Local Body Funding: Recommends measures to enhance Panchayat and Municipality resources.
  
  
• Disaster Management Financing: Reviews funding mechanisms under the Disaster Management Act, 2005.
  
  
• Report Submission Deadline: October 31, 2025.
  
  

Conclusion

The Finance Commission plays a pivotal role in maintaining fiscal balance and cooperative federalism in India. By ensuring equitable tax revenue distribution, reviewing state finances, and providing policy guidelines, it acts as a financial expert body. Despite criticisms, it remains an essential institution for India's economic stability and federal governance.