Role of the Finance Commission

Syllabus: GS3/Economy

Context

• The sixteenth Finance Commission headed by Arvind Panagariya has begun its work by inviting suggestions from the public on the mandate set for it by the Centre.

Role of the Finance Commission:

1. Constitutional Mandate and Functions:
   • The Finance Commission is constituted every five years by the President under Article 280 of the Constitution.
   • Its primary function is to recommend the distribution of tax revenues between the Centre and the States.
2. Tax Devolution:
   • Vertical Devolution: Determines the share of central taxes that should be allocated to States. This ensures a fair distribution based on factors like population, income levels, etc.
   • Horizontal Devolution: Distributes funds among States based on a formula that considers factors like population, area, and fiscal capacity.
3. Grants and Aids:
   • Besides devolution, the Commission recommends grants-in-aid to States for specific purposes as decided jointly with the Centre.

Issues and Disagreements:

1. Demand for More Funds:
   • States argue that they bear significant responsibilities but receive insufficient funds compared to what they contribute through taxes like GST.
2. Disparities Among States:
   • Developed states like Karnataka and Tamil Nadu argue they receive less than their due share compared to less developed states, leading to a perception of unfairness.
3. Divisible Pool Concerns:
   • Cesses and surcharges, which are not shared with States, constitute a substantial part of the Centre’s revenue, reducing the pool available for distribution.
4. Shortfall in Devolution:
   • Despite recommendations, actual devolution from the Centre to States has sometimes fallen short of what was suggested by the Finance Commission.
5. Criticism of Independence:
   • There are concerns about the Commission’s independence due to its members being appointed by the Centre, potentially affecting its impartiality in recommending fiscal transfers.

Way Ahead:

1. Addressing Economic Dynamics:
   • The Finance Commission needs to adapt to changing economic and social conditions brought about by GST implementation, COVID-19, climate change, and digital transformation.
2. Ensuring Fairness and Equity:
   • Addressing the concerns of developed states and ensuring that fiscal transfers do not penalize states for their development efforts is crucial.
3. Enhancing Independence:
   • Steps should be taken to enhance the Commission’s autonomy to ensure it can function independently and make recommendations based solely on fiscal and developmental considerations.

In conclusion, while the Finance Commission serves as a vital institution in India’s federal structure by recommending fiscal transfers, addressing the concerns regarding fairness, efficiency, and independence is crucial to maintaining trust and equity among all stakeholders – both at the Centre and in the States.