FINANCE COMMISSION (FC) -

 
 
1. Introduction -
 
 
1.1 The Member-Secretary XIIth Finance Commission, Dr. G.C.
Srivastava has conveyed to me vide his D.O. no. TFC/11019/3 dated August
11, 2003, that the Commission would like the following issues to be
examined (referred to, hereafter, as the Study) : -
 
“
i)                   Desirability of the present arrangement under which the
Commission is positioned in the Finance ministry and goes into
oblivion after submitting the report – whether any change in this
system based on Australian or other international experience will
be desirable;
  
ii)                 Adequacy of the existing arrangements for provision of
administrative infrastructure (including personnel) for making a
new Finance Commission fully operational without loss of time –
The best mechanism to ensure continuity in terms of infra-
structural support;
  
iii)               Adequacy of time-frame allowed to Finance Commission for
submission of their recommendations in the context of its
expanding terms of reference;
  
iv)               The system, of collection/ maintenance of data base during the
interregnum between Finance Commissions and its importance in
facilitating an effective start for the new Commission –
Mechanism to ensure continuity of data – Need to standardize the
formats for collection of information from Central Ministries and
States including computerization of such data;
  
v)                 The need for a neutral institutional arrangement for the evaluation
of the fiscal performance of the Centre as well as the States against
targets/norms prescribed by the Finance Commission and for
monitoring the implementation of the recommendations especially
those relating to matters other than devolution and grants-in-aid;
 
 
vi)               Adequacy of administrative and financial powers delegated to
Finance Commissions to enable independent functioning as a
Constitutional body in the context of the Central and State
Governments both being parties before the Commission. ”
 
1.2 As a background to the need for such an examination, it has been
mentioned that the Finance Commission has been assumed to be a
temporary body. This assumption has led to extra expenditure and serious
administrative problems. Each time a new Commission is appointed, all
administrative and infra-structural arrangements such as hiring of office
building, appointment of personnel, procurement of equipment etc., are
made afresh. The new Commission also spends considerable time collecting
preliminary data and information as there is no continuity in the collection
and analysis of data. There is no appropriate mechanism either for
monitoring implementation of ! the recommendations of the Finance
Commission, particularly those relating to issues other than the devolution
and grants- in- aid. The letter of Member-Secretary also points out that
earlier too some commissions had expressed their dismay regarding the
difficulties experienced in making a new Commission operational. The DO
of Shri Srivastava is enclosed as annexure - I.
 
1.3 Article 280 of the Constitution, under which a Finance Commission is
set up, lays down certain mandatory duties of the Commission. Article 280
(3) (a), (b), (bb), and (c), enjoin upon the President to seek from the Finance
Commission recommendations regarding distribution of taxes between the
Union and the States, and States inter-se ; principles which should govern
the grants-in-aid of the revenues of the States ; and measures needed to
augment the Consolidated Fund of a State to supplement the resources of
Local Bodies. In making these recommendations, the Finance commission
defines, delineates, and prescribes constitutional rights of the States and
Local Bodies. The Finance Commission’s Report may be only
‘recommendations’ but effectively, the recommendatio! ns stand for an
expert, non-partisan, determination of the financial rights of States and Local
Bodies, vis-à-vis the Union, and inter-se States. Weighed under such
responsibility, it seems only right that the Finance Commission should be
looking for answers to questions (raised in the Study proposal) which have a
decided bearing on it’s ability to discharge it’s Constitutional obligations.
 
1.4 Some of the earlier Finance Commissions, VIIth onward, had also
expressed their unease about the consequential effects of their temporary set
up. The Seventh Finance Commission had observed : “ The position which
prevails now is that once a Commission completes its work, a small and
ineffective cell comes into being in the Union Ministry of Finance (MOF),
and this cell is merged in the Secretariat of the next Commission. This
arrangement, in our view, is inadequate.”
 
1.5 The Finance Commissions that followed, like wise, seemed unhappy
with the contribution of Cell / Division (working in MOF) towards bridging
the gap between completion of one Commission’s work and starting of the
next. Successive Finance Commissions have also reiterated, in their
respective Reports, the difficulties faced by them as they began setting up
office and started working. Yet, in their respective recommendations, they
clung on to a belief that strengthened (as recommended) and more active
Finance Commission Division of the Ministry of Finance might still be able
to remove many of the difficulties and disadvantages, normally faced by a
newly constituted Finance Commission. But these expectations ! have been
belied again and again. So much so, that the XIIth Finance Commission has
now decided to look beyond the mechanism of Finance Commission
Division and explore alternative possibilities that might enable Finance
Commission to discharge its duties unencumbered by the disadvantages of a
temporary body. Some of the disadvantages, adversely affecting the work of
Finance Commission, have been pointed out in Dr. Srivastava’s above
mentioned letter. The objective set for this Study clearly seems to be to
explore how the working environment of Finance Commission can be
improved, keeping in view its responsibilities, and thereby also facilitate
better and more constructive regimen of inter-governmental financial
relations.
 
1.6 The XIIth Commission, set up by a Presidential order (vide Min. of
Finance notification dated,1st November, 2002) has , among its terms of
reference, a term, no.5, which reads as follows:
 
“ The Commission shall review the state of the finances of the
Union and the States and suggest a plan by which the governments,
collectively and severally, may bring about a restructuring of the public
finances restoring budgetary balance, achieving macro-economic stability
and debt reduction along with equitable growth”.
 
1.7 A plan for the restructuring of public finances would require building
up of substantial database over time. What is more, it requires addressing
some major issues which have a bearing not only on the measurement of
Fiscal Performance but also on the nature of Data required. For instance, at
present there is no agreement among different bodies on the definition of the
public debt at the State level. “ The definition used by the State governments
differs substantially from RBI which, in turn, differs considerably from the
concept used in the Discussion Paper on Subsidies,i.e.DPS(1997). The
Eleventh Finance Commissio! n (2000) uses none of these definitions but
has its own definition.” (source: ‘Measurement Issues in comparing Fiscal
Performance of States –Ravindra H. Dholakia’). But public Debt and Fiscal
Deficit are closely related and therefore any restructuring of public finances
should also address the issue of defining public debt. There are other such
issues also which would perhaps need to be studied to reach a more
informed assessment of the federal fiscal relations.
 
1.8 As a long term measure it might also become necessary to identify
and examine structural factors contributing systematically to the creation of
macroeconomic imbalances. For instance in the Planning Commission
transfers, calculation of State shares to finance their development plans
contributes to the emergence of structural fiscal imbalance. The grant-loan
formula has translated into increasing State indebtedness and so contributed
to macroeconomic imbalances.
 
1.9 This particular term of reference( No.5), therefore, does seem to
suggest that the Finance Commission should also examine data related
problems, monitoring, and course correction mechanisms to ensure the
success of it’s restructuring proposals. Continuous up dating of data base is a
pre-requisite of a monitoring system. In this context, therefore, the Study
initiated by the Commission ( reference -Dr. G.C.Srivastava’s D.O.) seems
very timely and significant.
 
1.10 The broad focus of examination would be as follows:
 
i)                   Can there be a permanent Finance Commission under the
existing Constitutional provisions ?
 
ii)                 International experience (specially Australian) – trends and
lessons – pointers to setting up of a permanent Finance
Commission.
 
iii)               If for some reason idea of a permanent Commission is not
considered at present, are then any additional administrative,
financial autonomy measures required to strengthen the existing
Finance Commission Division to empower and enable it to
collect every year standardised, consistent fiscal data both from
the Centre and States, analyse it, and monitor implementation of
the recommendations of the Finance Commission, specially those
relating to matters other than devolution and grants-in-aid.
Further, should this Division, and the Finance Commission too,!
be dealt with by some Ministry other than the Finance Ministry,
since the latter is one of the parties (representing the Union)
before the Commission ?
 
iv)               The need for a neutral institutional arrangement for the
evaluation of the fiscal performance of the Centre as well as the
states against targets/ norms prescribed by the Finance
Commission.
  
