Role of the Finance Commission

The sixteenth Finance Commission, chaired by former Niti Aayog Vice-Chairman Arvind Panagariya, has begun its work. The Commission is inviting suggestions from the public on its mandate, set by the Centre.

Finance Commission's Role

• Constitutional Body: The Finance Commission is a constitutional body tasked with recommending how tax revenues collected by the Central government should be distributed between the Centre and various States.
• Vertical and Horizontal Devolution: It decides the proportion of the Centre’s net tax revenue that goes to the States overall (vertical devolution) and how this share is distributed among various States (horizontal devolution).
• Local Bodies Revenue: The 16th Finance Commission is also expected to recommend ways to augment the revenues of local bodies such as panchayats and municipalities.
• Decision-Making Process
• Vertical Devolution: This refers to the share of funds from the divisible pool that the Centre allocates to the States. The last few Finance Commissions recommended an increasing share: 32% by the 13th, 42% by the 14th, and 41% by the 15th Finance Commissions.
• Horizontal Devolution: This involves distributing the States’ share based on a formula considering factors like population, fertility level, income level, and geography.
• Additional Grants: The Centre may also provide additional grants to States for certain jointly funded schemes.

Friction Between Centre and States

• Revenue Sharing Disputes: The Centre collects major taxes, while States rely on taxes from goods like liquor and fuel. States argue they need more funds to fulfill their responsibilities, which include providing education, healthcare, and police services.
• Unmet Recommendations: States often receive less than the recommended share from the Finance Commission. For example, under the 15th Finance Commission, States received an average of only 38% of funds from the divisible pool, against the recommendation of 41%.

Disagreements and Criticisms

• Divisible Pool Calculation: There is contention over what portion of the Centre’s overall tax revenues should be part of the divisible pool. Cesses and surcharges, not shared with the States, can constitute up to 28% of the Centre’s tax revenues, reducing the effective share for States.
• Perceived Inequities: More developed States like Karnataka and Tamil Nadu argue they receive less in proportion to their contributions, whereas States like Bihar receive significantly more than their contributions.
• Independence Concerns: Some critics believe the Finance Commission, appointed by the Centre, may not be fully independent and could be influenced politically.

Impact on Governance

• Fiscal Federalism: The Finance Commission’s recommendations impact the fiscal federalism in India, influencing how resources are shared and utilized at different levels of government.
• Economic Disparities: Disputes over revenue sharing can exacerbate economic disparities between States, affecting regional development and governance quality.

Required Measures

• Transparent Calculations: Ensure transparent and fair calculation methods for the divisible pool and distribution of funds.
• Addressing Root Causes: Strengthen mechanisms to address the root causes of revenue-sharing disputes and foster cooperative federalism.
• Enhanced Autonomy: Grant more financial autonomy to States to manage their resources and responsibilities effectively.

Mains Practice Question

Q: "Discuss the role of the Finance Commission in ensuring equitable distribution of resources between the Centre and States, highlighting the challenges faced in this process."