FINANCE

CHAPTER
FINANCE COMMISSION

FOR RBI GRADE B AND SEBI GRADE A

2019

1|P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

Contents
1 The need for a body like Finance Commission ..................................................................................................... 3
2 APPOINTMENT ...................................................................................................................................................... 4
3 COMPOSITION OF FINANCE COMMISSION .......................................................................................................... 4
4 ROLES & RESPONSIBILITIES ................................................................................................................................... 5
5 PROCEDURES & FUNCTIONING ............................................................................................................................ 5
6 FINANCE COMMISSIONS CONSTITUTED TILL DATE .............................................................................................. 6
7 14th Finance Commission ...................................................................................................................................... 7
7.1 Broad Parameters in recommendation: ....................................................................................................... 8
7.2 Vertical Distribution to States: ..................................................................................................................... 8
7.3 Tax devolution to be primary route of transfer: .......................................................................................... 9
7.4 Grants to States for Local Bodies:................................................................................................................. 9
7.5 Use of SDRF Funds: .....................................................................................................................................10
8 15th Finance Commission ....................................................................................................................................10
8.1 Composition of the Commission: ...............................................................................................................10
8.2 Operational Period of recommendations:..................................................................................................10
8.3 Terms of Reference (Operational Framework)...........................................................................................11

2|P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

The need for a body like Finance Commission
• Vertical and horizontal imbalances are common features of most federations and India is
no exception to this.
• The Constitution has assigned taxes with a nation-wide base to the Union to make the
country one common economic space unhindered by internal barriers to the extent possible.
• States being closer to people and more sensitive to the local needs have been assigned
functional responsibilities involving expenditure disproportionate to their assigned sources
of revenue resulting in vertical imbalances.
• Horizontal imbalances across States are on account of factors, which include historical
backgrounds, differential endowment of resources, and capacity to raise resources.
• Unlike in most other federations, differences in the developmental levels in Indian States are
very sharp.

In an explicit recognition of vertical and horizontal imbalances, the Indian Constitution embodies
the following enabling and mandatory provisions to address them through the transfer of
resources from the Centre to the States.

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.
(Effective from April 1, 1996, following the eightieth amendment to the Constitution replacing the
earlier provisions relating to mandatory sharing of income tax under Article 270 and permissive
sharing of Union excise duties under Article 272).

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).

In addition to provisions enabling transfer of resources from the Centre to the States, a
distinguishing feature of the Indian Constitution is that it provides for an institutional mechanism to
facilitate such transfers.

The institution assigned with such a task under Article 280 of the Constitution is the Finance
Commission.

3|P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

APPOINTMENT
Article 280 of the Indian Constitution reads:

President should, within two years of commencement of the Constitution and thereafter on expiry
of every 5th year, or at such intervals as he/ she thinks necessary, would constitute a Finance
Commission.

COMPOSITION OF FINANCE COMMISSION

• A Finance Commission would consist of a Chairman and 4 other members who are all will be
appointed by the President.
• As per the provisions contained in the Finance Commission [Miscellaneous Provisions] Act,
1951 and The Finance Commission (Salaries & Allowances) Rules, 1951, the Chairman of the
Commission is selected from among persons who have had experience in public affairs, and
the four other members are 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

4|P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

 (d) have special knowledge of economics.

ROLES & RESPONSIBILITIES

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

• 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.
• Determination of principles and quantum of grants-in-aid to States which are in need of such
assistance.
• 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 last function was added following the 73rd and 74th amendments to the Constitution in 1992
conferring statutory status to the Panchayats and Municipalities.

These Constitutionally mandated functions are the same for all the Finance Commissions and
mentioned as such in the terms of reference (ToR) of different Finance Commissions.

Finance Commission does not tell the Union Government on how to increase its funds. Its work is
to make recommendations on distribution between the Union and the States of the net proceeds of
taxes and 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 which are in need of assistance
by way of grants-in-aid of their revenues.
The role of the Finance Commission has widened after the 73rd and 74th Constitutional
amendments to recognise the rural and urban local bodies as the third tier of government.

Article 280 (3) (bb) and Article 280 (3) (c) of the Constitution mandate the Commission to
recommend measures to augment the Consolidated Fund of a State to supplement the resources of
Panchayats and Municipalities based on the recommendations of the respective State Finance
Commissions (SFCs). This also includes augmenting the resources of Panchayat and municipalities.

PROCEDURES & FUNCTIONING

• The Finance Commission is considered a quasi-judicial body because it has powers of the
civil court according to the Court of Civil Procedure.
• The Commission can summon and enforce the attendence of any witness. It can ask any
person to share information or produce a document, which it deems relevant for carrying
out its work.
• The Commission can ask for any public record or document from any court or office in the
country.

