Finance Commission of India - Indian Polity Notes What is of India? Finance Commission is a constitutional body for the purpose of allocation of certain revenue resources between the Union and the State Governments. It was established under Article 280 of the Indian Constitution by the Indian President. It was created to define the financial relations between the Centre and the states. It was formed in 1951. Table of Contents: What is Finance Commission of India? • Recommended Video • Which articles deal with Finance Commission of India? • Who Constitutes Finance Commission of India?

What is composition of Finance Commission of India? • Finance Commission Chairman and Members • Qualifications of Finance Commission Chairman and Members

What are functions of Finance Commission of India? • Functions of Finance Commission • Advisory Role of Finance Commission

Finance Commission List • List of Finance Commissions of India Which articles deal with Finance Commission of India? Article 280 of the Indian Constitution • President after two years of the commencement of Indian Constitution and thereafter every 5 years, has to constitute a Finance Commission of India. • It shall be the duty of the Commission to make recommendations to the President in relation to the: o 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; o the principles which should govern the grants in aid of the revenues of the States out of the Consolidated Fund of India; o any other matter referred to the Commission by the President in the interests of sound finance o The Commission shall determine their procedure and shall have such powers in the performance of their functions as Parliament may by law confer on them Note: President can also constitute Finance Commission before the expiry of five years as he considers necessary Article 281 of the Indian Constitution • It is related to the recommendations of the Finance Commission: o The President has to lay the recommendation made by Finance Commission and its explanatory memorandum before each house of Parliament Who Constitutes Finance Commission of India? President of India constitutes the Finance Commission every five years or on time considered necessary by him. What is composition of Finance Commission of India? Finance Commission Chairman and Members • Chairman: Heads the Commission and presides over the activities. He should have had public affairs experience. www.pragnyaias.com 7288081111

• One Secretary and four Members. • The Parliament determines legally the qualifications of the members of the Commission and their selection methods. Qualifications of Finance Commission Chairman and Members • The 4 members should be or have been qualified as High Court judges, or be knowledgeable in finance or experienced in financial matters and are in administration, or possess knowledge in economics. • All the appointments are made by the President of the country. • Grounds of disqualification of members: • found to be of unsound mind, involved in a vile act, if there is a conflict of interest • The tenure of the office of the Member of the Finance Commission is specified by the President of India and in some cases, the members are also re-appointed. • The members shall give part-time or service to the Commission as scheduled by the President. • The salary of the members is as per the provisions laid down by the Constitution. What are functions of Finance Commission of India? Functions of Finance Commission The Finance Commission makes recommendations to the president of India on the following issues: • The net tax proceeds distribution to be divided between the Centre and the states, and the allocation of the same between states. • The principles governing the grants-in-aid to the states by the Centre out of the consolidated fund of India. • The steps required to extend the consolidated fund of a state to boost the resources of the panchayats and the municipalities of the state on the basis of the recommendations made by the state Finance Commission. • Any other matter referred to it by the president in the interests of sound finance. • The Commission decides the basis for sharing the divisible taxes by the centre and the states and the principles that govern the grants-in-aid to the states every five years. • Any matter in the interest of sound finance may be referred to the Commission by the President. • The Commission’s recommendations along with an explanatory memorandum with regard to the actions done by the government on them are laid before the Houses of the Parliament. • The FC evaluates the rise in the Consolidated Fund of a state in order to affix the resources of the state Panchayats and Municipalities. • The FC has sufficient powers to exercise its functions within its activity domain. • As per the Code of Civil Procedure 1908, the FC has all the powers of a Civil Court. It can call witnesses, ask for the production of a public document or record from any office or court. Advisory Role of Finance Commission The recommendations made by the Finance Commission are of an advisory nature only and therefore, not binding upon the government. It is up to the Government to implement its recommendations on granting money to the states. To put it in other words, ‘It is nowhere laid down in the Constitution that the recommendations of the commission shall be binding upon the Government of India or that it would amount to a legal right favouring the recipient states to receive the money recommended to be provided to them by the Commission. Context: RBI governor bats for permanent status to Finance Commission. Permanent Status To Finance Commission The Finance Commission is constituted by the President under article 280 of the Constitution, mainly to give its recommendations on 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 centre and the States respectively and equalization of all public services across the States. Why Permanent Status to Finance Commission?

