[Answered]What are the important functions of the Finance Commission? Discuss the terms of reference of the 15th finance commission and various apprehensions about it.

Demand of the question

Introduction. Contextual introduction.

Body. Functions of finance Commission. Key terms of references of 15th Finance Commission and various apprehensions.

Conclusion. Way forward.

Finance Commission is a statuary, independent, non-political body set up by President of India every five years (or earlier) under Article 280 of the Constitution. The Finance Commission of India came into existence in 1951. It was established to define the financial relations between the centre and the state.

Functions of the Finance Commission: Article 280 (3) speaks about the functions of the Finance Commission. The Article states that it shall be the duty of the Commission to make recommendations to the President as to:

  1. The net tax proceeds distribution to be divided between the Centre and the states, and the allocation of the same between states. 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.
  2. The principles governing the grants-in-aid to the states by the Centre out of the consolidated fund of India.
  3. The steps required to extend the consolidated fund of the 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.
  4. Any matter in the interest of sound finance may be referred to the Commission by the President.
  5. 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.

Key Terms of Reference (ToR) of 15th Finance Commission: The mandate of the Finance Commission is defined by its ToR:

  1. Review the current status of finance, deficit, debt levels, and cash balances and fiscal discipline efforts of the Union and the States.
  2. Recommending a fiscal consolidation roadmap for sound fiscal management.
  3. Take into account the responsibility of the Central Government and State Governments to adhere to appropriate levels of general and consolidated government debt and deficit levels.
  4. Foster higher inclusive growth in the country, guided by the principles of equity, efficiency and transparency.
  5. Examine whether revenue deficit grants be provided at all.
  6. Review the present arrangements on financing Disaster Management initiatives, with reference to the funds constituted under the Disaster Management Act, 2005 (53 of 2005), and make appropriate recommendations thereon.
  7. Other key issues for consideration by the commission are as under:
  • Impact on the fiscal situation of the Union Government of substantially enhanced tax devolution to States following recommendations of the 14th Finance Commission, coupled with the continuing imperative of the national development programme including New India-2022.
  • Impact of the GST, including payment of compensation for possible loss of revenues for 5 years, and abolition of a number of cesses.
  • Efforts and progress made in moving towards replacement rate of population growth.
  • Progress made in increasing tax/non-tax revenues, promoting savings by adoption of Direct Benefit Transfers and Public Finance Management System, promoting digital economy and removing layers between the government and the beneficiaries.
  • Progress made in sanitation, solid waste management and bringing in behavioural change to end open defecation.

Various apprehensions about the terms of reference of 15th FC:

  1. Revenue deficit grants are additional transfers made to states to fill the gap between the state’s revenue share and expenditure- Gap filling approach of fiscal transfer. These grants are given under Article 275(1). Critics argue that denial of revenue deficit grants conflict with the mandate of the finance commission.
  2. The gap filling approach has been widely criticised for the adverse incentives that it generates. Economists like C. Rangarajan argues that it’s better to discontinue the gap filling approach and recommend grants based on better principles.
  3. While the terms of reference for the 14th Finance Commission were to use the 1971 Census data for determining devolution of taxes, duties and grants-in-aid. The Central government asked the 15th Finance Commission’s ToR to use the 2011 data. This move would result in lower resource allocation to the southern States.

Way Forward: Economist C. Rangarajan suggests a Comprehensive equalisation approach through:

  1. Proper estimation of states fiscal capacities reflecting their tax base: both GST taxes and non-GST taxes to be considered.
  2. Proper assessment of expenditure needs of states is needed. Needs, cost and special needs must be incorporated.
  3. Efficient fiscal transfer to ensure equity among states, balanced regional development, stability and integrity in the federal structure and uphold cooperative federalism.
  4. FC has to ensure that the poorer states have adequate resources to promote socio-economic development, critical infrastructure, balanced regional development etc.

The FC allocation helps in providing economic and social services to the population. There is no denying that the rich states will have to help the poorer states but the developmental gap has not narrowed even after providing the assistance for decades. The reduction of funds going to states may not necessarily mean a bad thing as the central government is more important in terms of industrial growth, inter-generational concerns, environmental concerns etc. as in such cases the centre is suited better compared to the states to take care of the issues.

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