FINANCE COMMISSION OF INDIA

FINANCE COMMISSION
A body set up under Article 280 of the Constitution. Its primary job is to recommend measures and
methods on how revenues need to be distributed between the Centre and states.

job of addressing the imbalances that often arise between the taxation powers and expenditure
responsibilities of the centre and the states, respectively

Finance Commission in India was an original idea, not borrowed from anywhere. That is why it is called
the original contribution.

The Finance Commission is a body set up by the President of India every 5 years under Article 280 of
the Constitution. It consists of a Chairman and four members. The main task of the Commission is to
make recommendations about the distribution of tax revenues between the Centre and states. For
doing so, it consults with various ministries and departments, as well as stake holders and policy makers
at the state and local government level.

The Finance Commission of India was formed in 1951. It was established under Article 280 of the Indian
Constitution by the President of India. It was formed to define the financial relations between the
centre and the state. (The Finance Commission Act of 1951). As per the Constitution, the commission
is appointed every five years and consists of a chairman and four other members. Since the institution
of the first finance commission, stark changes have occurred in the Indian economy causing changes in
the macroeconomic scenario. This has led to major changes in the Finance Commission’s
recommendations over the years. Till date, 14 Finance Commissions have submitted their reports.

Why do we need a Finance Commission?

In most federal systems, there are

 vertical and

 horizontal fiscal imbalances.

The Finance Commission is required to recommend the distribution of the net proceeds of taxes of the
Union between the Union and the States (commonly referred to as vertical devolution What /how
much % ); and

Allocation between the States of the respective shares of such proceeds (commonly known as
horizontal devolution- Formula Criteria for Transfers).

Vertical imbalances occur because the central government has the power to levy and/or appropriate
more taxes than the states. As a result states do not have sufficient tax revenues to fund their
expenditures. This is resolved by allocating some taxes from a common divisible tax pool to states.

Horizontal imbalances occur because states have different levels of

 development,

 income and

 expenditure.

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Some states have high incomes, and can deliver public services such as roads, schools, and hospitals
from their own revenues. Others may struggle to even pay salaries of civil servants. The aim of the
Finance Commission is to ensure that all states have enough resources to fund a minimum level of
expenditure each year.

Mandatory provisions to address Vertical and horizontal imbalances entrusted with FC by Indian
constitution

1. Levy of duties by the Centre but collected and retained by the States (Article 268)

2. Taxes and duties levied and collected by the Centre but assigned in whole to the States (Article 269).

3. Sharing of the proceeds of all Union taxes between the Centre and the States under Article 270.
(Effective from April 1, 1996, following the eightieth amendment to the Constitution replacing the
earlier provisions relating to mandatory sharing of income tax under Article 270 and permissive sharing
of Union excise duties under Article 272).

4. Statutory grants-in-aid of the revenues of States (Article 275)

5. Grants for any public purpose (Article 282).

6. Loans for any public purpose (Article 293)

Finance Commissions appointed so far

Finance Year of Chairman Operational

Commission Establishment Duration
1 1951 K.C Neogy 1952-1957
2 1956 K.Santhanam 1957-1962
3 1960 A.K. Chanda 1962-1966
4 1964 P.V. 1966-1969
Rajamannarr
5 1968 Mahaveer Tyagi 1969-1974
6 1972 K. Brahmananda 1974-1979
Reddy
7 1977 J.M. Shellet 1979-1984
8 1983 Y. B. Chavan 1984-1989
9 1987 N.K.P. Salve 1989-1995

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10 1992 K.C Pant 1995-2000

11 1998 A.M.Khusro 2000-2005
12 2003 C.Rangarajan 2005-2010
13 2007 Vijay l kelkar 2010-2015
14 2013 Dr. Y. V Reddy 2015-2020
15 2017 N.K.Singh 2020-2025

14TH FINANCE COMMISSION

The Fourteenth Finance Commission was constituted by the President on 2 January 2013. Dr. Y. V.
Reddy was appointed as the Chairman. Three full time members

Ms. Sushama Nath,

Dr. M. Govinda Rao and

Dr. Sudipto Mundle and one part-time member

Prof. Abhijit Sen were also appointed.

The recommendations of FC-14 cover the five year period from 2015-16 to 2019-20. The final report
was submitted in December 2014, and made public in February 2015

FUNCTIONS OF FC

A. Distribution of net proceeds( All taxes collected by union Govt ie Corporation + Income +
Customs + Excise + service tax etc..) of taxes between Centre and the States, to be divided as per
their respective contributions to the taxes.

B. Determine factors governing Grants-in Aid to the states and the magnitude of the same.

C. Work with the State Finance Commissions and suggest measures to augment the Consolidated
Fund of the States so as to provide additional resources to Panchayats and Municipalities in the
state.