To enable the Finance Commission to discharge its responsibilities in an effective manner, the
Constitution vests the Finance Commission with power to determine its procedures.

5|P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

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

Since the commission has to be constituted at regular intervals, a certain measure of continuity in
the work of these commissions is ensured.

Each commission benefits by the work of previous commission.

Finance commission has to make recommendations to the President on two specific matters and on
any other mater referred to the commission by the president in the interest of Sound Finance.

The two specific matters are as follows:

1. How the net proceeds of taxes should be distributed between the Union and States?

2. On what principles, the grants-in-aid of the revenues of the State out of the Consolidated
Fund of India should be give to needy states?

The President, after considering the recommendations of the Finance Commission with regard to
income tax, prescribes by order the percentages and the manner of distribution. So, parliament is
not directly concerned with the assignment and distribution of the income tax.

Here it must be noted that, the recommendations made by the Finance Commission are merely
advisory in nature and therefore, not binding on the Government. This advisory nature of
recommendations was envisioned to keep the Fiscal Federalism in India balanced.

FINANCE COMMISSIONS CONSTITUTED TILL DATE

• The first finance commission was established in 1951.

The Constitutional requirement for setting up a Finance Commission in India was an original idea,
not borrowed from anywhere. That is why it is called the original contribution.

Important factual information w.r.t. 15 finance commissions which have been constituted till date is
as follows:

6|P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

14th Finance Commission
• The 14th Finance Commission was constituted in January 2013. Commission chairman was
former RBI governor Y V Reddy and its members were Sushma Nath, M. Govinda Rao, Abhijit
Sen and Sudipto Mundle. In December 2014, Commission had submitted its report to the
then President Pranab Mukherjee.

7|P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

1.1 Broad Parameters in recommendation:
In recommending horizontal distribution, the FFC has used broad parameters of population (1971)
and changes of population since, income distance, forest cover and area.

1.2 Vertical Distribution to States:

With regard to vertical distribution, FFC has recommended by majority decision that the the States’
share in the net proceeds of the Union tax revenues be 42%.

The recommendation of tax devolution at 42% is a huge jump from the 32% recommended by the
13th Finance Commission.

8|P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

The transfers to the States will see a quantum jump. This is the largest ever change in the
percentage of devolution.

The consequence of this much greater devolution to the States is that the fiscal space for the Centre
will reduce in the same proportion. A

s recorded in Chapter-8 of FFC’s Report, amongst other demands of the States, the States had
demanded both an increase in share of tax devolution, and a reduced role of CSS.

1.3 Tax devolution to be primary route of transfer:

FFC has taken the view that tax devolution should be primary route of transfer of resources to
States. It may be noted that in reckoning the requirements of the States, the FFC has ignored the
Plan and Non-Plan distinction; it sees the enhanced devolution of the divisible pool of taxes as a
“compositional shift in transfers from grants to tax devolution”.

Thus, basically the FFC Report expects the CSS, in fact Central assistance to State Plans as a whole,
to reduce and be replaced by greater devolution of taxes.

Keeping in mind the spirit of cooperative federalism that has underpinned the creation of National
Institution for Transforming India (NITI), the Government has accepted the recommendation of the
FFC to keep the States’ share of Union Tax proceeds (net) at 42%.

1.4 Grants to States for Local Bodies:

FFC has recommended distribution of grants to States for local bodies using 2011 population data
with weight of 90% and area with weight of 10%.

The grants to States will be divided into two, a grant to duly constituted Gram Panchayats and a
grant to duly constituted Municipal bodies, on the basis of rural and urban population.

FFC has recommended grants in two parts; a basic grant, and a performance grant, for duly
constituted Gram Panchayats and municipalities. The ratio of basic to performance grant is 90:10
with respect to Panchayats and 80:20 with respect to Municipalities.

9|P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

1.5 Use of SDRF Funds:
FFC has recommended that up to 10 percent of the funds available under the SDRF (State Disaster
Response Fund) can be used by a State for occurrences which State considers to be ‘disasters’
within its local context and which are not in the notified list of disasters of the Ministry of Home
Affairs.

Union government has accepted recommendations of the 14th Finance Commission (FC) as per its
agenda of cooperative federalism. The accepted recommendations are for the five-year period
2015-16 to 2019 20.

15th Finance Commission

• The Government of India, with the approval President of India, has constituted Fifteenth
Finance Commission in pursuance of clause (1) of article 280 of the Constitution, read with
the provisions of the Finance Commission (Miscellaneous Provisions) Act, 1951.

