Notes

04 Finance Commission

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What is Finance Commission

  • art 280
  • by President every 5yr or at such earlier times as he/she considers necessary
  • reccos on distribution of tax revenues b/w Union & States & among States themselves
  • not permanent

Composition

  • chairman + 4 mem, appt by president
  • hold office for such period as specified by president
  • reappointment ✅✅
  • Quals: determined by Parliament: Finance Commission Act 1951 & Finance Commission Rules 1951
    • chairman: exp in public affairs
    • 4 members:
      • HC Judge/qual
      • spl knowledge of fin & accts of govt
      • wide exp in fin matters & admin
      • spl knowledge of economics

Functions

  • tax devolution (H+V)
  • principles governing of GiA (from CFI)
  • strengthening PRI by augmenting State CF, supplementing PRI resources
  • financial requirements of municipalities based on SFC reccos
  • advisory role on fiscal matters, as referred by president

16th FC report for 2026-31

  • Chair: Dr. Arvind Panagariya

Key recommendations

  • 41% share of states in central tax (same as 15th FC)
  • criterion for devolution
    • horizontal includes 10% weight for contribution to GDP replacing tax & fiscal efforts
    • 10% demographic performance
      • for 1971-2011
  • Per capita GSDP distance
  • population 2011 census
  • forest share incl. open forest
  • GiA: 9.47LCr over 5yr
    • disaster management
    • urban, rural local bodies
  • discontinued grants
    • revenue deficit
    • sector specific
    • state specific
  • grants for local bodies
    • 4.4LCr for rural
    • 3.6LCr for urban
    • divided into basic 80% and performance based 20%
  • Basic grant
    • 50% untied
    • 50% tied to sanitation, SWM, water mgmt
  • local body grants made available only when
    1. local bodies constituted
    2. provisional & audited accounts of local bodies published
    3. SFC constituted timely
  • Special infra grants & urbanization premium grants also recommended for ULB
    • Special infra
      • tied to dev of wastewater mgmt system in cities w/ population 10-40L
      • 56,100Cr over 5 years
    • Urbanization premium: released to state as one time grant for
      • merger of peri urban villages into adjoining ULB area
      • formulation of rural urban transition policy
  • Disaster Management Grants
    • 2.04LCr for SDRF & SDMF
  • fiscal roadmap
    • projected debt of C+S to decline from 77.3% in 2026-27 to 73.1% of GDP in 2030-31
    • center should bring down fiscal deficit to 3.5% of GDP by 2030-31
    • recommended annual fiscal deficit limit for states to be 3% of GSDP
    • discontinue off budget borrowing for states
    • definition of fiscal deficit & debt should expand to include off budget borrowings
  • subsidy
    • rationalization recommended
    • criticized schemes with unconditional cash transfer
    • recommends clear exclusion criteria, rigorous review process
    • discontinuing financing of subsidies through off budget borrowing
  • power sector
    • states should actively pursue privatization of DISCOM
  • PSU reforms
    • review & closure of 308 inactive SPSE
    • state/union PSE which incur losses for 3/4 consecutive year should be placed for cabinet’s consideration
      • may close, privatize or continue depending on strategic importance of enterprise

Why GDP Contribution in formula

  • 10% weight
  • changes
    • Karnataka: +0.48% points
    • Kerala: +0.45%
    • MP: -0.50%
    • Bihar: -0.11:
  • efficiency signal
  • efficiency of production system vs efficiency of fiscal system
    • GSDP & GDP are outcome of production system
  • growth & consequent improvement in per capita income of citizens as imp imperative

Key concerns

  • rising cess & surcharges (against fiscal federalism)
  • Art 275 allows grants for specific needs & equalize public services, but not used
    • discontinuation of revenue gap & state specific grants further reduced equalization
  • reduction in fiscal support from centre to states
  • use of square root formula in contribution to GDP dilutes its impact
  • richer states wanted “share in total tax contribution”
  • current approach doesn’t account for migration trends for population
  • puts pressure on local revenue generation

Challenges confronting fiscal federalism

  • shrinking divisible pool (cess, surcharge)
  • reduced financial autonomy & GST implementation issues
  • vertical fiscal imbalance & dependence on transfers
  • over dependence on centrally sponsored schemes
  • state borrowing constraints (3% of GSDP)
  • political bias in fund allocation
  • fiscal crisis of local governments

Strengthening fiscal federalism

  • empower institutions
    • Finance commission greater autonomy
    • NITI Aayog be used as effective platform for C-S collab
  • PRI/ULB strengthen - admin capacity, functional autonomy
  • independent fiscal council, & fiscal responsibility legislation for transparent, accountable and prudent fiscal management
  • limit use of cess & surcharge
  • reinforce cooperative federalism
  • rework the structure of CSS for greater fiscal autonomy to states

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