 
2 . Constitutional Position –
 
 
2.1 Article 280 of the Indian Constitution enjoins upon the President of
India to constitute a Finance Commission (FC) “ within two years from the
commencement of the Constitution and thereafter at the expiration of every
fifth year or at such earlier time as the President considers necessary ” . The
use of the words ‘thereafter’ and ‘at the expiration of every fifth year or
at such earlier time’ are prima facie suggestive of the periodic, and
therefore temporary, nature of the Finance Commissions. But does the
wording of the Article exclude altogether setting up of a permanent
Commission ?
 
2. Clearly, the use of expression ‘at the expiration of every fifth year’
can not be interpreted to suggest that five years must necessarily elapse
between the setting up of one Commission and another for, the President can
set it up even at an ‘earlier time’. Instead, ‘at the expiration of every fifth
year’ indicates a binding duty cast upon the President to constitute a
Finance Commission and seek its recommendations at least every five
years, if not earlier! That is because the Finance Commission, so constituted,
has certain mandatory functions to perform. Under, Section 3, sub-sections
(a), (! b), (bb), and (c) of Article 280, it is duty bound to make it’s expert
recommendations regarding the distribution of taxes between the Union and
the States and States inter-se; principles which should govern the grants-in-
aid of the revenues of the States; and measures needed to augment the
Consolidated Fund of a State to supplement the resources of Local Bodies.
In many other countries such matters are negotiated between the Union and
the States, and their determination is then made on the recommendations of
an expert Commission – which might be a permanent body, as for instance,
in Australia. Our Constitution, on the other hand, does not leave the division
of taxes between the Union and the States or, principles to be followed in
devolving grants-in –aid, or measures needed to augment the Consolidated
Fund of a State, as issues to be agreed upon through a political settlement
between the Union and the States. These are considered so crucial to the
building up of a healthy inter-gov! ernmental financial relationship that the
Constitution expressly provides for them and also requires the President
and the Parliament to settle them on the basis of the recommendations of an
apolitical, expert body ; Finance Commission .
 
2.3 Apart from its Constitutional status, the sanctity and importance of a
Finance Commission is greatly enhanced by the fact that its
recommendations form the fulcrum balancing inter-governmental financial
relations in our federation. It is precisely in aid of this purpose – developing
and maintaining healthy federal financial relationship – that the President
is empowered to set up a Finance Commission even earlier than at the
expiration of five years. Carrying this logic further, if the President forms a
view that the deman! ds of a balanced federal financial relations - rationale
for the existence of a Finance Commission - would be better served by
having a continuing body, can it not be so constituted under our
constitution?
 
2.4 In the IXth Finance Commission’s Report, a note of dissent was
appended by one of its members, Shri Justice A.S. Qureshi. Among other
issues, he also examined the constitutional validity of a permanent Finance
Commission. This is what he had to say “ At the outset, I must say that
Article280 of the Constitution of India under which a Finance Commission
is constituted is misunderstood and misconstrued right from the beginning.
In my opinion, Article 280(1) envisages a permanent Finance Commission
to be reconstituted every five years, unless for some reason, it ceases to exist
before the expiry of its full tenure of five years. This interpretation is in
consonance with the scheme of Chapter I of Part XII and other provisi! ons
of the Constitution of India.”
 
2.5 The Commission on Centre-State Relations, headed by a retired
Judge of the Supreme Court, Justice Sarkaria (after whose name that
Commission came to be generally known as Sarkaria Commission), also
examined the demand from some States for a permanent Finance
Commission. It did not specifically rule out the possibility of having a
permanent Commission. Instead, in Para 10.8.26 of it’s Report, it concluded
that “ there is no need for a permanent Finance Commission”. In reaching
this conclusion it gave two ‘pertinent’ considerations : “ Firstly, the Finance
Commission is essentially an expert recommendatory body and cannot be
expected to participate in active determi! nation of the transfers on annual
basis corresponding to changes in the economic situation. Indeed the very
scheduling of such exercises in an annual setting may be quite cumbersome
and reopen a whole host of issues for consideration every year. Secondly, a
measure of stability is desirable in the transfers and frequent changes may be
very unsettling and counter- productive, giving rise to avoidable friction in
Union-State financial relations. “
 
2.6 The Sarkaria Commisssion’s negation of States’ demand for a
permanent FC was perhaps also influenced by the trust it placed in the
efficacy of an alternate mechanism, i.e., a permanent Finance Commission
Division. It’s Report,Para 10.8.25, spells out clearly the expectations from a
permanent Finance Commission Division : “ During the interregnum
between one Finance Commission and the appointment of the next
Commission, the Finance Commission Division ( reinforced as suggested in
paragraph 10.8.30), should in cooperation with the States, organize
comprehensive studies in trends in growth of public expenditure in the
States in ! the light of the findings of the previous Finance Commission. It
shall also collect, study and analyse the data with reference to the relevant
parameters which would help a more critical appraisal of the achievements
and failings of the States in the fiscal sphere. The studies conducted by the
Finance Commission Division should be available well in time for the use of
the next Finance Commission. This Division can also, with the cooperation
of the Union Ministries and agencies under their control, arrange similar
review of the expenditure of the Union Government. Professional institutes,
organizations and Universities aided by the Union Government Funds, can
also be involved in such studies.”
 
2.7 Sarkaria Commission’s Report became available in 1988. Since
then, IXth, Xth, XIth have all expressed their discomfort and dissatisfaction
at having to spend much of their limited time only on collection and
updating of data and organizing studies. The present XIIth Commission also
does not seem to have gained from the exertions, if any, of the Finance
Commission Division. The terms of reference of this Study are in
themselves an eloquent testimony to the Finance Commission’s
disenchantment with the mechanism of permanent Finance Commission
Division, as a means of overcoming the disadvantages of constituting
Finance Commissions for a limited period .
 
2.8 Is this disenchantment with the working of Finance Commission’s
Division, including repeated complaints about it by earlier finance
commissions, merely a ruse to argue for a permanent Finance Commission?
What has been the actual experience so far ?
 
2.9 The Union Ministry of Finance reported to the Sarkaria
Commission that, in pursuance of the recommendations of Eighth Finance
Commission, it had created a Finance Commission Division with following
functions :

“ (i) Continuously update the data, both in financial and physical

terms relating to performance of Union and each of the State
Governments in fields which have been or could be of interest to the
work ordinarily assigned to the Finance Commission;
 
(ii)                  Compilation of data and analysis of the working of the State
undertakings including irrigation schemes to see whether the
prescribed norms are being achieved and to suggest remedial
measures;
 
(iii)                To prepare analytical studies on the basis of the data collected from
the State Governments regarding revenues, expenditure and prepare
comprehensive reviews;
 
(iv)                Rescheduling and consolidation of loans on the basis of the Finance
Commission’s recommendations;
 
(v)                  Allocation of additional grants to States for meeting interest
liability in respect of fresh loans advanced;
  
(vi)                Allocation of additional grants in respect of committed liability for
the new schemes taken up in 1984-85;
 
(vii)              To monitor and evaluate the utilization of the upgradation grants
provided by the Finance Commission to States;
 
(viii)            Collection of data about non-developmental sectors for preparation
of comprehensive proposals for achieving equalization of the
standards of administration and social services in States within a
definite period;
 
(ix)                Organisation of suitable training workshops for the benefit of States
which may be in need of such assistance.”
 

