Q14. How is the Finance Commission of India constituted? What do you know about the terms of reference of the recently constituted Finance Commission? Discuss.

Model Answer:

Introduction

The Finance Commission (FC) of India is a constitutional body that plays a crucial role in determining the financial relationship between the central government and the states. It is constituted every five years under Article 280 of the Indian Constitution, and its recommendations shape the division of financial resources between the Union and the States.

Body

Constitution of the Finance Commission:

  1. Constitutional Provisions: The Finance Commission is constituted by the President of India under Article 280.
  2. Composition: The Commission consists of a chairman and four other members, appointed by the President. The chairman is usually a person with expertise in public finance or economics, while other members are experts in various fields such as finance, law, and administration.
  3. Tenure: The Finance Commission is constituted every five years, or earlier as the President deems necessary.
  4. Qualifications: The qualifications of the members are determined by the Parliament and typically include experience in public affairs, administration, finance, and economics.

Terms of Reference (ToR) of the Recently Constituted 15th Finance Commission: The 15th Finance Commission, chaired by N.K. Singh was constituted in 2017 and submitted its final report in 2020, covering the period 2021-2026. Some key aspects of its ToR include:

  • Vertical and Horizontal Devolution: The commission was asked to recommend the division of net tax proceeds between the Union and the States (vertical devolution) and among the states themselves (horizontal devolution) based on factors such as population, income distance, area, forest cover, and performance.
  • Impact of GST: The ToR included assessing the impact of Goods and Services Tax (GST) on revenue distribution, considering the shift to a uniform tax regime.
  • Debt and Fiscal Discipline: The commission was tasked with recommending measures to improve fiscal consolidation, particularly focusing on debt management and sustainable fiscal practices at the state level.
  • Defence and Internal Security: For the first time, the ToR asked the Commission to examine the funding requirements for defence and internal security, and whether specific allocations from the central pool should be earmarked for these sectors.
  • Population Factor: The ToR directed the Commission to use the 2011 Census data as the basis for population-related calculations, which led to debates among southern states that had successfully implemented family planning programs and saw this as a disadvantage.
  • Local Body Grants: It emphasised improving the financial health of local governments by recommending grants to Panchayats and urban local bodies, with a focus on strengthening governance at the grassroots level.

Challenges and Criticisms of the ToR:

  1. Population Debate: The use of the 2011 Census for determining the share of states caused friction, particularly with southern states, as it could reduce their share of resources despite better population control.
  2. Earmarking for Defence: The suggestion of separate allocations for defence spending raised concerns about reducing the overall pool of funds available for states.
  3. Fiscal Federalism Concerns: There were concerns that the ToR might centralise power, potentially undermining the autonomy of states.

Conclusion

The Finance Commission plays an indispensable role in maintaining the fiscal federalism of India. Its recommendations on revenue-sharing shape the financial landscape of the Union-State relationship. The 15th Finance Commission, with its expanded ToR, took significant steps to address contemporary fiscal challenges, such as the impact of GST, fiscal discipline, and defence needs. However, balancing equitable resource distribution, while addressing state-specific concerns, remains a critical challenge for any Finance Commission.

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