The next Finance Commission will have a tough task

• Posted on June 15, 2023
• Editorials

The next Finance Commission will have a tough task

Context : 

In the next months, the government will appoint a Finance Commission to decide how much of the tax money from the Centre should be distributed to States (the vertical share) and how that should be done (the horizontal sharing formula).

Historical Background:

• The Finance Commission was founded by Dr B.R. Ambedkar in 1951 to address the budgetary inequalities between the federal government and the states.
• Several clauses in the Indian Constitution, including Articles 268, 269, 270, 275, 282, and 293, describe how the Union and states might share resources.

Composition of the Finance Commission:

• The Finance Commission is made up of one Chairman and four additional members. There are five people on the commission.
• The President of India appoints each member and sets their terms of service as well.
• The qualifications and selection processes for the Chairman and members are set by the Parliament.
  1. The Chairman needs to be knowledgeable about public affairs.
  2. The other members are chosen based on their credentials in administration, accounting, finance, and economics.

Grounds for Disqualifying a Member:

A member may be disqualified if they are mentally ill, have outstanding indebtedness, have been found guilty of a morally repugnant act, or if their financial interests interfere with the Commission’s ability to carry out its duties.

Functions of the Finance Commission:

• The Finance Commission’s duties include recommending how tax revenues should be split between the Union and the states as well as between the states themselves.
• It makes recommendations for the Consolidated Fund of India’s grants-in-aid to states and union territories.
• Based on recommendations from state finance commissioners, the Commission offers actions to increase state funding for the operation of panchayats and local governments.
• The Commission may review financial-related issues that the President refers to it and report its findings to the President.
• The report of the Commission and a memo outlining the steps taken in response to its recommendations are presented to both Houses of Parliament by the President.

Advisory Role of the Finance Commission:

• The President of India receives recommendations from the Finance Commission, which serves in an advising capacity.
• The recommendations of the Commission are up to the President to approve or reject, and it is up to the Union Government to carry them out.
• The Commission’s advice function is crucial for preserving fiscal federalism in India’s balance.

Significance of Finance Commission:

• The advisory role of the Finance Commission is significant because it assures a technical and rational approach to financial issues.
• According to Dr P.V. Rajamannar, the chairman of the Fourth Finance Commission, the government shouldn’t reject the recommendations of the commission unless there are compelling justifications.
• The Commission’s advisory function assists in maintaining budgetary parity between the Union and states, particularly when there are coalition governments in place.

Report from the 15th Finance Commission:

•  The 15th Finance Commission delivered its report for the years 2021–2022 to 2025–2026 in November 2020.
• The research made suggestions regarding tax devolution, local government grants, grants for emergency management, and state performance incentives.
• It also addressed the requirement for a different system to pay for internal and external security.
• The main report, annexes, difficulties facing the federal government, and state budgets were all covered in the four volumes of the study.

Points to Ponder:

• Appointment of Finance Commission: A Finance Commission will be appointed in India by the government to decide how tax money will be split between the federal government and the states.
• Importance of the Finance Commission: The Finance Commission’s importance Since the Planning Commission was eliminated in 2014, the Finance Commission has become essential to India’s fiscal federalism. Being the only architect of India’s fiscal federalism has considerably enhanced its duty and influence.
• Vertical Share and Horizontal Sharing Formula: The vertical share, or the portion of the tax pool that is distributed to the states as a percentage, will be determined by the Finance Commission. The horizontal sharing formula, which defines how the revenue is allocated among the states, will be the main topic of discussion.
• Horizontal distribution problems: In the past, Finance Commissions have had trouble balancing the distribution formula. Mathematically speaking, it is impossible to increase one state’s funding without decreasing another, which has prompted accusations of unfairness or inefficiency.
• Population Statistics: When the previous Finance Commission was asked to utilise the 2011 population data rather than the conventional 1971 figures to assess a state’s expenditure needs, there was debate. States that had effectively managed population increase objected to the shift because they felt it penalised them for doing so.
• Grants for Revenue Deficit: The Finance Commission provides grants for revenue deficit to states that continue to run deficits even after tax devolution. There are worries that this method would inadvertently encourage states to rely on federal payments rather than increase their resources.
• Deepening Fault Lines: Political, economic, and fiscal differences between states have widened recently. The north-south split widens because southern states are frequently thought to perform better than northern states in a variety of indices.
• Cesses and Surcharges: Rather than raising taxes, the central government is increasingly turning to the levying of cesses and surcharges. This enables the federal government to keep all extra revenue without distributing it to the states. To restrict the use of such taxes and set a limit on the amount that can be raised through them, the Finance Commission should develop rules.
• Limiting Freebies: The Finance Commission should concentrate on how much money the government spends on populist initiatives or “freebies.” Although safety nets for the impoverished are crucial, fiscal prudence must be practised. To guarantee long-term fiscal sustainability, guidelines should be offered.
• Prime Minister’s Role: The role of the prime minister is to demonstrate the value of sound governance over populist promises by acting on the recent statements made by the prime minister regarding the negative financial effects of excessive giveaways.
• Formalising methods: To encourage fiscal prudence and sustainability, the Finance Commission should formalise methods to address the problems of cesses and surcharges as well as spending on freebies.