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Finance Commission in India

  • Article 280 of the Indian Constitution establishes the Finance Commission as a quasi-judicial body. 
  • The President of India constitutes this Commission every five years or earlier if deemed necessary. 
  • So far, fifteen Finance Commissions have been set up. 

Laxmikanth Summary: Finance Commission | Indian Polity for UPSC CSE

Composition of Finance Commission

  • The Finance Commission has a chairman and four other members who are appointed by the President.
  • They serve for a time period set by the President in their appointment order.
  • These members can be reappointed.
  • The Constitution allows Parliament to decide on the qualifications for the members of the commission and how they should be chosen.

Parliament has defined the qualifications for both the chairman and the other members:
The chairman must have experience in public affairs.
One of the four members should be:

  • A judge of a high court or someone qualified to be a judge.
  • A person with specialized knowledge in government finance and accounts.
  • A person who has extensive experience in financial matters and administration.
  • A person with special knowledge in economics.

Functions of Finance Commission

  •  The Finance Commission must provide advice to the President of India on the following issues: 
  •  The sharing of the net tax earnings between the Centre and the states, as well as how to divide these earnings among the states. 
  •  The guidelines for grants-in-aid that the Centre should give to the states, which come from the Consolidated Fund of India
  •  The actions needed to increase the resources of a state's Consolidated Fund to help support local governments, such as panchayats and municipalities, based on the recommendations from the state finance commissions. 
  •  Any other issues that the President wants the commission to address for better financial management. 
  •  Up until 1960, the commission also recommended grants for the states of Assam, Bihar, Odisha, and West Bengal as compensation for not receiving a share of the export duty on jute and jute products. These grants were meant for a temporary duration of ten years starting from the implementation of the Constitution. 
  •  The commission sends its report to the President, who then presents it to both Houses of Parliament along with a detailed explanation about the actions taken based on the recommendations. 

Finance Commission: Advisory Role

  •  It is important to understand that the suggestions made by the Finance Commission are only advisory and not mandatory for the government. 
  •  The decision to act on these recommendations regarding funding for the states lies with the Union government
  •  In other words, there is nothing in the Constitution that makes the Finance Commission's recommendations obligatory for the Government of India or creates any legal rights for the states to receive the suggested funds. 
  •  As noted by Dr. P. V. Rajamannar, who was the chair of the Fourth Finance Commission, it is crucial for the government to have very strong reasons if it decides to reject the Finance Commission's recommendations. 
  •  The Constitution of India sees the Finance Commission as a key element in maintaining balance in the country's financial federalism. 
  •  However, up until 2014, the role of the Finance Commission in managing financial relations between the center and the states was weakened by the former Planning Commission, which was neither a constitutional nor a statutory body. 
  •  Dr. P. V. Rajamannar also pointed out that there was a conflict in responsibilities and roles between the Finance Commission and the old Planning Commission concerning federal financial transfers. 
  •  In 2015, the Planning Commission was replaced by a new organization called NITI Aayog (National Institution for Transforming India). 

Need to Set up State Finance Commission

The 15th Finance Commission (headed by N K Singh) recently held a detailed meeting with RBI.

Key issues that were discussed:

  • Continuity of the Finance Commission: A permanent status to Finance Commission and a robust expenditure planning is the need of the hour. This is required, in view of the fiscal management requirements of the States.
  • State Finance Commissions (SFCs): States have not been setting up their State Finance Commissions every five years as mandated by 73rd Constitutional Amendment Act. Therefore, they discussed the necessity of SFCs to rationalize and systematize State/sub-state fiscal relations in India.
  • Expenditure codes: Expenditure norms vary from state to state; therefore there is a need of uniform standard expenditurecodes across the country.
  • Public Sector Borrowing Requirement (PSBR): It is defined as borrowing by not just Central and State governments but also by all public sector corporations and agencies. This consolidated figure will more or less put an end to the manipulation the fiscal deficit by the government. The main issues discussed are the increasing orientation of State governments’ borrowing from markets, improving secondary market liquidity and cash management.
  • Importance of States in the economy: The role of states in the growth of Indian economy has increased given the Shift in composition of government finances’. States are now getting much higher share of transfer (devolution of 42%) from Centre, on the recommendation of 15th FC.
  • Factors driving fiscal slippage: These factors include UDA, farm loan waivers and income support schemes; rising outstanding debt as a percentage of GDP despite moderation in interest payments as a percentage of revenue receipts.

15th Finance Commission (FC):

  • Finance Commission is a constitutional body under Article 280 created every five years to recommend the transfer of financial resources from the Centre to the States.
  • The Commission also decides the principles on which grants-in-aid will be given to the States.
  • The 15th FC was constituted on November 27, 2017 and is headed by Mr. N.K. Singh.
  • The recommendations, to be observed for a period of five years, will kick in from April 1, 2020.

State Finance Commissions (SFCs):
The State Finance Commission (SFC) is an institution created by the 73rd and 74th Constitutional Amendments (CAs) to rationalize and systematize State/sub-State-level fiscal relations in India.
(i) Article 2431 of the Constitution mandated the State Governor to constitute a Finance Commission every five years.
(ii) Article 243Y of the Constitution states that the Finance Commission constituted under article 243 I shall also review the financial position of the Municipalities and make recommendations to the Governor.
(iii) Concerns:

  • States have not been setting up their SFCs regularly as mandated.
  • They are not submitting the reports in time, lacking the proficiency.
  • They have huge task of considering large number of local governments,
  • They face a crucial problem of reliable data.
  • SFCs and local governments are seen to be of inferior constitutional status than the Union FC.
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FAQs on Laxmikanth Summary: Finance Commission - Indian Polity for UPSC CSE

1. What is the Finance Commission?
Ans. The Finance Commission is a constitutional body in India that is responsible for recommending the distribution of financial resources between the central government and the state governments. It is established every five years and consists of a chairman and four other members.
2. What is the role of the Finance Commission?
Ans. The main role of the Finance Commission is to make recommendations regarding the sharing of tax revenues between the central and state governments, as well as the distribution of grants-in-aid to states. It also suggests measures to improve the financial position of states and reviews the fiscal performance of the central and state governments.
3. How is the Finance Commission appointed?
Ans. The Finance Commission is appointed by the President of India. The chairman is selected from individuals who have held high office in the government or who have had experience in financial matters. The other members of the commission are appointed by the President in consultation with the chairman.
4. What factors does the Finance Commission consider in making its recommendations?
Ans. The Finance Commission takes into account various factors, including the needs of the states, the resources available to the central government, the expenditure requirements of the central government, and the debt levels of the states. It also considers the need for a stable and predictable flow of funds to the states and the need to maintain a balance between the needs of the center and the states.
5. How are the recommendations of the Finance Commission implemented?
Ans. The recommendations of the Finance Commission are not binding on the government. However, they are usually accepted by the government and form the basis for the devolution of funds to the states. The recommendations are implemented through the finance ministry and other relevant ministries and departments, which take necessary actions to allocate funds based on the commission's recommendations.
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