Finance Commission

Article 280 provides for the constitution of Finance Commission. It is constituted every fifth year or as deemed necessary by the President. Comprising a Chairman and four members whose qualifications are outlined by the Parliament. Its functions include advising the President on financial matters which are given to it in its terms of reference. The recommendations made by the Finance Commission are considered as advice and are not binding on the Central Government.

Article 280 establishes a Finance Commission as a quasi-judicial body. The President of India forms the Commission every fifth year or earlier if deemed necessary. The Article also mentions the broad terms of reference of the Finance Commission. The Government of India has recently constituted the Sixteenth Finance Commission.

Composition: Article 280 states that the Finance Commission shall consist of a Chairman and four other members who are appointed by the President. They serve for a period specified by the President.

under the Finance Commission Act, 1951 the Parliament has laid down the following conditions:

• Chairman should be a person having experience in public affairs; and
• Other four members: should be selected from among persons who:
  • Are or have been qualified to be appointed as a Judge of a High Court; or
  • Have specialised knowledge in financial and accounts matters; or
  • Have wide experience in financial and administration related matters
  • Have special knowledge of economics

the Finance Commission is tasked with advising the President of India on several matters like:

• Division of taxes between Centre and States, and manner of allocation of share of States
• Principles governing grants-in-aid from the Centre to the States from the Consolidated funds of India
• Measure to boost Consolidated Funds of a State, supporting local panchayats and municipalities based on the recommendations made by State Finance Commission (added by the 73rd and 74th Constitutional Amendment: this amendment also granted constitutional status and protection to the panchayats and the municipalities)
• Deciding whether to keep or change the terms of an agreement between the government of India and a specific state in Part B of First Schedule under Article 278 or Article 306.
• Any other financial matters which are referred to by the President.

• Constitution of Commission: government constitutes finance commission and its terms of reference under Article 280
• Commission takes estimates from States: the estimates are taken of the States expenditure and revenue for a period of 5 years, where needed clarification is taken
• Stakeholder Consultation: Commission members meet with Chief Ministers and Finance Ministers to discuss financial estimates. States have the option to present a memorandum laying out their needs and demands. Commission takes opinion of Stakeholders from Industries and bankers
• Submission of Report: Report is submitted to the President of India before the annual budget. The president then presents the reports before both the Houses of the Parliament. Along with it an “Explanatory Memo” is given which explains the action taken, or not taken, on the recommendations by the Finance Commission.

The accepted recommendations are put in force for a period of usually 5 years by a Presidential Order. These are implemented and then monitored by the respective ministries and authorities incharge of the issue at hand e.g. the National Disaster Management Authority will overlook setting up of the Disaster Mitigation Fund.

Was chaired by Mr. Nand Kishore Singh.

• Objective: enhancing cooperative federalism, improving public spending quality and supporting fiscal stability. Its Terms of Reference (TOR) were quite wide and included incentives for performance to States,
• Recommendations: In February 2021, the Commission reassessed the revenue devolution formula from the Union to the States. It gave the following formula based on which tax sharing should be decided:-
  1. Vertical Devolution: 41% to all States and 1% to the Union Territories of Ladakh and Jammu and Kashmir. The rest of the tax pool would go to the central government. This devolution stayed consistent and was the same 42% as was recommended by the 14th Finance Commission. It is to be noted that this tax pool is calculated after deduction of cesses, surcharges and the administrative costs of collection.
  2. Horizontal Devolution: This discusses how the money would be divided between the various states. For this, 6 criteria were identified, which would together ensure distribution of money to the states based on their need, their performance and also principles of equity.

     Criteria	Weight (%)
     Population	15.0
     Area	15.0
     Forest & ecology	10.0
     Income distance	45.0
     Tax & fiscal efforts	2.5
     Demographic performance	12.5
     Total	100

  3. The Report also suggested the allocation for Revenue Deficit Grants and grants to Local Government. Apart from this, the Commission also allotted sector specific grants in health, education, to aspirational districts, judiciary etc.
  4. Performance Incentives: Grants to be allocated to States based on achieving certain benchmarks by States in various welfare programmes like
     1. Developing online and professional courses in regional language
     2. Undertaking agricultural reforms.
     3. Aligning land laws with the NITI Aayog model law
     4. Growth in agricultural exports.
     5. Maintenance of roads under Pradhan Mantri Gramin Sadak Yojana.
     6. Power Sector reforms
  5. Modernisation Fund for Defence and Internal Security (MFDIS): Was recommended as a non-lapsable dedicated fund for the importance of modernisation of technology which is necessary to defend India in the times of rising cyber crime.
  6. Disaster Risk Management: Finance Commission recommended that a mitigation fund should be used for local level and community-based interventions to reduce risks, in line with the Disaster Management Act.

• Chairman: Dr. Arvind Panagariya
• Term of reference : the sixteenth Finance Commission is tasked with making recommendations on the following matters:
  • The division of net tax proceeds between the Union and the States along with the allocation of these proceeds among the States.
  • The principles which should govern the grants-in-aid of the revenue of the States from the Consolidated funds of India
  • The sum to be paid to the States through grants-in-aid
  • Suggest measures for the Consolidated Funds of India to be used for Panchayats and Municipalities
  • Review the financing arrangement of Disaster Management initiatives from funds constituted under the Disaster Management Act 2005.

1. Informational & Statistical Challenges: The data based on which the Finance Commission prepares its report is sometimes outdated or inconsistent with the reality on the ground. Sometimes there is no data on some things like unit cost of public services disbursed, inter-state trade flows etc. In this case data has to be reverse -engineered which is not optimal for arriving at recommendations.
2. Dissatisfaction among States: The vertical and horizontal devolution amongst states has created dissatisfaction and they have registered their protest. Kerala is one of the leading sources of tax collection for the Central pool, however the amount they have received from the pool has reduced over time. This
3. Issue of Cess & Surcharge Exclusion: States have protested that Cess and Surcharge go directly to the Central Government and they should also have a share in this income.
4. Lack of Implementation: While the Finance Commission recommendations are not binding, even those which the government accepts do not come in force sometimes and there is no accountability for this e.g. the MFDIS was accepted but still not constituted.

• The Constitution of India,under Article 243-I (73rd Constitutional Amendment Act) and 243-Y(74th Constitutional Amendment Act), mandates the establishment of a State Finance Commission every five years for rural local government (Panchayats) and Urban local bodies respectively.
• The State Finance Commission is constituted by Governor of each state to rationalise the fiscal relations of States with the local governments.

Decentralization of Power: SFCs play an important role in strengthening the financial autonomy of local governments, thereby promoting decentralization of power.

Equitable Distribution of Resources: By recommending the distribution of financial resources, SFCs ensure that local bodies have sufficient funds to discharge their responsibilities effectively.

Financial Accountability and Transparency: SFCs enhance accountability and transparency in the local adminstration by setting guidelines for the distribution and utilization of funds.

The Finance Commission plays a crucial role in ensuring fiscal stability and equity within India's federal structure. It is one of the pillars of fiscal federalism and that is why its role is also hotly contested. The Finance Commission's recommendations are advisory in nature and are not binding on the government. It's the Union government's decision to implement the recommendations regarding money allocation to states. The Constitution doesn't mandate that the government must follow the commission's suggestions, and there's no legal right for beneficiary states to receive the recommended funds. However, the Commission's periodic assessments and consultations with stakeholders help maintain a balanced and dynamic financial ecosystem, supporting the development of both the nation and its constituent states.