www.pragnyaias.com 7288081111

• Need for robust expenditure planning: While it is important to adhere to fiscal deficit targets, it is equally important to undertake robust expenditure planning to address the socio-economic challenges. • To ensure consistencies: According to the RBI governor, finance commissions have over the past several decades adopted different approaches with regard to principles of tax devolution, grants to be given to states and fiscal consolidation issues. There is a need to ensure consistency between finance commissions so that there is some certainty in the flow of funds to states. To promote fresh and innovative thinking: • During the intervening period, it can also address issues arising from the implementation of the recommendations of the finance commission. According to former Reserve Bank Governor Y.V. Reddy, the Finance Commission should be allowed to function in the same manner as it is doing currently. “Currently, the Finance Commission has a five-year term. The system of appointing a Finance Commission once in five years is fine. Let it continue. The way forward is to stick to the old approach, New approach is not warranted. What is warranted is to behave more faithfully, with honesty and integrity. Implications The proposal for making the Finance Commission a permanent body could evolve in two ways: • First, the government would abdicate its discretion currently available in designing and implementing the specific purpose transfers. • Second, creating permanent finance commission with a particular set of rules may hamper fiscal federalism as it would dilute the neutrality of the Finance Commission between the Union and the States through a process of continuous association with the government. So there is considerable merit in having one apolitical body that provides stability and predictability primarily to share taxes that ensured fiscal balance and another forum of transfers involving continuous political bargaining with a broader mandate. MAINS:

Finance Commission of India Topics Covered: 1. Appointment to various Constitutional posts, powers, functions and responsibilities of various Constitutional Bodies. What to study? For Prelims and Mains: About FC- roles, objectives, functions, criteria used and need for reforms. Context: Shri recently joined the Fifteenth Finance Commission as its Member. The Fifteenth Finance Commission was constituted by a Presidential Order in November, 2017 under the Chairmanship of Shri N. K. Singh to decide the formula for devolution of revenue between Centre and States, for a period of 5 years – April, 2020 to March, 2025. 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 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 centre 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:

www.pragnyaias.com 7288081111

1. the distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them and the allocation between the States of the respective shares of such proceeds; 2. the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India; 3. the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State; 4. any other matter referred to the Commission by the President in the interests of sound finance. The Commission determines its procedure and have 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 selected from among persons who have had experience in public affairs, and the four other members are selected from among persons who: 1. are, or have been, or are qualified to be appointed as Judges of a High Court; or 2. have special knowledge of the finances and accounts of Government; or 3. have had wide experience in financial matters and in administration; or 4. have special knowledge of economics The recommendations of the Finance Commission are implemented as under: Those to be implemented by an order of the President: 1. The recommendations relating to distribution of Union Taxes and Duties and Grants-in-aid fall in this category. 2. Those to be implemented by executive orders: 3. Other recommendations to be made by the Finance Commission, as per its Terms of Reference When was the first Commission Constituted and how many Commissions have been Constituted so far? The was constituted vide Presidential Order dated 22.11.1951 under the chairmanship of Shri K.C. Neogy on 6th April, 1952. Fifteenth 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 centre and states. Correspondingly, the taxation powers are also broadly divided between the centre and states. State legislatures may devolve some of their taxation powers to local bodies. Formula used for distribution: The share in central taxes is distributed among states based on a formula. Previous Finance Commissions have considered various factors to determine the criteria such as www.pragnyaias.com 7288081111

the population and income needs of states, their area and infrastructure, etc. Further, the weightage assigned to each criterion has varied with each Finance Commission. The criteria used by the 11th to 14thFinance Commissions are:

