Laxmikanth Summary: Finance Commission

Table of Contents
1. Finance Commission in India
2. Composition of Finance Commission
3. Functions of the Finance Commission
4. Finance Commission: Advisory Role
5. Need to Set up State Finance Commissions
6. 15th Finance Commission
7. State Finance Commissions (SFCs)
View more

Finance Commission in India

The Finance Commission is a constitutional, quasi-judicial body established under Article 280 of the Constitution of India. It is constituted by the President of India every five years or earlier if considered necessary, to recommend measures for the distribution of financial resources between the Centre and the states, and to review the financial position of the states. So far, fifteen Finance Commissions have been set up.

• Constitutional provision: Article 280 provides for constitution, composition, terms of reference and reporting by the Finance Commission.
• Periodicity: Constituted every five years, unless the President directs otherwise.
• Number so far: Fifteen Finance Commissions constituted to date.

Composition of Finance Commission

The Finance Commission consists of a Chairman and four other members, all appointed by the President. The term of office and conditions of service are determined by the President in the appointment order. Members may be reappointed.

• Chairman: Appointed by the President; the Chairman must have experience in public affairs.
• Other members: Four members appointed by the President; Parliament has provided qualifications and procedures for appointment.
• Parliamentary provision on qualifications: The statutes make it clear that at least one of the members should be a person who is, or has been, a judge of a High Court or is otherwise qualified to be a judge, or a person with specialised knowledge of government finance and accounts, or a person with extensive experience in financial matters and administration, or a person having special knowledge of economics.

Functions of the Finance Commission

The Finance Commission's primary role is advisory: it recommends how financial resources should be shared and distributed between the Union and the states, and among the states themselves. Its principal functions include:

• Distribution of tax revenues: Recommending the distribution of the net proceeds of taxes between the Centre and the states, and the allocation among the states.
• Grants-in-aid: Suggesting principles that should govern the grants-in-aid to states from the Consolidated Fund of India.
• Augmentation of state resources: Recommending measures required to augment the Consolidated Fund of a state to supplement funds for the panchayats and municipalities, based on recommendations of the State Finance Commissions.
• Other matters: Advising on any other matter referred to it by the President in the interest of better financial management and fiscal federalism.
• Historical compensation role: Up to 1960, the Finance Commission recommended grants to states such as Assam, Bihar, Odisha, and West Bengal to compensate for not receiving a share of export duty on jute and jute products for a limited period.
• Reporting: The Commission submits its report to the President, who places it before both Houses of Parliament along with a memorandum explaining the action taken on the recommendations.

Finance Commission: Advisory Role

• Advisory, not binding: The recommendations of the Finance Commission are advisory. There is no constitutional compulsion on the Union government to accept them, nor do they create enforceable legal rights in favour of states.
• Executive discretion: The Union Government decides whether and to what extent to implement the Commission's recommendations; typically the government issues a White Paper or explanatory memorandum when placing the report before Parliament.
• Need for strong reasons to reject: As observed by Dr. P. V. Rajamannar (Chair of the Fourth Finance Commission), the government should have strong reasons if it decides to reject recommendations of the Finance Commission.
• Overlap with other bodies: Historically, the role of the Finance Commission in shaping inter-governmental transfers was complicated by the now-defunct Planning Commission, which was an extra-constitutional body. Concerns were raised about role-conflict between them. In 2015 the Planning Commission was replaced by NITI Aayog (National Institution for Transforming India), which has a different mandate focusing on cooperative federalism and policy design.

Need to Set up State Finance Commissions

State Finance Commissions (SFCs) are necessary to operationalise fiscal federalism at the sub-state level. The 15^th Finance Commission (headed by N. K. Singh) held detailed consultations, including with the Reserve Bank of India, to discuss issues concerning both Centre-State and State-local government fiscal relations.

Key issues discussed included:

• Continuity of the Finance Commission: Consideration of a more permanent institutional status and robust expenditure planning to meet evolving fiscal management requirements of the states.
• State Finance Commissions (SFCs): Many states have not been constituting SFCs every five years as mandated by the 73rd and 74th Constitutional Amendment Acts. Regularly constituted SFCs are essential to rationalise and systematise State-sub-state fiscal relations.
• Expenditure codes: Expenditure norms and classifications vary across states; the adoption of uniform standard expenditure codes would improve transparency, comparability and fiscal planning.
• Public Sector Borrowing Requirement (PSBR): Borrowing by Central and State governments and public sector entities needs consolidated monitoring to avoid manipulation of fiscal deficit figures. Issues discussed included the rising orientation of State governments to borrow from markets, improving secondary market liquidity and better cash management.
• Importance of states: States play an increasingly important role in the economy. The 15th Finance Commission recommended a higher share of tax devolution to states (notably a 42% share in tax devolution), reflecting the shift in composition of government finances.
• Factors driving fiscal slippage: Factors cited include farm loan waivers, direct income support schemes and rising outstanding debt as a percentage of GDP, even while interest payments as a percentage of revenue receipts moderate.

15th Finance Commission

• Constitutional basis: The Finance Commission is a constitutional body constituted under Article 280 every five years to recommend transfer of financial resources from the Centre to the States and principles for grants-in-aid.
• Constitution and chair: The 15th Finance Commission was constituted on 27 November 2017 and was headed by Mr. N. K. Singh.
• Applicability period: Its recommendations were designed to apply for a five-year period beginning 1 April 2020.
• Notable recommendation: The 15th Finance Commission recommended a 42% share of central tax devolution to the states.

State Finance Commissions (SFCs)

The State Finance Commission is an institution created by the 73rd and 74th Constitutional Amendment Acts to review fiscal relations between the state government and local bodies (panchayats and municipalities).

• Constitutional provisions: Article 243-I requires the Governor of a state to constitute a State Finance Commission at intervals not exceeding five years to review the financial position of panchayats and make recommendations. Article 243-Y contains corresponding provisions for municipalities.
• Functions: SFCs review the financial position of local bodies, recommend distribution of certain taxes, duties, tolls and fees between the state and local bodies, and suggest measures to improve the financial position of local governments.
• Concerns with SFCs: Many states do not constitute SFCs regularly; reports are often delayed or of limited quality; SFCs face the complex task of dealing with a large number of local governments and often lack reliable and standardised data; SFCs are perceived to have lower constitutional visibility compared to the Union Finance Commission.
• Suggested improvements: Regular constitution of SFCs every five years, capacity building for SFC secretariats, development of standardised expenditure codes, better data systems, and clear timelines for submission and publication of reports would strengthen state-local fiscal relations.

The Finance Commission is a cornerstone of India's fiscal federalism: it provides a periodic, rules-based mechanism for distributing resources and setting principles of inter-governmental fiscal transfers. Strengthening both the Union Finance Commission process and the institutional capacity of State Finance Commissions is essential for transparent, equitable and efficient fiscal federal relations in India.