Finance Commission of India
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Finance Commission of India

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Finance Commission of India

Why in News?

The report of the Fifteenth Finance Commission, along with an Action Taken Report, has been tabled in Parliament. 

The Commission, headed by N K Singh, had submitted its Report to the President in December 2019. 

What is the Finance Commission?

 

The Finance Commission is constituted by the President under article 280 of the Constitution, mainly to give its recommendations on the distribution of tax revenues between the Union and the States and amongst the States themselves.

Two distinctive features of the Commission’s work involve redressing the vertical imbalances between the taxation powers and expenditure responsibilities of the center and the States respectively and equalization of all public services across the States.  

What are the functions of the Finance Commission?

It is the duty of the Commission to make recommendations to the President as to:  

a. the distribution between the Union and the States of the net proceeds of taxes which are to be, or maybe, divided between them and the allocation between the States of the respective shares of such proceeds;

b. the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India; 

c. the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State based on the recommendations made by the Finance Commission of the State;

d. any other matter referred to the Commission by the President in the interests of sound finance.

The Commission determines its procedure and has such powers in the performance of their functions as Parliament may by law confer on them.  

Who appoints the Finance Commission and what are the qualifications for Members?

The Finance Commission is appointed by the President under Article 280 of the Constitution.

As per the provisions contained in the Finance Commission [Miscellaneous Provisions] Act, 1951 and The Finance Commission (Salaries & Allowances) Rules, 1951, the Chairman of the Commission is elected from among persons who have had experience in public affairs, and the four other members are selected from among persons who: 

are, or have been, or are qualified to be appointed as Judges of a High Court; or

have special knowledge of the finances and accounts of Government; or

have had wide experience in financial matters and administration; or

have special knowledge of economics.  

When was the first Commission Constituted and how many Commissions have been Constituted so far?

The First Finance Commission was constituted vide Presidential Order dated 22.11.1951 under the chairmanship of Shri K.C. Neogy on 6th April 1952.

Fifteen Finance Commissions have been Constituted so far at intervals of every five years.  

Why is there a need for a Finance Commission?

The Indian federal system allows for the division of power and responsibilities between the center and states.

Correspondingly, the taxation powers are also broadly divided between the center and states. State legislatures may devolve some of their taxation powers to local bodies.  

Need for permanent status:

Finance commissions have over the past several decade's adopted different approaches to principles of tax devolution, grants to be given to states, and fiscal consolidation issues. 

In other words, there has to be continuity and change between finance commissions.

There is a need to ensure broad consistency between Finance Commissions so that there is some degree of certainty in the flow of funds, especially to the states. This has become even more critical in the post GST scenario.

If it is given permanent status, the Commission can function as a leaner entity in the intervening period until the next Finance Commission is set up in a full-fledged manner. During the intervening period, it can also address issues arising from the implementation of the recommendations of the finance commission.  

Recommendations of the 15th Finance Commission:

How revenue has been divided?

FC has considered the 2011 population along with forest cover, tax effort, area of the state, and “demographic performance” to arrive at the states’ share in the divisible pool of taxes.

To reward population control efforts by states, the Commission developed a criterion For demographic effort — which is essentially the ratio of the state’s population in 1971 to its fertility rate in 2011 — with a weight of 12.5%.

The total area of states, the area under forest cover, and “income distance” were also used by the FC to arrive at the tax-sharing formula.  

Key recommendations:

The Commission has reduced the vertical devolution — the share of tax revenues that the Centre shares with the states — from 42% to 41%.

The Commission has said that it intends to set up an expert group to initiate a non-lapsable fund for defense expenditure.  

State-wise distribution:

Shares of the southern states, except Tamil Nadu, have fallen — with Karnataka losing the most.

Shares of states like Maharashtra, Himachal Pradesh, and Punjab, along with Tamil Nadu, all of which have fertility rates below the replacement level, have increased slightly.

On the other hand, Andhra Pradesh, Kerala, Karnataka, and West Bengal’s shares have fallen, even though their fertility rates are also low.

Incidentally, Karnataka, the biggest loser in this exercise, also had the highest tax-GSDP ratio is 2017-18, as per an RBI report on state finances.  

Criticisms:

The population parameter used by the Commission has been criticized by the governments of the southern states.

The previous FC used both the 1971 and the 2011 populations to calculate the states’ shares, giving greater weight to the 1971 population (17.5%) as compared to the 2011 population (10%).

 

The use of 2011 population figures has resulted in states with larger populations like UP and Bihar getting larger shares, while smaller states with lower fertility rates have lost out. 

The combined population of Bihar, Uttar Pradesh, Madhya Pradesh, Rajasthan, and Jharkhand is 47.8 crore.

This is over 39.48% of India’s total population and is spread over 32.4% of the country’s area, as per the 2011 Census.  

On the other hand, the southern states of Tamil Nadu, Kerala, Karnataka, and undivided Andhra Pradesh is home to only 20.75% of the population living in 19.34% of the area, with a 13.89% share of the taxes.

This means that the terms decided by the Commission are loaded against the more progressive (and prosperous) southern states.