Population is an indicator of the expenditure needs of a state. Over the years, Finance Commissions have used population data of the 1971 Census. The 14th Finance Commission used the 2011 population data, in addition to the 1971 data. The 15th Finance Commission has been mandated to use data from the 2011 Census. Area is used as a criterion as a state with larger area has to incur additional administrative costs to deliver services. Income distance is the difference between the per capita income of a state with the average per capita income of all states. States with lower per capita income may be given a higher share to maintain equity among states. Forest cover indicates that states with large forest covers bear the cost of not having area available for other economic activities. Therefore, the rationale is that these states may be given a higher share. Grants-in-Aid: Besides the taxes devolved to states, another source of transfers from the centre to states is grants-in-aid. As per the recommendations of the 14th Finance Commission, grants-in-aid constitute 12% of the central transfers to states. The 14th Finance Commission had recommended grants to states for three purposes: (i) disaster relief, (ii) local bodies, and (iii) revenue deficit. Mains Question: Discuss the role that Finance Commission play in improving centre state administrative relations? CURRENT AFFAIR: 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, especially given the absence of mid-term reviews of awards granted by the Finance Commission.

www.pragnyaias.com 7288081111

▪ 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 expenditure codes 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. ▪ Article 243I of the Constitution mandated the State Governor to constitute a Finance Commission every five years. ▪ 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. ▪ Concerns:

o States have not been setting up their SFCs regularly as mandated. o They are not submitting the reports in time, lacking the proficiency. o They have huge task of considering large number of local governments. o They face a crucial problem of reliable data. o SFCs and local governments are seen to be of inferior constitutional status than the Union FC. www.pragnyaias.com 7288081111

15th Finance Commission’s Interim Report Why in News? The interim report of the 15th Finance Commission (FC) has been tabled in Parliament this budget session. What is the Finance Commission? • Article 280 of the Constitution of India provides for a quasi-judicial body, the Finance Commission. • It is constituted by the President of India every fifth year or at such earlier time as he considers necessary. • The recommendations made by the Finance Commission are only advisory in nature and hence, not binding on the government. • The 15th Finance commission makes recommendations for the period of 2020-2025 (5 years). How the devolution to the States is to be carried out? • The report has largely preserved the devolution mathematics of its predecessor, belying concerns of a sizeable cut in States’ share. • (Devolution - A process in which a central government of a country grants powers to sub-national governments). • The report has recommended a one percentage point reduction in the vertical split of the divisible pool of tax revenues accruing to States to 41%. • This follows the reorganisation of the erstwhile State of Jammu and Kashmir into the Union Territories of Jammu and Kashmir and Ladakh. • The former State’s notional share based on the parameters for horizontal devolution would have been about 0.85%. • But, the FC has cited the security and other special needs of the two territories to enhance their aggregate share to 1%, which would be met by the Centre. How the devolution to the local bodies is to be carried out? • Urban local bodies, especially municipalities in cities with populations of more than one million, are set to get a larger share of the devolution. • There has been an increase in the percentage of outcome-tied funds from 10% to 50% • This could prove vexing to the last mile providers of basic services in India’s federal and highly fragmented structure of governance. What is done to balance the financial needs? • As part of an effort to balance the principles of fiscal needs, the following have been changed, 1. Equity and performance, 2. The need to ensure stability and predictability in transfers, 3. The criteria for the horizontal sharing of taxes among States. What is the new added parameter? • The demographic performance is the new crucial parameter that has been added to the mix.

