top of page

Simplified: Everything about Finance Commission including Constitutional Provisions

Government has recently constituted Sixteenth Finance Commission. In this article, we will discuss each and everything about Finance Commission and related issues for the benefit of the students.


Please join our whats app channel (Fab Gyan) for regular updates on Economics, Personal Finance & GST.


Topics Covered in the Article


Details of Gazetted Notification including mandate of Sixteenth Finance Commission


Government of India has notified constitution of Sixteenth Finance Commission on 31st December, 2023 with Dr. Arvind Panagariya, former Vice-Chairman, NITI Aayog and Professor, Columbia University, as its Chairman. Further, this time, Government has kept the Terms of the Finance Commission very limited and general in nature i.e.


a. The distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them under Chapter I, Part XII of the Constitution and the allocation between the States of the respective shares of such proceeds;


b. The principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India and the sums to be paid to the States by way of grants-in-aid of their revenues under article 275 of the Constitution for the purposes other than those specified in the provisos to clause (1) of that article; and


c. 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.


The Commission may 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.


Provisions of Finance Commission as per Constitution (Article: 280 & 281) & Explanation thereof.


Key Points

  1. It is mandatory for President (i.e. Govt.) to appoint Finance Commission every Five Years. However, Government can appoint Finance Commission before five years also.

  2. Finance Commission shall consists of Chairman and four other members.

  3. Finance Commission will recommend apart from others, division of Net Tax Proceeds from Centre to States (vertical distribution) and allocation of same among states (Horizontal Distribution).

  4. Recommendation of Finance Commission does not cover distribution of Funds from Centre to UTs. (That's why on account of conversion of J&K into UT, vertical distribution was reduced from 42% to 41%).

  5. Recommendation of Finance Commission is not mandatory but recommendatory in nature for the Government.

Legal Text of the Constitution Article 280:

(1) The President shall, within two years from the commencement of this Constitution and thereafter at the expiration of every fifth year or at such earlier time as the President considers necessary, by order constitute a Finance Commission which shall consist of a Chairman and four other members to be appointed by the President.

(2) Parliament may by law determine the qualifications which shall be requisite for appointment as members of the Commission and the manner in which they shall be selected.

(3) It shall be the duty of the Commission to make recommendations to the President as to—

(a) the distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them under this Chapter and the allocation between the States of the respective shares of such proceeds;

(b) the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India;

(bb) the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats in the State on the basis of the recommendations made by the Finance Commission of the State;

(c) the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State;]

(d)] any other matter referred to the Commission by the President in the interests of sound finance.

(4) 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.


Article 281- Recommendations of the Finance Commission.—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.



Salient Features of The Finance Commission (Miscellaneous Provisions) Act, 1951


It deals with Qualification, Disqualification, Terms of Office, Conditions of Service of Chairperson & members of the Commission and Procedure & Power of the Commission.


Qualification of Members & Chairperson


The Chairman of the Commission shall be selected from among persons who have had experience in public affairs, and the four other members shall be selected from among persons who—

(a) are, or have been, or are qualified to be appointed as Judges of a High Court; or

(b) have special knowledge of the finances and accounts of Government; or

(c) have had wide experience in financial matters and in administration; or

(d) have special knowledge of economies.



In this section, we will discuss different types of Taxes as per Constitution for distribution between Centre and State:


1.Duties levied by the Union but collected and appropriated by the States (Article 268): This includes Stamp Duty as mentioned in Union List which will be levied by the Union Government but completely belongs to State. (100% to State in which such stamp duty is levied)


2. Taxes which are levied & Collected by the Union but Assigned to the States (Article 269):

This includes Taxes on the inter state sale or purchase of goods and taxes on the consignment of goods except GST on inter-state supply of Goods. (100% to States). In this case, since two or States may be involved in case of inter-state sale, distribution among States will be determined by Parliament by law not by Finance Commission.


3. GST on Inter-State Supply of Goods & Service (Article 269A): In GST, there are three kind of taxes being imposed i.e.


In case of Intra-State Supply (i..e with in State)

a. CGST : That belongs to Centre that will be apportioned between Centre and State as per Finance Commission.

b. SGST: That 100% belongs to State.

c. Compensation Cess (on some specific products): will be used to compensate the Loss to the States on migration to GST.


In Case of Inter-State Supply

a. IGST (CGST+SGST): SGST will belong to State. CGST Component will be apportioned between Centre and State as per Finance Commission.

b. Compensation Cess (on some specific products): will be used to compensate the Loss to the States on migration to GST.