2.10 A query was raised with the Union Ministry of Finance to elicit
information about the work done so far by its Finance commission Division,
in discharge of its functional obligations
( Annexure II ). Their reply, vide Shri Swarup’s D.O. No. 11(4) FCD /2003
dated, 6th January, 2004 ( copy enclosed as Annexure III ), is as follows :
 
“ The Finance commission Division has been assigned the duties
detailed at Annexure “A”, which it is discharging fully.
The implementation of the Fiscal Reform Facility arising out of the
recommendations of the EFC has enabled the Finance Commission Division
to compile the financial data of the State Governments and also to analyse it
for designing and monitoring the programme of fiscal reform at the State
level. The debt data, however, is not compiled so far. The Division has also
not gone into compilation of the data and analysis of the working of the
State Undertakings. ….”.
 
2.11 To say the least, the reply is scanty and dismissive. No explanation
is forthcoming as to why the duties allocated to the Finance Commission
Division are vastly different from its predicated functions, as intimated by the
Ministry of Finance to the Sarkaria Commission. In the current work assigned
to the Finance Commission Division, emphasis is missing on two major
commitments made to the Sarkaria Commission:
 
 (1)    Continuously update the data, both in financial and physical
terms relating to performance of Union and each of the State
Governments in fields which have been or could be of
interest to the work ordinarily assigned to the Finance
Commission;
 
(2) To prepare analytical studies on the basis of the data
collected from the State Governments regarding revenues,
expenditure and prepare comprehensive reviews.
 
2.12 And as for implementation of recommendations of the Finance
Commission, there is no account available what–so-ever to assess whether
and what action was taken to implement which of the recommendations of
the Finance Commission ! And as for the Finance Commission Division’s
responsibility, “ to preserve the records of the previous Commissions & take
such necessary action to obtain further information as might be of use to
futureCommissions …. and preparation of material on State Finances for
the use of the Commission…”, it would be well worth recounting the
experiences of different Finance Commissions.
 
2.13 A review of the recommendations of Finance Commissions, that
followed MOF’s statement to the Sarkaria Commission regarding the
functions of its Finance commission Division’s, makes it amply clear that
the Division has not lived up to its promise. Immediately following the
Sarkaria report, the Ninth Finance Commission, in its second Report, had
this to say “ In the interregnum between two Finance Commissions, the
present Finance Commission Division should be entrusted with studies and
projects on different topics relevant to the work of the Finance Commission.
For this purpose, the Division should be substantially strengthened
(para10.7)”.
 
2.14 The Tenth Finance Commission too went on to recommend that ” a
full-fledged Division, appropriately staffed, and with adequate technical
expertise, be created at the earliest under a senior officer and made to
function within the Ministry of finance so that it can discharge the functions
assigned to it. State Governments may also be asked to designate officers
whose duty it would be to liaise with the Division to ensure continuity of
contact and updating of information (Para15.5)”.
 2.15 By the time Eleventh Finance Commission gave its report,
disenchantment with the working of Finance Commission Division of the
Ministry of Finance was more than apparent. Para12.10 of its report states “
Previous Finance Commissions have been recommending the creation of a
permanent secretariat for the Finance Commission to facilitate collection of
data and information. A Finance Commission Division is presently working
under the Department of Expenditure in the Ministry of Finance. Its sole job
is to monitor the expenditure and release of up gradation grants to the States.
It has not devoted itself to building a data base on Central/State finances or a
conduit for research in specified areas. …The work of the Commission is of
a highly technical n! ature and cannot be performed by normal secretariat
functionaries nor can it be done by research staff which does not have any
orientation in public finance.” It then went on to recommend that “ there is
a need to have a permanent secretariat with a core research staff placed
under an officer of the level of an Additional Secretary to the Government of
India. This would facilitate coordination with the Ministries/Departments of
the Government of India, as also with the state Governments at appropriate
level. This would also ensure an up-to-date building of data base on Central-
State finances, and documentation which could be used by the Commission
when it is constituted.”
 
2.16 It is obvious that inspite of successive Finance Commissions
repeatedly stressing, for more than a decade now, the importance and need
for constant up gradation of data and organising studies, relevant to the
working of future Commissions, not much seems to have been done by the
Finance commission Division of the Ministry of Finance. For whatever
reason the Division failed in complying with its mandate, it seems quite
reasonable to ask at this stage whether the Finance Commission itself should
not be turned into a permanent body, taking care on its own of all its data
and studies requirements.

2.17 Very broadly, the Finance Commission performs two kinds of

functions : -
 
(a)   Preparatory functions viz., collection /collation of data, it’s
analysis; discussions/studies leading to preparation of background
notes/papers etc., and,
 
(b)   Deliberative / Recommendatory functions.
 
2.18 The preparatory function – undertaken primarily by the Finance
Commission Secretariat, with the help of the Centre, States and outside
academic/professional bodies/persons - is very time consuming. It requires
constant updating of key data and building up of time series, Study /analysis
of issues material to the deliberation/ recommendations of the Finance
Commission.
 
2.19 The basic terms of reference of any Finance Commission are pre-
determined, as incorporated in Article 280, Cl.3, Sub-Clauses (a), (b),(bb),
and (c). Even among other matters, referred to Finance Commissions for
their recommendations, items like calamity relief, maintenance of capital
assets and monitoring of such expenditure, user charges and commercial
viability of projects, debt position and corrective measures, have become
more or less standard terms of reference. The broad scope of a Finance
Commission’s work is, therefore, known even when there is no Finance
Commission in existence.
 
2.20 It is therefore possible, nay, necessary to undertake the
preparatory work on a continuing basis. A permanent Commission would be
in an ideal position to initiate, organise, and keep a watch on the
requirements and progress of the preparatory work. Even if the two
‘pertinent’ considerations that prompted Sarkaria Commission to deny the
need for a permanent Finance Commission were still to be considered, the
nature and volume of preparatory work itself, in a fast changing politico-
economic environment, would perhaps justify the need for a permanent
Finance Commission.
 
2.21 For instance, the Constitutional amendments relating to Local
Self- Governments now necessitate that the Finance Commission should
take into consideration the Reports of various State Finance Commissions.
At present the State Finance commission Reports are given at different times
and in vastly different manner. The Finance Commission would perhaps
have to take a lead in bringing about some order in these various reports so
that, in keeping with its Constitutional obligation, it may be able to give due
consideration to them while determining the measures needed to augment
the Consolidated fund of a State to supplement the resources of Local Self
Governments. This in itself is a l! engthy time consuming process. What is
more, even if the permanent Finance Commission Division in the Ministry
of Finance had been very active, the Study and analysis of State Finance
Commissions’ Reports would be still the responsibility of the Finance
Commission.
 
2.22 Further, over the years, one party rule at the Federal and State
levels has increasingly yielded place to governments of many hues and
varying beliefs at the Union and the States’ levels. The Local Governments
too have their own points of views and demands. While the political views
of governments have no direct bearing on the Finance Commission’s
deliberations, the Commission’s work has nonetheless become more
exacting, arduous, and time consuming since it has to reconcile and resolve a
number of increasingly complex issues and demands that tend to put strain,
in the current environment, on the inter-governmental financial relations.
 