www.pragnyaias.com 7288081111

• The mandate to adopt the population data from the 2011 Census is the reason why the FC has incorporated this additional criterion. • This will ensure that the States which have done well on demographic management are not unfairly disadvantaged. • The norm has been assigned a 12.5% weight, as it indirectly evaluates performance on the human capital outcomes of education and health. • This should address the concerns voiced by several States over the switch to the 2011 Census from the 1971 data. What does the report say about the tax system? • Among the States, with the exception of Tamil Nadu, all the other four southern States see a reduction in the recommended share of taxes for the year 2020-21. • Notably, the suggested devolution to Odisha and Uttar Pradesh has also shrunk in percentage terms. • Crucially, the FC has flagged the issues dogging the GST as indirect taxes constitute almost half the total tax revenues of the Union. • The new tax has yet to stabilise which leaves a majority of the States dependent on compensation from the Centre. What was the criticism the report made? • The FC has also been justifiably critical of the Union and State governments’ tendency to finance spending through off-budget borrowings and via parastatals. • It has done well to ask that such extra-budgetary liabilities be clearly earmarked and eliminated in a time-bound manner. Source: The Hindu

MAINS-II: FINANCE COMMISSION Introduction President appoints this every five years or earlier if necessary. It a quasi judicial body under Article 280. Recommendations of the finance commission are not binding. Fourteenth finance commission under V. Y. Reddy submitted report on 2014 implementation time is 2015-2020.

Composition:

1. Commission has chairman and four members appointed by the president. Their term is decided by the president and they are eligible for re appointment.

Qualifications:

www.pragnyaias.com 7288081111

Constitution authorises parliament to decide qualification of members. Parliament specifies chairman to be a person of experience in public affairs. Other members should be selected from amongst following:

1. Judge of HC or one qualified to be appointed as one. 2. Person with specialised knowledge of finance and accounts. 3. Person with experience in financial matters and administration. 4. Person with specialised knowledge of economics. Functions:

1. Distribution of net proceeds of tax between centre and states and allocation of it between states. 2. Principles governing grants in aid to states from centre 3. Measures needed to augment consolidated fund of states to supplement resources of panchayats and municipality as recommended by State finance commissions. 4. Any other matter specified to it by president in interest of sound finance.

DISTRIBUTION OF FINANCIAL POWERS • NO system of federation can be successful unless both the Union and the States have at their disposal adequate financial resources to enable them to discharge their respective responsibilities under the Constitution. • Before entering into these elaborate provisions which set up a complicated arrangement for the distribution of the financial resources of the country, it has to be noted that the object of this complicated machinery is an equitable distribution of the financial resources between the two units of the federation, instead or dividing the resources into two watertight compartments, as under the usual federal system. • The Constitution makes a distinction between the legislative power to levy a tax and the power to appropriate the proceeds of a tax so levied. In India, the powers of a Legislature in these two respects are not identical. Distribution of legislative powers to levy taxes • The legislative power to make a law for imposing a tax is divided as between the Union and the States by means of specific Entries in the Union and State Legislative Lists • Thus, while the State Legislature has the power to levy an estate duty in respect of agricultural lands The power to levy an estate duty in respect of non-agricultural land belongs to Parliament [Entry 87 of List 1]. • Similarly, it is the State Legislature which is competent to levy a tax on agricultural income [Entry 46 of List IIJ. • While Parliament has the power to levy income-tax on all incomes other than agricultural • The residuary power as regards taxation (as in general legislation) belengs to Parliament and the Gift tax and Expenditure tax have been held to derive their authority from this residuary power. • There is no concurrent sphere in the matter of tax legislation.