D. Any other matter referred to the Commission by the President in the interest of sound finance

The finance commission makes recommendations on the following:

(i) Vertical Devolution: What % gross tax revenues should be distributed between the Centre and
States

(ii) Horizontal Devolution: How(Criteria for Transfers) the states’ tax quota should be
apportioned/assigned between different states

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FINANCE COMMISSION OF INDIA

(iii) The principles on which states should be given grants in aid from the Consolidated fund of India.

(iv) How to augment the Consolidated Funds of States to add to the resources of Panchayats and
Municipalities

(v) Review the state of finances and debt levels of the Union and States and review the fiscal
consolidation process.

Of these recommendations, (i) and (ii) usually receive the most media attention since they have an
important bearing on the Centre’s fiscal position as well as the flow of funds to states.

QUALIFICATIONS OF THE MEMBERS

The Chairman of the Finance Commission is selected among people who have had the experience of
public affairs. The other four other members are selected from people who:

 Are, or have been, or are qualified, as judges of High Court, or

 Have knowledge of Government finances or accounts, or

 Have had experience in administration and financial expertise; or

 Have special knowledge of economics

PROCEDURE AND POWERS OF THE COMMISSION

The Commission has the power determine their own procedure and:

• Has all powers of the civil court as per the Court of Civil Procedure, 1908.

• Can summon and enforce the attendance of any witness or ask any person to deliver
information or produce a document, which it deems relevant.

• Can ask for the production of any public record or document from any court or office.

• Shall be deemed to be a civil court for purposes of Sections 480 and 482 of the Code of Criminal
Procedure.

How did the Fourteenth Finance Commission allocate taxes among states?

FC-14 : Horizontal Devolution: Method

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1. Population -17.5% (More the population, better the share)

2. Demographic Change -10%(more the demographic change, more funds)

3. Income Distance -50% (Per capita income, Tax paying capability of individual etc considered.
Less the per capita, more funds)

4. Area -15% (Larger the area of state, more funds)

5. Forest Cover 7.5% (Larger the forest area, less area available for economic activities, so more
funds to Areas having more forest cover)

INCOME DISTANCE

The highest weight is assigned to income distance, which is defined as the distance of actual per capita
income of a state from the state with the highest per capita income. The farther a state is from the
highest per capita state, the more transfers it will get from tax devolutions

Forest cover is viewed as being critical to maintain ecological balance, but the trade off is that the
land is not available for any economic activity.

India has around 70 million hectares of its geographical area under forest cover, which works out to
around 21%. But 42% of the country’s forest cover falls in the “open forest” category where the quality
is poor. The very dense forest category accounts for around 12% of the area under forest cover and
about 46% is in the medium density forest category. If the area under tree cover is added to the area
under forest cover, the “green” area of the country is approximately 24% of its geographical area.

FFC has used “very dense” and “medium density” forest cover. The states with the largest such area (as
a proportion of the national area) are Arunachal Pradesh (13%), Madhya Pradesh (11%), Chhattisgarh
(10%), Maharashtra (7.5%), Odisha (7%) and Uttarakhand (5%). Not surprisingly, the share of these
states in tax devolution, barring that of Odisha, has increased in the FFC award.

 The 14th Finance Commission has given a 7.5% weight to forest cover in the formula to
determine how much different states will get from tax devolution.

 The Economic Survey(2014-15) had a significant discussion on how the higher charges on fuel
consumption should be seen as carbon tax.

 The first move is about a fair deal to states with high forest cover. These states act as national
carbon sinks (by absorbing carbon dioxide), and they will help India meet its international
climate change commitments in the future. It is only fair that the more industrial states, in
effect, pay forested states for this.

 Centre for Climate and Energy Solution –Target under UNFCCC(Framework convention on
climate change) 20-25% reduction in emissions per unit of GDP from 2005 level by 2020.

 The second move is about inter-generation equity. There is a heated debate in environmental
economics about the extent to which the present generation should pass on the costs of
pollution to future generations.

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STATE-WISE SHARE OF TAX POOL

The highest share goes to Uttar Pradesh (17.9%), simply because of its population (highest), and low per
capital state domestic product (the lowest was Bihar, UP was the second from the bottom). Bihar also
gets a high portion of union taxes (9.7%) as its income is quite far from all-states average per capita
income. The north-eastern states receive a very low share of union taxes, because they are covered by
special unconditional central aid that covers their expenditures.