2.23 The economic scenario has also changed very considerably.
Competitive populism of governments (such as in the grant of needless
subsidies, placatory gifts/benefits to particular regions/sections of people
without any commensurate effort to raise resources, scattering thinly of
available funds on too many programmes without paying any heed to
prolonged delays in completion schedules and cost over runs, etc., ) has
brought us to a situation where both the Centre and the States are
experiencing mounting deficits on their revenue accounts along with
increases in overall fiscal deficits. Under! these circumstances, studying and
addressing issues of vertical and horizontal imbalances is qualitatively
different from the situation when the Centre and some States at least had
revenue surpluses.
 
2.24 Further complications are created by an uneven pace of financial
reforms being adopted and carried out by the Centre and different States, the
varying impact of opening up of economy on the revenue raising capacity of
different States, and the consequential added need for horizontal
equalization. There is a need to constantly keep under observation and
evaluate these developments. A permanent Finance Commission would be
such an ideal body .

2.25 The short point is that the preparatory work of the Commission has
now become very demanding. The XIth Finance commission was asked to ‘
review the state of finances of the Union and the States and suggest ways
and means by which the governments, collectively and severally, may bring
about a restructuring of the public finances so as to restore budgetary
balance and macro economic stability ’. The XIIth finance Commission too
is required to suggest a plan of restructuring for ‘achieving macro-economic
stability and debt reduction along with equitable growth ’. It has also been
asked to ‘ review the Fiscal Reform Facility introduced by the Central
Government on the basis of the recommendations of the Eleventh ! Finance
Commission, and suggest measures for effective achievement of its
objectives’. The XIIth Commission would have greatly benefited in its task
if, until such time it was set up, its predecessor had continued updating data,
monitoring the progress of implementation of its own recommendations, and
so organized evaluatory and other relevant Studies that their results would
have been straight away available to the present Commission.An unbroken
thread of direction and consistent effort seems definitely called for.
 
2.26 Within our Constitutional framework it seems certainly possible to
provide for the continuity of one Finance Commission, until it is time for
another Commission to be appointed. The Finance Commission demits its
office once its mandate is fulfilled. But Article280 (3) (d) is wide enough for
the President to refer to a Finance Commission to make recommendations
on ‘ any other matter …in the interest of sound finance’. Thus it opens the
way for a Finance commission to continue until just before a new
Commission is appointed, to submit a valedictory report on the follow up of
its recommendations. Such a Re! port would enormously help the new
Commission, besides putting pressure on the governments to enforce
implementation of the Finance Commission recommendations.
 
2.27 After the Commission’s Report is submitted there could still arise
matters requiring interpretation or even determination. For instance, under
the present dispensation, when new States are formed they have to wait a
long time for determination of their rightful share of revenues i.e., till the
next Finance Commission gives its recommendations! But if the
Commission were to continue working, even after submitting its report, it
could sort out such vexatious issues without waiting for the next
Commission to do so!
  
2.28 Alternatively, a straightforward Constitutional amendment could
be made to provide for a continuing Commission, on the analogy of similar
Commissions in some other countries.
 
 3. International Experience
 
 3.1 Transfer of financial resources from one level of government to
another takes place in every federation. That is because, specified in a
federal constitution there is often an inequity between Revenue and
Expenditure assignments at different levels of government. Maintaining
balanced intergovernmental relations, under these circumstances, requires
adjustments in the availability of financial resources through Vertical
transfers. Besides there are also inequities between States inter-se, as
manifested in their relative capacity to provide average standard of public
servic! es (assuming it does so at an average level of operational efficiency
and makes an average effort to raise revenue from its own sources). This
relative inequality is adjusted through the principle of Fiscal Equalisation.
 
3.2 The authority for these adjustments is quite often derived from
agreements arrived at, from time to time, politically between the Union and
the States; especially where the States or Provinces of the federation are
traditionally strong. In USA, inter -governmental finance is a grant from the
granting government and an expenditure of the receiving government.
Almost all transfers from the National to State and Local governments are
given in the form of specific grants; revenue sharing having been eliminated
a decade ago. In Canada, as both federal and provincial governments have
full access to all current major revenue sources, the traditional concept of
vertical fiscal transfer from the federal go! vernment - because it enjoys
major share of taxation powers - does not apply. However, Federal and
Provincial finance departments maintain a number of joint committees to
produce technical and policy options with respect to financial arrangements.
Canada also has a number of private, academic and social agencies which
are influential in developing technical and policy options in the area of inter-
governmental arrangements, including fiscal arrangements. In Australia,
negotiation between the Commonwealth and the states, conducted largely
through their treasuries, settles the content of the advice sought from the
Commonwealth Grants Commission on relativities for distributing among
the States and Territories (the States) the pool of general revenue assistance
made available by the Commonwealth. In some other countries also, like
Germany, China, Russia, the transfers are decided in accordance with the
parameters worked out from time to time, politically.
 
3.3 On the other hand, in some other countries viz., in India, Pakistan, Sri
Lanka, South Africa, the Constitution itself provides for revenue sharing and
grants. A machinery to recommend transfers, such as the Finance
commission in India, is also laid down in the Constitution itself to ensure
that transfers are not left to the mercy of bargaining power of the States and
the Local bodies. Besides the mandatory constitutional obligations of the
Finance Commissions, or such like bodies, they are also required to give
their recommendations on such other matters as may be referred to them.
Such references, though made by the federal ministry of Finance, could be
the product of consultation/ agreement between the Union and the
States/Local governments.
 
3.4 Thus, there is considerable variation between countries in respect of
both, the obligation to transfer resources from one level of the government
to another and, the constitution and status of the machinery which
recommends such transfers. But whatever the nature of a recommending
body –Constitutional, Statutory, or an outside agency – the common source
of their strength is grounded in their expertise, objectivity, and impartiality.
These lend weight to their recommendations. In addition, the work of these
recommendatory bodies is often also facilitated and fortified by the work of
supporting outside instituti! ons. But finally, it is the tradition or the sanctity
attached by the governments to the recommendations that largely paves the
way for their general acceptance and implementation.
 
3.5 In Canada, for instance, there is no Standing Commission to
recommend transfers from one level of government to another. Yet every
year the federal government does make large transfers to the provinces and
territories. The need for such transfers is argued for by the Provincial
governments and they even try to project and bolster their claim on the
recommendations of independent Commissions specially constituted to
identify and analyse the causes and impact of federal imbalance. The
province of Quebec set up such a Commission –The Commission of Fiscal
Imbalance – in May, 2001. Later, in May, 2002, Provincial and Territorial
Ministers of Finance asked Conference Board of Canada – an independent
non-profit applied research organization – to! Extend the Feb.2002 study
prepared for Commission on Fiscal Imbalance to cover all provinces/
territories.
 
3.6 The Department of Finance Canada itself has a Federal – Provincial
Relations Division. It focuses on the direction of fiscal federalism, federal-
provincial fiscal and financial relations, especially as they affect public
policy, division of roles and responsibilities and the affordability of national
social programmes. The Division coordinates meetings of federal and
provincial ministers of Finance and Treasuries and their deputies.
 
3.7 These efforts are supported and supplemented by a set of
intergovernmental institutions and arrangements. Statistics Canada, a federal
agency, provides accurate and unbiased demographic, economic and fiscal
data. This data is used to calculate transfer payment entitlements to the
provinces. There is also a federal-provincial Committee on Economic and
Fiscal Data which ensures that the framework for collecting and analyzing
data is applied on a consistent basis across Canada. It also projects economic
and fiscal results based on budgets and other information.
 
3.8 In Australia, on the other hand, there does exist a statutory
Commonwealth Grants Commission. It is a permanent body with a mandate
‘to make recommendations concerning the Granting of Financial Assistance
to the States and autonomous territories, the financing of works and services
in respect of the other Territories and the financing of works and services in
respect of indigenous persons. ’ The Commission was set up in 1933 to
assess claims made by States for financial assistance. However, the
Commission does not have powers to initiate and pursue inquiries on its own
authority.
 