www.pragnyaias.com 7288081111

• Before leaving this topic, it should be pointed out that though a State Legislature bas the power to levy any of the taxes enumerated in the State Legislative List, in the case of certain taxes, this power is subject to certain limitations imposed by the substantive provisions of the Constitution. History of Finance commissions • The First Finance Cornmtsslon was constituted in 1951, with Sri Neogy as the Chairman, and It submitted its report in 1953. Its recommendations were : 1. 55 per cent of the net proceeds of income-tax shall be assigned by the Union to the States and that it shall be distributed among the States In the shares prescribed by the Commission. 2. The Commisstion laid down the principles for guidance of the Government of India in the matter of making general grants-in-aid to States which require financial assistance and also recommended specific sums to be given to certain States such as West Bengal. Punjab, Assam, during the five years from 1952 to 1957. • A Second Finance Commission, with Sri Santhanam as the Chairman. A Third Finance Commission, with Sri AK. Chanda as its Chairman, was appointed. The Fourth Finance Commission with Dr. RAJAMANNAR, retired Chief Justice of the Madras High Court, as its Chairman, was constituted in May, 1964. • A , headed by Sri Mabavir Tyagi, was constituted in March. 1968. It submitted its final report in July 1969, and recommended that the States' share of Income-tax should be raised to 75 per cent and of Union Excise duties should be raised to 20 per cent. • The Sixth Finance Commission, beaded by Sri Brahmananda Reddy, submitted its Report in October, 1973. This Commission was, for the first time, required to go into the debt position of states. • The Eighth Finance Commission was set up in 1982, with ex-Minister, Shri Y.B. Chavan as its head. • The Eighth Finance Commission submitted its report in 1984. but its recommendations, granting moneys to the States, were not implemented by the Government of India, on the ground of financial difficulties and late receipt of the Commission's Report • Obviously, this placed some of the States in financial difficulty and the State of West Bengal raised vehement protest against this unforeseen situation. • Responsible authorities in West Bengal threatened litigation but eventually nothing was done presumably because the matter was non-justiciable. • Article 280(3) enjoins the Finance Commission to make 'recommendations' to the President and the only duty imposed on the President, by Art. 281, is to lay the recommendations of the Commission before each House of Parliament. • It is nowhere laid down in the Constitution that the recommendations of the Commission shall be binding upon the Government of India or that it would give rise to a legal right In favour of the beneficiary States to receive the moneys recommended to be offered to them by the Commission. • Of course. non-Implementation would cause grave dislocation in States which might have acted upon their anticipation founded on the Commission's Report. • The remedy for such dislocation or injustice lies only in the ballot box. www.pragnyaias.com 7288081111

Financial control of union over states during emergencies • (a) While a Proclamation of Emergency is in operation, the President may by order direct that, for a period not extending beyond the expiration of the financial year in which the Proclamation ceases to operate, all or any of the provisions relating to the division of the taxes between the Union and the States and grants-in-aid shall be suspended • In the result, if any such order is made by the President, the States will be left to their narrow resources from the revenues under the State list, without any augmentation by contributions from the Union. • (b) While a Proclamation of Financial Emergency is made by the President, it shall be competent for the Union to give directions to the States- • (i) to observe such canons of financial propriety and other safeguards as may be specified In the directions; • (ii) to reduce the salaries and allowances of all persons serving in connection with the affairs of the State. including High Court Judges; • (iii) to reserve for the consideration of the President all money and financial Bills, after they are passed by the Legislature of the State (Art. 360] Borrowing powers of union and states • The Union shall have unlimited power of borrowing, upon the security of the revenues of India either within India or outside. The Union Executive shall exercise the power subject only to such limits as may be fixed by Parliament from time to time • The borrowing power of a State is, however, subject to a number of constitutional limitations: • It cannot borrow outside Iodia. Under the Govt of India Act, 1935, the States had the power to borrow outside India with the consent of the Centre. But this power is totally denied to the States by the Constitution; the Union shall have the sole right to enter. into the international money market in the matter of borrowing. • The State Executive shall have the power to borrow, within the territory of India upon the security of the revenues of the State; subject to the following conditions: • Limitations as may be imposed by the State Legislature. • If the Union has guaranteed an outstanding loan of the State, no fresh loan can be raised by the State without consent of the Union Government • The Government of India may itself offer a loan to a State, under a law made by Parliament So long as such a loan or any part thereof remains outstanding, no fresh loan can be raised by the State without the consent of the Government of India. The Government of India may impose terms in giving Its consent as above.

www.pragnyaias.com 7288081111