GRANTS –IN –AID

Normally the FC recommends grants in aid for five purposes

1. Revenue deficit

2. Disaster relief

3. Local bodies

4. Sector specific schemes and

5. state specific schemes

But 14th FC proposed only 3

1. Post devolution revenue deficit

2. Local Gvt and

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3. Disaster management

Total revenue deficit grant of Rs. 1, 94,821 crore is recommended during the award period for eleven
States

MAJOR RECOMMENDATIONS OF FFC

1-The FFC has enhanced the share of the states in the central divisible pool from the current 32 percent
to 42 per cent which is the biggest ever increase in vertical tax devolution.

 12th-30.5 % ( 1% hike)

 13th-32% (1.5% hike)

 14th -42% =10% hike

DIVISIBLE POOL

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The divisible pool is that portion of the gross tax revenue which is distributed between Centre and
States .It consist of all taxes excepts surcharges and cess levied for specific purpose ,net of collection
charges .

2-The FFC has also proposed a new horizontal formula for the distribution of the states’ share in
divisible pool among the states.

3- Revenue deficit to be progressively reduced and eliminated.

4- Fiscal deficit to be reduced to 3% of the GDP by 2017–18.

( fiscal deficit of 3% in 3 years, rather than the two years envisaged previously. Thus, for the next three
years, my targets are: 3.9%, for 2015-16; 3.5% for 2016-17; and, 3.0% for 2017-18).

5.The Medium Term Fiscal Plan(MTFP)should be reformed and made the statement of commitment
rather than a statement of intent.

6.FRBM Act need to be amended.(Debt ceiling and Fiscal Responsibility Legislation)

7.Both centre and states should conclude 'Grand Bargain' to implement the model Goods and Services
Act(GST)

8.Initiatives to reduce the number of Centrally Sponsored Schemes(CSS)and to restore the

predominance of formula based plan grants.

9.States need to address the problem of losses in the power sector in time bound manner.

10.FFC has not made any recommendations concerning sector specific grants . therefore, all such
transfers, in whichever sectors are considered necessary,should be addressed through a different
institutional arrangement

IMPACT OF FC-14

There has been an increase in grants for Centrally Sponsored Schemes in recent years. Such grants
require states to make matching contributions and do not give them the autonomy to design or
implement the schemes. They are also “one-size-fits-all” schemes; as they are not tailored to the
specific ground level requirements of each state.

FC-14 strongly recommends that the centre reduce the number of Centrally Sponsored Schemes, and
instead move the resources directly to the states so that they can design, implement and monitor the
end use of funds at the state and local level.

Co-operative federalism- the aim of the present government- is best served through formula based,
non-discretionary transfers such as tax devolution. The increase in tax devolution rate, therefore, may
be an important step towards shifting the institutional mechanism towards transfers that promote
states’ fiscal autonomy.

GRANTS TO STATES ARE DIVIDED INTO TWO

Grants to States are divided into two

1, grant to duly constituted gram panchayats

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2, grant to duly constituted municipal bodies

And, it has divided grants into two parts

(i)A basic grant, and

(ii)a performance one for gram panchayats and municipal bodies

The ration of basic to performance grant is 90:10 for panchayats; and 80:20 for municipalities

SPECIAL CATEGORY STATES (SCS) AND GENERAL CATEGORY STATES (GCS)

The concept of a special category state was first introduced in 1969 when the Fifth Finance Commission
sought to provide certain disadvantaged states with preferential treatment in the form of central
assistance and tax breaks. Initially three states

1. Assam,

2. Nagaland and

3. Jammu & Kashmir were granted special status

but since then eight more have been included,

1. Arunachal Pradesh,

2. Himachal Pradesh,

3. Manipur,

4. Meghalaya,

5. Mizoram,

6. Sikkim,

7. Tripura and

8. Uttarakhand.

9. Some of the features required for special status are:

(i) hilly and difficult terrain;

(ii) low population density or sizeable share of tribal population;

(iii) strategic location along borders with neighbouring countries;

(iv) economic and infrastructural backwardness; and

(v) non-viable nature of state finances.

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MAIN TASKS OF THE 15TH F COMMISSION?

"strengthen cooperative federalism, improve the quality of public spending and help protect fiscal
stability".

Fifteenth Finance Commission comes in the context of few historical fiscal and economic developments
in the country

 This is the first FC after the abolition of the Planning Commission.

 This is the first FC after the launch of the GST.

 This is the first FC after the elimination of Plan and Non-Plan expenditure.

What is there in the Terms of Reference of the Fifteenth Finance Commission?

The Terms of Reference for the Fifteenth Finance Commission has been given under eight (1 to 8)
guidelines.