3.9 The Commissions’ recommendations are solicited by the
Commonwealth Minister for Finance and Administration. But, the reference
content is usually decided in negotiations between the Commonwealth and
the States, conducted largely through their Treasuries. The resulting reports
are formally provided to the Commonwealth Government but are also made
available to the States immediately thereafter. The recommendations are
considered at the annual Treasurers’ Conference.

3.10 The Commonwealth commission consists of a Chairperson and not

less than two other members. The members (full time/ part time) hold office
for such period, being not less than one year or more than five years as may
be specified. They are also eligible for re-appointment. The Commission is
statutorily required to ‘inquire into and report to the Minister upon any
matters that the Minister refers to the Commission relating to matters
specified in Sec.18 of the Act of 1973 (generally speaking mandate of the
commission, referred to earlier). The only exception to the requirement of a
‘reference’ from the Minister is provided under Section 16 (a) of the Act of
1973. Here the ! Statute itself has stipulated that the Commission “ shall
inquire into and report to the Minister upon; (a) any application made by a
State for the grant, under section 96 of the Constitution, of special assistance
to the State;” .
 
3.11 There is however a later trend, as can be seen from the example of
Finance Commission of India and likewise bodies in Pakistan, Sri Lanka,
and South Africa, which clearly marks out certain specific areas of working
of these bodies, besides such others as may be referred to them. For instance,
in Pakistan, like India, the Constitution prescribes duty of the National
Finance Commission to make recommendations to the President as to “ (a)
the distribution between the Federation and the Provinces of the net
proceeds of the taxes in clause (3); (b) the making of grants-in –aid by the
Federal Government to the Provincial Governments; (c)the exercise by the
Federal Government and the Provincial Governments of the borrowing
powers conferred by the Constitution; and (d) any other matters relating to
finance referred to the Commission by the President “ The Commission is
also appointed, as in India, from time to time.
 
3.12 In Sri Lanka, the Finance Commission is a permanent body with
members holding office for a period of three years. The duty of the
Commission is specifically prescribed. It shall “ make recommendations to
the President as to – (a) the principles on which such funds are granted
annually by the Government for the use of Provinces, should be apportioned
between various Provinces; and, (b) any other matter referred to the
Commission by the President relating to Provincial finance.” The word
“such’ refers to an earlier stipulation that “ the Government shall, on the
recommendations of and in consultation with the Commission, allocate
from the Annual Budget,! such funds as are adequate for the purpose of
meeting the needs of the Provinces”. The Commission’s mandate is thus to
identify the need for annual transfers to Provinces and to recommend the
manner in which these should be apportioned between the Provinces. In
formulating its proposals for Provincial allocations, the Commission is
expressly required to aim at achieving balanced regional development. Thus,
in the specific functions entrusted to the Commission there is no ambiguity.
As regards reference of other matters to the Commission, the discretion rests
with the President. The President is required to lay before the Parliament
every recommendation of the Finance Commission along with a report on
the action taken there on. Since recommendations of the Finance
Commission have a bearing on and figure in the annual budgetary transfers
to the Provinces, they are more than likely to be scrutinized in depth by the
Parliament.
 
3.13 The recent Constitution of South Africa has perhaps the most
elaborate provisions for dealing with intergovernmental finance. Being a
product of multi-party Constitutional negotiations, the Constitution of
Republic of South Africa (promulgated in 1996 after elections in 1994)
contains a range of checks and balances considered necessary to promote,
inter- alia, healthy financial relations in the federation.
 
3.14 The Financial and Fiscal Commission (FFC) is a permanent expert
Commission established in terms of Article 220 of the Constitution and the
Financial and Fiscal Commission Act
(99 of 1997).
 
3.15 Section 2 of the Act, declares the Commission to be a ‘juristic
person, independent and subject only to the Constitution, this Act and the
law.” The functions enunciated in Section 3 are as follows:
“ (1) The Commission acts as consultative body for, and makes
recommendations and gives advice to, organs of state in the national,
provincial and local spheres of government on financial and fiscal matters.

(2) The Commission -

 
(a) must perform the functions mentioned in sub-section (1) to the
extent that its performance of these functions are envisaged in the
Constitution or required by national legislation; and

(b) may perform these functions -

 
(i)                on its own initiative;or
(ii)              on request of an organ of state. …..”
 
3.16 This section also requires the Commission to act impartially, and
enjoins upon all persons and organs of state to assist and not interfere in the
working of the Commission. The Commission’s recommendations are to be
submitted to both Houses of Parliament and the Provincial Legislatures and
also to the Minister their recommendations for each financial year.
 
3.17 The FFC is an advisory body but it draws sustenance and support
from certain other features of the South African legal system. The
Intergovernmental Fiscal Relations Act of 1997, for instance, seeks “ To
promote co-operation between the national, provincial and local spheres of
government on fiscal, budgetary and financial matters; to prescribe a process
for the determination of an equitable sharing and allocation of revenue raised
nationally; and to provide for matters in connection therewith”. The
Financial and Fiscal Commission has an important role to play in furthering
the objective of the Act.
 
3.18 This Act provides for a Budget Council in which the national and
provincial governments are represented and consult each other on any fiscal,
budgetary or financial matter affecting the provincial governments. The
Budget Council, presided over by the national Minister, must meet at least
twice every year. The Chairperson of the Financial and Fiscal Commission
or the designated representative may attend its meetings.
 
3.19 Similarly organized is the Local Government Budget Forum with
representations from national, state and local levels. This also is presided
over by the Federal Finance minister and must meet at least once a year.
Here too the FFC has a representation.
 
3.20 When the Minister presents the Annual Budget to the National
Assembly, a Division of Revenue Bill is introduced. Before this Bill is
introduced, the Minister must consult the Provincial and Local Governments
and the Commission. The Bill must be accompanied by a memorandum
explaining, among other things, the extent to which action was taken on the
recommendations of the Commission.
 
3.21 The above mentioned examples indicate a trend in favour of a
permanent Commission to study issues affecting intergovernmental finance.
The Commission’s advice and recommendations are sought through a
reference made by the Union Ministry of Finance. The main points of
reference are either agreed upon ab initio between the federating units and
included in Articles of the Constitution or language of a Statute or else
decided through consultation / parleys between the various levels of
government.
 
3.22 When reference issues are turned into Constitutional /Statutory
rights, it makes for neater, healthier inter-governmental relations, as it
reduces areas of discord. In the spirit of transparency and objectivity, some
of the independent, expert Commissions are statutorily required to make
their recommendations available not only to the Ministry of Finance from
which they receive the reference but also to the States/ Provinces. It seems a
welcome trend. This generates greater all round pressure to settle
contentious intergovernmental financial issues by accepting
recommendations of an independent expert Commission.
 
3.23 In Sri Lanka and in South Africa, recommendations of their respective
Finance Commissions are, moreover, taken into account in their respective
annual budgetary exercises. In India it was not thought of. Indirectly,
however, while rejecting the case for a permanent Finance commission, the
Sarkaria Commission did consider the question of annual recommendations
and opined that “the Finance Commission being essentially an expert
recommendatory body cannot be expected to participate in active
determination of the transfers on annual basis corresponding to changes in
the economic situation. “ Further, the scheduling of such exercises in an
annual setting was consider! ed ‘quite cumbersome’ and liable to ‘reopen a
whole host of issues for consideration every year’. What is more, Sarkaria
Commission felt, it would be’ very unsettling and counter- productive,
giving rise to avoidable friction in Union-State financial relations.’ But at
the time these apprehensions were expressed, examples of Sri Lanka and
South Africa were not available.
 