4. Taxes levied and distributed between the Union and the States (Article 270)

All taxes and duties referred to in the Union List including Income Tax, Custom Duty, Excise Duty, GST (as explained above) etc. will be distributed among Centre & State except:

a. Surcharge & Cess levied by the Parliament for the use of Union on these taxes except Cess on GST which will be used to compensate State.

(Note: Now you can understand why States oppose Union in case of imposition of Surcharge and Cess)


Discussion about Grant-in-aid to States under Article-275


There are three kind of grants which have been prescribed in the Article 275. It may be noted that it needs to be provided by the Centre from its pool not from the total pool of resources.


Revenue Deficit Grant:


Such sums as Parliament may by law provide shall be charged on the Consolidated Fund of India in each year as grants-in-aid of the revenues of such States as Parliament may determine to be in need of assistance, and different sums may be fixed for different States. It is also known as Post Devolution Revenue Deficit (PDRD) Grant.


Until Law is made by Parliament this power will be exercised by the President. (i.e. Government of the Day).


The Fifteenth Finance Commission has recommended a total Post Devolution Revenue Deficit Grant of Rs. 86,201 crore to 14 States for the financial year 2022-23. are released to the States as per the recommendations of the successive Finance Commissions to meet the gap in Revenue Accounts of the States post devolution.


The Revenue Deficit Grant was decided by the Fifteenth Finance Commission based on the gap between assessment of revenue and expenditure of the State after taking into account the assessed devolution during this period. 


The States who have been recommended Post Devolution Revenue Deficit Grant by the Fifteenth Finance Commission  during 2022-23 are : Andhra Pradesh, Assam, Himachal Pradesh, Kerala, Manipur, Meghalaya, Mizoram, Nagaland, Punjab, Rajasthan, Sikkim, Tripura, Uttarakhand and West Bengal.


Grants to State for Schemes for STs & Scheduled Areas


There shall be paid out of the Consolidated Fund of India as grants-in-aid of the revenues of a State such capital and recurring sums as may be necessary to enable that State to meet the costs of such schemes of development as may be undertaken by the State with the approval of the Government of India for the purpose of promoting the welfare of the Scheduled Tribes in that State or raising the level of administration of the Scheduled Areas therein to that of the administration of the rest of the areas of that State


Grants to Assam

For development of Tribal areas, Autonomous State with in State of Assam as created under Article 244A.


Allocation Methodology of Fifteenth Finance Commission


The share of states in the central taxes for the 2021-26 period is recommended to be 41%, same as that for 2020-21.  This is less than the 42% share recommended by the 14th Finance Commission for 2015-20 period.  The adjustment of 1% is to provide for the newly formed union territories of Jammu and Kashmir, and Ladakh from the resources of the centre. 


This 41% is vertical devolution i..e from Centre to States. Now this 41% also needs to be distributed among States known as Horizontal Distribution.


Horizontal Distribution was recommended by the Fifteenth Finance Commission as follows:




Income distance: Income distance is the distance of a state’s income from the state with the highest income. Income of a state has been computed as average per capita GSDP during the three-year period between 2016-17 and 2018-19. A state with lower per capita income will have a higher share to maintain equity among states..


Demographic performance: The Terms of Reference of the Commission required it to use the population data of 2011 while making recommendations. Accordingly, the Commission used 2011 population data for its recommendations. The demographic performance criterion has been used to reward efforts made by states in controlling their population. States with a lower fertility ratio will be scored higher on this criterion.


Forest and ecology: This criterion has been arrived at by calculating the share of the dense forest of each state in the total dense forest of all the states.


Tax and fiscal efforts: This criterion has been used to reward states with higher tax collection efficiency. It is measured as the ratio of the average per capita own tax revenue and the average per capita state GDP during the three years between 2016-17 and 2018-19.


Please join our whats app channel (Fab Gyan) for regular updates on Economics, Personal Finance & GST.


Disclaimer: We have taken due care to the best of our knowledge while explaining the provisions surrounding the issue purely for informational/academic purpose. While due care has been taken by Fab Gyan in preparing this article, certain mistakes and omissions may creep in. The Fab Gyan or its Author does not accept any liability for any loss or damage of any kind arising out of any inaccurate or incomplete information in this document nor for any actions taken in reliance thereon.












Recent Posts

See All

Meaning of Tax Buoyancy

Meaning of Tax Buoyancy: Generally Tax collection will also increase in relation to increase in GDP of the country. However, it may not be in same proportion, so Tax Buoyancy is a parameter used to de

コメント


bottom of page