(1) the Fifteenth Finance Commission has to make recommendations on(the traditional three
recommendatory functions)/

core responsibility(i to iii )

(i) The distribution between the Union and the States of the net proceeds of taxes which are to be, or
may be, divided between them under and the allocation between the States of the respective shares of
such proceeds;

(ii) The principles which should govern the grants-in-aid of the revenues of the States out of the
Consolidated Fund of India and the sums to be paid to the States by way of grants-in-aid of their
revenues under Article 275 of the Constitution for purposes other than those specified in the provisos to
clause (1) of that article; and

STATUTORY GRANTS-IN-AID OF THE REVENUES OF STATES (ARTICLE 275)

(iii) The measures needed to augment the Consolidated Fund of a State to supplement the resources of
the Panchayats and Municipalities in the State on the basis of the recommendations made by the
Finance Commission of the State

(2) Asks the FC to consider the finances of the centre and states, fiscal consolidation map etc.

But under this head, the ToR specifically asks that “The Commission may also examine whether
revenue deficit grants be provided at all.”

(3) Here, the FC is asked to consider six ((i) to (vi)) federal finance aspects while making its
recommendations. Some of these are:

(i) The demand on the resources of the Central Government particularly on account of defence,
internal security, infrastructure, railways, climate change, commitments towards administration of UTs

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without legislature, and other committed expenditure and liabilities; (this consideration is from the
center’s angle).

(ii)The demand on the resources of the State Governments, particularly on account of financing
socioeconomic development and critical infrastructure, assets maintenance expenditure, balanced
regional development and impact of the debt and liabilities of their public utilities; (this is made from
the states’ angle).

(iii) The impact on the fiscal situation of the Union Government of substantially enhanced tax
devolution to States following recommendations of the 14th Finance Commission, coupled with the
continuing imperative of the national development programme including New India – 2022; (this aspect
gives the idea that after the 14th FC, states got tremendous revenue whereas centre is facing shortages).

(iv) The impact of the GST, including payment of compensation for possible loss of revenues for 5 years,
and abolition of a number of cesses, the compensation to states etc., on the finances of Centre and
States;

(v) On article (293), that is about the conditions that can be set by the centre on states’ borrowings.

(VI) The resources of the Central Government and the State Governments for the five years
commencing on 1st April 2020 on the basis of the levels of tax and the non-tax revenues likely to be
reached by 2024-25. In the context of both tax and non-tax revenues, the Commission will also take into
consideration their potential and fiscal capacity.

4) Commission may consider proposing measurable performance-based incentives for States, at the
appropriate level of government, in following areas ( briefly mentioned and only the important ones
are mentioned in this article).

(i) Efforts made by the States in expansion and deepening of tax net under GST;

(ii) Efforts and Progress made in moving towards replacement rate of population growth;

(iii) Achievements in implementation of flagship schemes of Government of India, disaster resilient

infrastructure, sustainable development goals, and quality of expenditure;

(iv) Progress made in increasing capital expenditure, eliminating losses of power sector

(v) Progress made in increasing tax/non-tax revenues, promoting savings by adoption of Direct Benefit
Transfers and Public Finance Management System, promoting digital economy and removing layers
between the government and the beneficiaries;

(vi) Progress made in promoting ease of doing business.

(vii) Provision of grants in aid to local bodies for basic services and other incentives.

(viii) Control or lack of it in incurring expenditure on populist measures.

(ix) Progress made in sanitation, solid waste management and open defecation.

5) The Commission shall use the population data of 2011 while making its recommendations.

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The sixth (6) guideline is for disaster management initiatives and the other two guidelines (7 to 8) are of
just procedural importance.

FIFTEENTH FINANCE COMMISSION

1. Shaktikanta Das, IAS -former economic affairs secretary(Das resigned as member on 11

December 2018,to become the Governor of Reserve Bank of India)

2. Anoop Singh -professor at Georgetown University (full-time members)

3. Ramesh Chand -NITI Aayog member and

4. Ashok Lahiri- former chief economic adviser (part-time members)

5. Ajay Narayan Jha Member (Was appointed member of the commission in lieu of Das.)

The Fifteenth Finance Commission was constituted by the Government of India, after the approval from
the President of India, through a notification in the Gazette of India.

Nand Kishore Singh was appointed as the Commission's chairman, with its full-time members being
Shaktikanta Das and Anoop Singh and its part-time members being Ramesh Chand and Ashok Lahiri.

The Commission was set up to give recommendations for five years commencing on 1 April 2020.The
main tasks of the commission was to "strengthen cooperative federalism, improve the quality of public
spending and help protect fiscal stability".

 The commission held its first meeting on 4 December 2017.

 has been asked to submit its report by 30 October 2019

The 15th Finance Commission has also been asked to propose measurable performance-based
incentives in areas such as efforts made by the states in expansion and deepening of the tax net under
GST, 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.

Replacement level fertility is the rate which stem the population growth and make population nearly
static. Fertility rate 2.1 Considered as the replacement rate.

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