3.24 India of course has another institution, the Planning Commission,
which undertakes annual reviews of Central and State Plans and is
instrumental in transfer of resources by way of assistance for execution of
the Plans approved by the Planning Commission. These are labeled as ‘
discretionary’ transfers but are nevertheless a major source of meeting
development requirements of States. The presence of two institutions –
Finance Commission and Planning Commission- has given rise to the
present dichotomy between plan and non-plan transfers.
 
3.25 The Finance commissions have always asserted, as clinched by the
Fourth Finance commission, that ‘ The Constitution does not make any
distinction between plan and non-plan expenditure, and it is not
unconstitutional for the Finance Commission to go into the whole question
of the total revenue expenditure of the States. It has been pointed out to us
that the reference to Capital and recurring sums in the first proviso to Artcle
275(1) of the Constitution suggests that even capital expenditure need not
necessarily be outside the scope of the Finance Commission’. But
considering the purpose for which Planning commission was set up, Finance
Commissions have eschewed the task of dealing with the states’ new plan
expenditure. The Finance Commissions’ are perhaps! also prompted to adopt
this attitude because they are set up periodically, for short periods, and have
neither the time nor resources to deal with devolutions in all aspects.
 
3.26 Interestingly, as per para 4.2 of the Report of the XIth Finance
Commission, the Central Government themselves represented in their
memorandum before the Commission that
“ the Commission should not view the share of Central Taxes, and the grants
given under article 275 in isolation, but to calibrate these transfers taking
into account the overall resource transfers from the Centre to the States. The
memorandum says that unless such a holistic approach is adopted, it would
not be possible to bring about a restructuring of the public finances ……
We, in principle, agree with this view ”. The Commission also mentioned
that its own approach was outlined in Ch.II of its Report.

3.27 In Ch. II, Para 2.39 of its Report, the XIth Commission noted “ The
most serious flaw in the current system of federal transfers in India is the
flow of the Centre’s revenue to the States in segments, viz., devolution of a
fraction of the Centre’s divisible taxes and grants–in-aid of revenue of States
in need of assistance under Article 275 of the Constitution through the
Finance Commission(FC), transfers through the Planning Commission(PC)
in the form of assistance for State Plans, transfers to implement
Centrally Sponsored Schemes(CSS) under the Central Sector Plan, and other
discretionary transfers.” The XIth Finance Commission concluded, in para
2.63, of it’s Report “ The point that bears reiteration is that restructuring
towards fiscal balance is not possible unless the expenditure needs of the
Centre and the States are looked at in their totality and not segregated into
compartments like plan and non-plan.”

3.28 The Sarkaria Commission had also examined, inter-alia, the question
of enlarging functions of the Finance Commission so that it could ‘also
consider Plan and other transfers and/or undertake comprehensive
annual/periodical reviews of the financial performance of the Union and
State governments’ (Para 10. 8.07-a). It took a view (Para 10.8.17) that
‘ the present division of responsibilities between the two bodies, which has
come to be evolved with mutual understanding of their comparative
advantage in dealing with various matters in their respective spheres, should
continue. The present arrangements have also not given rise to any serious
problems to necessitate any change.’
 
3.29 The Sarkaria Commission took its cue from the observations of various
Finance Commissions themselves. The Finance Commissions, in turn, had
set out their position by taking their temporary tenure as axiomatic.
Consequently, even when they asserted that a holistic view needed to be
taken of the expenditure and that in the language of Article 275 ‘ there is
nothing to exclude from its purview grants for meeting revenue expenditure
on plan schemes, nor is there any explicit bar against grants for capital
purposes ’ , they nevertheless shied away from dealing with the Plan
expenditure. But the need for adopting a holistic approach in dealing with
expenditure began to assume urgency with the passing! of successive Plan
periods. As deficits were spurred on more and more by deficits on revenue
account, the Xth Commission noted that “the clubbing of the revenue and
capital components in one category termed the Plan outlay has generated a
tendency to use borrowings to finance revenue expenditure. It is imperative
to match the revenue resources separately with the revenue component of the
Plan. Failure to appreciate this basic requirement of discipline is one of the
main causes of the endemic fiscal disequilibrium”. As pointed out earlier,
the Central Government itself gave a memorandum to the XIth Commission
pleading that it “should not view the share of Central Taxes, and the grants
given under article 275 in isolation, but to calibrate these transfers taking
into account the overall resource transfers from the Centre to the States.”

3.30 The Eleventh Finance Commission recommended in Para 3.64 of its

Report “Another necessary reform in budgeting is to do away with the ‘plan’
and ‘non-plan’ in expenditure”. This followed the Union Finance Minister’s
observation in the budget speech for 1998-1999 : “ The distinction between
plan and non-plan expenditure in our budgetary system has created several
problems.” But this was said to seek “recommendations for a functionally
viable and more focussed presentation of government expenditure in the
budget. ” Can this logic be automatically extended to support the argument
for a combined body performing the functions of both the Finance
Commission and the Planning Commission, as some have de! manded ?
 
3.31 The relationship of Finance Commission – Planning Commission was
examined by the Sarkaria Commission. But the basis of Sarkaria’ rationale
for its recommendation was the hypothesis that Finance Commission was a
temporary body. If this hypothesis is jettisoned, Sarkaria Commission’s
recommendation on this issue may not remain strictly relevant. The Sarkaria
Commission, in Para10.8.16 of its Report, had stated ‘ …practical
difficulties would arise if Plan transfers are also entrusted to the Finance
Commission. The present division of labour which has developed over the
years is that the Finance Commission advises on the non-plan revenue
requirements and non-plan capital gap. In certain sectors, where the problem
is clea! r and the numbers are reasonably sure, the Finance Commission has
recommended capital resource devolution also only to a limited extent .’ The
rationale espoused was ‘Finance Commission is constituted periodically and
works for a short period. Planning is a dynamic process and as such
continuous appraisal and adjustments are essential. A static five-year frame
would not meet the requirements of planning’. Hence, the Sarkaria
Commission concluded “ We are of the view that the present division of
responsibilities between the two bodies, which has come to be evolved with
mutual understanding of their comparative advantage in dealing with various
matters in their respective spheres, should continue. The present
arrangements have also not given rise to any serious problems to necessitate
any change.”
 
3.32 But the Sarkaria Commission’s hypothesis about the temporary
nature of Finance Commission is now under question. There is also now a
changed climate so far as the planning process itself is concerned. The Xth
Finance Commission observed “ it is becoming quite clear that the planning
process will have to undergo a material change in the wake of the economic
reforms now underway. ... The greater market orientation of the economy
and the enhanced role for private and foreign investment will put additional
responsibility on the public sector to strengthen the economic and social
infrastructure and reinforce the legislative, legal and judicial processes
which make for good governance. … Since the bulk of such o! utlays are on
revenue account, we think it should be the responsibility of future Finance
Commissions to deal with them along with revenue receipts.”( Para 15.11) .
But this commission did not suggest merger of the two Commissions. It did
however recommend synchronisation of the Plan period with the Award
period of the Finance Commission.
 
3.33 In the XIth Commission, one of its members Shri N.C.Jain suggested
in a separate note that “ both the Finance and Planning Commissions be
merged into one Commission under Article 280 by making necessary
Constitutional amendments to have a full view of both plan and non-plan
sides of the economy.” However, the Commission itself did not support the
merger of Finance and Planning Commissions. In fact, it assumed, like other
Finance Commissions before it, that Finance Commissions would continue
to have a limited period of existence.
 
