THE FINANCE COMMISSION

01 Jan THE FINANCE COMMISSION

UPSC MAINS SYLLABUS GS2 PAPER: Appointment to various Constitutional Posts, Powers, Functions and Responsibilities of various Constitutional Bodies

WHY IN NEWS? 

1. The government on Sunday appointed former NITI Aayog Vice-Chairman Arvind Panagariya as the Chairman of the 16th Finance Commission, which will recommend the tax revenue sharing formula between the Centre and States for the 5 year period beginning from April 2026.
2. October 2025 is the deadline set for the commission to submit its recommendations, so that they can be incorporated in the Budget exercise.

WHAT IS FINANCE COMMISSION? 

1. It is a constitutional body formed by the order of the President every 5 years or whenever he deems fit under Article 280 of the Indian Constitution to define the Centre-states financial relations.
2. The First Commission was established in 1951 headed by KC Neogy. 
3. As per the constitution, the Commission consists of a chairman and 4 other members.
4. Qualifications required for Chairman of Finance Commission: “Experience of Public affairs”.
5. Qualifications required for Members of Finance Commission:
   1. Are, or have been, or are qualified, as judges of a high court,
   2. Have knowledge of government finances or accounts, or
   3. Have had experience in administration and financial expertise; or
   4. Have special knowledge of economics

FUNCTIONS OF THE FINANCE COMMISSION: 

As a federal nation under 7th Schedule, India suffers from both vertical and horizontal fiscal imbalances:

1. Vertical imbalances between the central and state governments result from states incurring expenditures disproportionate to their sources of revenue, in the process of fulfilling their responsibilities.
2. Horizontal imbalances among state governments result from differing historical backgrounds or resource endowments and can widen over time.

Thus, under the Constitution, the main responsibilities of a Finance Commission are the following:

1. The distribution  between the Union and the States of the net proceeds of taxes which are to be divided between them and the allocation between the States of the respective shares of such proceeds.
2. Determination of principles and quantum of grants-in-aid to States which are in need of such assistance.
3. 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. The last function was added following the 73rd and 74th amendments to the Constitution in 1992 conferring statutory status to the Panchayats and Municipalities.

Constitutional provisions providing functions of the Finance Commission:

1. Levy of duties by the Centre but collected and retained by the States (Article 268)
2. Taxes and duties levied and collected by the Centre but assigned in whole to the States (Article 269).
3. Sharing of the proceeds of all Union taxes between the Centre and the States under Article 270.
4. Statutory grants-in-aid of the revenues of States (Article 275)
5. Grants for any public purpose (Article 282)
6. Loans for any public purpose (Article 293) 

The President shall cause every recommendation made by the Finance Commission under the provisions of this Constitution together with an explanatory memorandum as to the action taken thereon to be laid before each House of Parliament.

RECOMMENDATIONS OF THE 15TH FINANCE COMMISSION: 

15TH Finance Commission which was headed by NK Singh made following recommendations will cover a period of five years from the year 2021-22 to 2025-26: 

1. Vertical Devolution (Devolution of Taxes of the Union to States) to be kept at 41%:
   1. It is at the same level of 42% of the divisible pool as recommended by the 14th Finance Commission.
   2. It has made the required adjustment of about 1% due to the changed status of the erstwhile State of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir.
2. For Horizontal devolution, it has suggested:
   1. 45% to income gap between the states
   2. 15% each to population and area,
   3. 12.5% weightage to demographic performance
   4. 10% to forest and ecology
   5. 2.5% to tax and fiscal efforts
3. It has recommended post-devolution revenue deficit grants amounting to about Rs. 3 trillion over the five-year period ending FY26.

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PRELIMS 2024 PRACTISE QUESTIONS: 

Q1: Which of the following are associated with ‘Planning’ in India?

1. The Finance Commission
2. The National Development Council
3. The Union Ministry of Rural Development
4. The Union Ministry of Urban Development
5. The Parliament

Select the correct answer using the code given below:

A. 1, 2 and 5 only
B. 3 and 4 only
C. 2 and 5 only
D. 1, 2, 3, 4 and 5

ANSWER: C

Q2: Consider the following: (2023 Prelims Question):

1. Demographic performance
2. Forest and ecology
3. Governance reforms
4. Stable government
5. Tax and fiscal efforts

For the horizontal tax devolution, the Fifteenth Finance Commission used how many of the above as criteria other than population area and income distance?
(a) Only two
(b) Only three
(c) Only four
(d) All five

ANSWER: B 

Suyash Rai

I have appeared in Mains 2022 & 23 of UPSC CSE exam. I also guide students regarding their NEET & JEE preparations.
Working as Content developer at Plutus IAS since 2023.