Role of the Finance Commission in the Devolution of Financial Resources

The Finance Commission is a pivotal constitutional body in India responsible for ensuring a fair distribution of financial resources between the Union and state governments. Established under Article 280 of the Indian Constitution, the Commission’s primary role is to recommend the distribution of the net proceeds of taxes between the Union and the states and among the states themselves.

Key Responsibilities:

1. Tax Revenue Distribution: The Finance Commission recommends the formula for dividing the central tax revenue between the Union and the states. This includes considerations for equity, efficiency, and the fiscal capacity of states.
2. Grants-in-Aid: It suggests the distribution of grants-in-aid to states in need of assistance for maintaining fiscal stability and for specific purposes such as disaster relief, education, and health.
3. Fiscal Consolidation: The Commission advises on measures to ensure fiscal prudence and to reduce fiscal deficits both at the Union and state levels.

Recent Examples and Developments:

1. 15th Finance Commission (2020-2025):
   • Formula Revisions: The 15th Finance Commission recommended an increase in the share of states in the central tax pool from 32% to 41%. This shift aimed to provide more financial resources to states to address their fiscal needs.
   • Performance-Based Grants: The Commission introduced performance-based grants for states, linking the distribution of funds to improvements in specific sectors like health and education, incentivizing states to achieve better outcomes.
   • Disaster Relief: It allocated a substantial amount for disaster management and relief, reflecting the increased frequency and intensity of natural disasters, such as the 2020 floods in Assam and Kerala.
2. Impact of the COVID-19 Pandemic:
   • Fiscal Stress: The pandemic placed immense fiscal pressure on state governments due to increased expenditure on healthcare and reduced revenue from taxes and other sources. The Finance Commission’s recommendations for enhanced borrowing limits for states helped in mitigating some of the financial stress.
   • Special Grants: The Commission recommended additional grants to states hit hard by the pandemic to support their healthcare systems and economic recovery efforts.

Fairness and Adequacy of Transfers:

Equity Considerations:

• The Finance Commission aims to balance the distribution of resources among states considering their population, area, and fiscal needs. This helps address disparities among states of different sizes and fiscal capacities.
• The formula also includes factors such as demographic performance and fiscal discipline to promote equitable growth and reduce regional imbalances.

Challenges and Criticisms:

1. Revenue Shortfalls: Despite the increased share of central tax revenue, many states still face significant revenue shortfalls, impacting their ability to deliver essential services.
2. Dependence on Central Grants: There is a growing dependence on central grants for state budgets, which may limit states’ fiscal autonomy and their ability to tailor policies according to local needs.
3. Evolving Centre-State Relations: The evolving Centre-State fiscal relations, particularly in light of new initiatives like the Goods and Services Tax (GST), have shifted some financial responsibilities and powers. The integration of GST has led to disputes over compensation and revenue-sharing, highlighting tensions in fiscal federalism.

Conclusion: The Finance Commission plays a crucial role in the devolution of financial resources by recommending equitable tax revenue distribution and providing grants to states. While its recommendations generally promote fairness, the adequacy of transfers remains a contentious issue, particularly in light of evolving fiscal challenges and intergovernmental dynamics. Continued assessment and adjustments are necessary to ensure that fiscal transfers are both fair and sufficient to meet the diverse needs of the states in a rapidly changing economic landscape.