3.34 The Sarkaria Commission had also rejected the idea of a statutory
Planning Commission. In doing so ( Para 11.7.11 ) it also gave convincing
reason why functions of Finance and Planning Commissions should
continue to be viewed differently. The argument: “ Economic and social
planning does not merely depend on the professional advice of experts. It is
also a matter of political consideration and decision…It is the association of
the highest political executive, which is the motive force behind the planning
process.” A statutory Planning Commission would be “ stymied by legalism,
rigidities ,and technicalities”. Very obvious from these observations is also
the reason why the Finance Commission and the Planning Commission,
given their distinct mandate and approach, must continue to remain separate.
 
3.35 However, on the question of a permanent Finance Commission, it
needs to be pointed out that it does not necessarily result in annual
determination of financial transfers and so, any apprehension as expressed
by Sarkaria Commission that it would inject in the Union-State financial
relations a measure of instability, is not strictly valid. There is the example
of the Commonwealth Grants Commission in Australia, a permanent body
performing functions essentially similar to our own Finance Commission. It
has no fixity either of terms of reference or of the period over which its
recommendations must remain effective. In other words, it is not at all
necessary t! o keep the term of existence of a Commission coterminous with
the operative period of it’s reference and recommendations.
 
3.36 To make matters absolutely clear, it would be desirable to suitably
amend Article 280 of the Constitution and provide for a permanent Finance
Commission. It could be a core Commission with proviso to induct more
members once a reference is made inviting recommendations, as at present.
A draft is appended for consideration at Annexure IV.
 
3.37 Such an amendment would combine the advantages of existing
system with flexibility of action and depth of consideration permissible
under a permanent commission system. A permanent Commission would be
able to review fiscal performance, examine in impartial manner budgetary
practices, and take up other studies which would help guide and promote
healthy federal financial relations. Also, it may help Finance and Planning
Commissions to work in tandem.
  
 
4. Even if the idea of a permanent FC is not considered immediately,
 
 4.1 The oft-expressed grievances of a Constitutional body like the Finance
Commission must be given a very positive, earnest consideration by the
government. Several Finance Commissions have, for instance, lamented the
fact that initial task of setting up a fully going office takes considerable time,
especially since the Commissions do not enjoy full administrative and
financial autonomy in managing their own affairs. From the hiring of office
space, filling up posts in the Commission, to deciding even what studies to
undertake and how much is required to be spent on it, the Finance
Commission, headed by a Chairman of the rank of a Union Cabinet Minister
and operating under an officer of the rank of Secretary to the Government of
India, has to depend every inch of the way on the approval of the Finance
Ministry. To say the least, it is a very frustrating, time consuming process.
Further, lack of continuity of information from the past necessitates
rebuilding of the entire information structure from the very beginning. One
consequential effect is that the format in which the data is required also
keeps changing. The States too take their own time to gear up afresh their
machinery to interact with the Finance Commission, each time a new one is
set up. This in itself takes not only much time and effort but also deprives a
new Finance Commission of the benefit of work done by preceding
Commissions. Then again, there is usually no realistic estimation made of
the time needed by a newly set up Finance Commission to gather
information, interact with the States, the Centre, and ! other relevant parties
in order to give its recommendations. Quite often the task given to the
Commission, particularly its expanding terms of reference in recent years,
demands much more time than is originally allotted. The extension of time,
though usually given, still constrains the Commission in it’s initial planning
of time and work schedules. The constraint of time, experienced by Finance
Commissions, affects also the collection of data and offering of satisfactory
solutions.
 
4.2 Take for instance the VIth Finance Commission’ observation “ ..in
assessing sound fiscal management one should have regard both to the
manner in which the State has endeavoured to raise the resources needed for
meeting its commitments and also the manner in which it has deployed the
resources so raised as to get the best possible results for the expenditure
incurred. A review of fiscal management in this broad sense will call for a
comprehensive and critical survey of the fiscal policies and administration of
State Governments over a period of time. This is a task which is too difficult
to undertake within the limited time at our disposal.”
 
4.3 More recently, the XI th Finance Commission formulated a fiscal
behaviour rule that interest payments as a proportion of revenue receipts
should be confined to a level which permits the available receipts to meet the
requirements of expenditure. It required working out a macro-model
incorporating the relevant structural relations (taking into account the
elasticity of government revenues and expenditure to GDP growth and of
interest rates to deficit ). But the Commission could not do so “ Given our
limitations of data and time, it was not possible for us to set up such a model
” (para 3.20).
 
4.4        Once the Commission submits its Report, it demits office. Usually the
Commission secretariat continues for a few more days to complete the
winding up process and to hand over all assets and documents of the FC to
the Finance Commission Division of the Union Ministry of Finance(MOF).
From then on, till the Finance Commission is reconstituted, it is the Finance
Commission Division of MOF which acts as a custodian of the FC’s Report
and other papers.
 
4.5 The recommendations of the Finance Commission are usually accepted
by the Government, in so far as the devolution of resources is concerned, but
when it comes to its other recommendations and observations, the position
remains nebulous. “ Other recommendations will be considered in due
course” or words to that effect have been the constant refrain of the
Government in its intimation to the Parliament. The outcome of
Government’s consideration is rarely known.
 
4.6 In fact even when the ‘other recommendations’ are accepted, over time
they may not be properly implemented. For instance, the Government had
accepted Supplementary Report of the XIth Finance Commission that
disbursements from the Incentive Fund recommended by it and the
utilisation of the grants in the Main Report,“ will be subject to review by the
12th Finance Commission”. The recommendation regarding the Incentive
Fund was that 15% of the revenue deficit grants meant for 15 States was to
be initially withheld and pooled in the Incentive Fund but released
proportionately during 2000-05 based on the performance of a State in the
implementation of State-specific monitorable fiscal reform. The second part
of the Incentive! Fund comprised contribution of the Central Government,
equivalent to 15 percent of the revenue deficit grants recommended by the
Commission. The incentive component was recommended to be provided to
all the States, again on the basis of performance criterion drawn up by a
Monitoring Agency, to be constituted by the Government of India. As
mentioned earlier, the Government accepted this recommendation and to
 ensure its proper implementation also agreed to refer it to the 12th Finance
Commission for review. Yet it does not specifically form part of the terms
of reference of the 12th Finance Commission!
 
4.7 And as for the monitoring and evaluation of the implementation of
Finance Commission’s recommendations, the task was supposed to have
been carried out by the Finance Commission Division of the Min. of Finance
and results appraised, inter-alia, to the successor Finance Commission. This
has not worked. The disillusionment with the working and utility of the
Finance Commission Division, as experienced by successive Finance
Commissions, has already been brought out in sufficient detail.
 
4.8 Therefore, if the idea of a permanent Finance Commission does not
immediately find favour, for whatever reason, steps should certainly be
taken to create suitable conditions for effective working of any new Finance
Commission. At present a skeleton office usually comes into existence under
the charge of an Officer on Special Duty (OSD) even before the
Commission is formally set up. The OSD is appointed in the Ministry of
Finance. It falls to the lot of OSD to arrange for office space, make initial
selection of some staff, and generally to prepare for the Commission’s
installation. The real working starts only after Chairman of the Commission
takes office and the OSD is redesignated or replaced by a Member
Secretary/Secretary of the Commission. The regular s! taff of the
Commission is drawn from various sources, generally from within the
Government on a deputation basis. The selection of properly qualified
suitable staff becomes so much more difficult as there are few such takers
willing to join the Commission for a short period of time. And even those
who do join are often on the look out for greener pastures. In the IXth and
Xth Commissions even the Member Secretaries had to be replaced mid way
during the incumbency of the Commission. During the tenure of the Xth
Finance Commission the Economic Adviser deserted mid way and a quick
relief, fortunately a very able and dedicated substitute, had to be found. The
selection and positioning of suitable staff, therefore, naturally takes time.
Most of the staff comes for the first time to work for the Finance
Commission. The work procedures are evolved as part of the settling down
process of the Commission. Hence, orientation and familiarisation of staff
with the work requirements and output needs of the Commission consumes a
good part of its working life.
 