1.6 Composition of the Commission:

This Commission is headed by Shri. [Link], former Member of Parliament and former Secretary
to the Government of India. Shri Shaktikanta Das, former Secretary to the Government of India and
Dr. Anoop Singh, Adjunct Professor, Georgetown University shall be the members of the
Commission.

Dr. Ashok Lahiri, Chairman (Non-executive, part time), Bandhan Bank and Dr. Ramesh Chand,
Member, NITI Aayog shall be the Part time members of the Commission. Shri Arvind Mehta shall be
the Secretary to the Commission.

1.7 Operational Period of recommendations:

The new Finance Commission will cover five-year period commencing April 1, 2020.

The Finance Commission is required to give its report by 30th October, 2019. Its recommendations will
cover the five year period commencing from 1st April, 2020.

10 | P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

1.8 Terms of Reference (Operational Framework)
• As per Article 280 of the Constitution, the Commission is required to make
recommendations on the distribution of the net proceeds of taxes between the Centre and
the states.
• The Commission will also suggest the principles which should govern the grants in aid of the
revenues of the states out of the Consolidated Fund of India.
• It will also recommend a fiscal consolidation road map for sound fiscal management. This
time it will have to take into account the impact of the Goods and Services Tax, which kicked
in from July, on the resources of the central as well state governments. Further, the
commission will examine progress made in promoting ease of doing business by effecting
related policy and regulatory changes and promoting labour intensive growth.
• The Commission will make recommendations on distribution of net proceeds of taxes
between Centre and States, the principles which should govern grants-in-aid of revenues of
States out of Consolidated Fund of India. It will also suggest measures needed to augment
Consolidated Fund of State to supplement resources of Panchayats and Municipalities in
State on basis of recommendations made by Finance Commission of State.
• It will also review current status of finance, debt levels, cash balances, deficit and fiscal
discipline efforts of Centre and States and recommend fiscal consolidation roadmap for
sound fiscal management.
• While making its recommendations, it will look at resources of Central Government and State
Governments for five years commencing on 1st April 2020 on basis of levels tax and non-tax
revenues likely to be reached by 2024-25. Finance Commission’s changing roles, challenges
over the years:

Much has changed since the First Commission was set up in November 1951 under the
Chairmanship of K C Neogy, a former member of the Constituent Assembly and diwan of a princely
state. The President has appointed many more Commissions since then.

In the years following the reforms of the 1990s, Commissions have been headed by reputed
economists and administrators — from A M Khusro, who headed the Eleventh Finance Commission,
to Chakravarthi Rangarajan, Vijay Kelkar, and Y V Reddy, who were Chairmen of subsequent
Commissions. Senior politicians like K Brahmananda Reddy, Y B Chavan and N K P Salve had helmed
earlier Commissions; the last politician in this role was K C Pant, who then went on to be Deputy
Chairman of the Planning Commission.

With the years passing by, it was also alleged that Planning Commission, a non-constitutional body
has restricted Finance Commission's role to merely recommend grants to states on revenue
account only under article 275 of Indian constitution.

However, after the formation of NITI Aayog (National Institute of Transforming India), which seeks
to empower Finance Commission with the originally envisaged task of distribution of revenue to the
states, it will regain its prestigious status. The Planning Commission in its old structure and form has
been dismantled.

11 | P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241

What has also changed dramatically since the 1950s, when the First Commission presented its
recommendations on the transfer of resources between the Centre and the states, is the scale of
distribution of tax proceeds.

From 10% of the total tax receipts of the Centre in 1950, it has now risen to a record 42% after the
recommendations of the Fourteenth Finance Commission headed by Reddy — a share that makes
previous awards look conservative, and sits well with the spirit of cooperative federalism.

Along with these changes has been the widening of the terms of reference of the Commission —
the Thirteenth Commission was told to assess the impact of the proposed GST from April 1, 2010
and the need to improve the quality of public expenditure, to review the finances of both the Centre
and the states, to suggest measures to maintain a stable fiscal environment consistent with
equitable growth, and to suggest a revised roadmap to maintain the gains of fiscal consolidation
through 2015.

As the recently constituted Fifteenth Commission starts working on its agenda, the criteria for
distribution will be reviewed. The challenge this time will be the fact that unlike in the past, the
share of net tax proceeds between the central government and states is almost equal. After the last
Commission’s recommendation to distribute 42%, raising the bar on higher transfer of resources will
have a much bigger impact on the federal government. There has just been perhaps one case of a
dissent note being accepted in the recommendations of the Commission; in general, the boat has
not been rocked.

The Commission itself reckons that its biggest role has been to uphold the country’s federal
structure, and to be an architect of fiscal restructuring — from being mainly an arbitrator
between the Centre and states.

12 | P a g e W W W . E D U T A P . C O . I N QUERY? HELLO@[Link] / 8146207241