 
4.9 The Commissions have had little financial autonomy as all their
financial proposals have to be cleared by the Union Finance Ministry, which
acts as the nodal Ministry in the Government in respect of the Finance
Commission’s set up. This results in references, back references, and delays,
particularly as Finance Commission’s work has no priority for the Finance
Ministry; it being only a peripheral aspect of the Ministry’s working. The
effect of delays in the sanctioning of posts, entrustment of Studies, etc., is
adversely felt all the more since the Finance Commissions are at present
appointed only for a limited time.
 
 
4.10 Experience of the Twelfth Finance Commission itself brings this out
forcefully. Though the process to set up its administration started with an
Officer on Special Duty taking charge on 1.6.2002,and sanction for a total of
139 posts being given on 12.7.2002 ( i.e., before the Commission itself was
set up in November, 2002), the procedure for filling up posts was so
cumbersome that by 31.12.2002, only 19 officers/officials had joined the
Commission’s office. This, notwithstanding the fact that the sanctioned
posts had been advertised in early August,2002, and the Departments/
Ministries of the GOI were also requested to forward the applications of
suitable willing personnel. The intake of staff grew gradually but even till
31.3.2004, only 111 of the 141 sanctioned posts could be filled up. The
main difficulty encountered in finding suitable candidates for these posts
was the rigidity of Department of Personnel and Training (DOPT) norms.
There was little flexibility with the Commission for offering higher pay
scales/ incentives to many deserving candidates. This limited the range of
selection as many suitable candidates did not find appointment in the
Commission rewarding enough. On the other hand, elaborate procedures
such as interviews and skill tests had to be conducted for making recruitment
to various posts. This kept the Commission staff, at all levels, preoccupied
for long periods. Even so, many a times selected candidates were not
relieved by their parent Departments on the plea that they themselves were
facing shortage of manpower. Then again, many of those who did join the
Commission, later felt that they were better off in their parent department
and so represented that they be repatriated. As no substitutes were readily
available in most cases, the Commission had no option but to retain even the
unwilling workers. It’s impact on the Commission’s working can easily be
perceived.
 
 4.11 Apart from the delays and difficulties encountered by the Commission
in the recruitment of its staff, it had also to undergo like its predecessors
considerable hardship in finding accommodation and equipping it to become
operational. Initially, the Office of OSD started functioning from a small
rented portion of Lok Nayak Bhawan. It was subsequently decided to hire
two floors of Jawahar Vyapar Bhawan (STC Building) at Janpath, New
Delhi. A lease agreement to this effect was signed with STC on 27th
September, 2002 for an area measuring 16043 Sft. on the 16th and 19th
floors of the building @ Rs.140/- per Sft. per month. Monthly rent bill of the
Commission is Rs.22,46,020/-. Since STC provided only vacant space, the
Commission had to enter into another agreement with NBCC for furnishing
and interior decoration of the hired premises. A turn key contract with
NBCC was signed on 8th November, 2002 for an amount of Rs.2.22 Crore.
The contract required the agency to complete the work in all respects, within
three months from the date of signing of the contract. The agency failed to
keep up its commitment and the premises were finally handed over to the
Commission in the 1st week of June, 2003. An enormous amount of limited
time available for completion of the Commission’s work was thus lost to
finding a suitable accommodation!
 
 
4.12 Another major difficulty experienced by the Commission, working to
a tight time schedule, has been the lack of sufficient delegation in financial
matters. The Member- Secretary exercises powers only of the Head of a
Department. Now the Delegation of Financial Powers Rules, schedule V,
provide that Head of a Department is authorized to incur recurring
expenditure of Rs.25,000/- and non-recurring expenditure of Rs.60,000/-
p.a.. Sanctions issued by him are subject to the concurrence of FA (Finance).
The experience of the Commission suggests that the FA (Finance) takes
his/her own time in clearing these proposals. The need for frequent and
repeated references to the FA (Ministry of Finance) has proved to be a great
hindr! ance to the smooth functioning of the Commission. This has
indirectly contributed to the Commission invariably seeking extension of
tenure. To cite an example, the Commission decided to assign study on VAT
to NIPFP in June, 2003. When the file was sent to the FA (Finance) for
concurrence, they agreed to the proposal on the condition that the cost of
study be reduced by more than half of the cost approved by the
Commission. When this decision of the FA was conveyed to the NIPFP, the
institute expressed their inability to undertake the work, causing a lot of
inconvenience and embarrassment to the Commission, to say nothing of the
 delay in its work. Similarly, a body like the Finance Commission, which has
necessarily to rely on outside expertise to help it reach its recommendations,
is allowed a limited engagement of a maximum of 8 consultants. The choice
is further circumscribed by the DOPT’s general guidelines which are
required to be followed. Such restrictions tend to affect adversely the
working results of the Commission.
 
4. 13 these problems need to be taken care of even under the present system
of appointing Finance Commissions and certainly as and when the case for a
permanent Commission is considered or it is so appointed. The experiment
of a permanent Finance Commission Division under the Ministry of Finance
has failed. But until such time as the Finance Commission itself becomes a
permanent body, there would still be needed a permanent set up to act in the
interregnum between two Commissions as a repository of Finance
Commission’s work and assets and to follow up on its recommendations. A
permanent Commission Office needs to be set up. It would have to have a
semi-autonomous set up - dedicated solely to building up and constant
upgrading of relevant data and carrying out such independent Studies as
might be useful to a Finance Commission in the discharge of its mandate
(much of it constant, as per the provisions of the Constitution). To enable
this, it should work under an officer of the rank of an Additional Secretary to
the Government of India and be staffed by specially recruited core expert
staff. The office itself could be attached to either the Cabinet Secretariat or
preferably with the Inter-State Council. The Cabinet Secretariat has basically
a co-ordinating role vis-à-vis the Central government departments. The
Finance Commission’ work, on the other hand, embraces not only the Centre
but also the States. It would be more appropriate therefore to link it and its
permanent secretariat with the Inter-State Council, which has representation
of both the Centre and States and deals with their common issues. Under the
guidance of the Inter-State Council it should be authorised to
undertake/organise studies relevant to fiscal issues. It should have a
permanent office space with provision for accommodating expanded staff
strength when a new Commission is set up. Such an arrangement could
provide continuity to the work of a Finance Commission and keep in
readiness basic facilities like accommodation, staff and data to enable any
new Commission to become operational almost immediately.
 
4.14 Besides, when the Commission is finally set up it should have its
own Financial Adviser. After all the Member secretary or secretary of the
Commission is almost invariably of the rank and status of a Secretary of a
Department of the Government of India. The Chairmen of a Finance
Commission have enjoyed the status of a Cabinet Minister while other
Members also enjoy Ministerial status. Surely the Commission could be
trusted to supervise and work with an internal Financial Adviser as is usually
the practice with the Departments of Government of India. Since Finance
Commissions are at present appointed for a short period, it stands to reason
that they should have greater autonomy than normally available to a
government department so that within its limited tenure it may be able to
resolve its administrative, financial worries in time for it to be effective. The
Commission should have full powers to authorise and commission needed
‘Studies’ on such terms as may be approved by the full Commission. No
Financial Adviser or even some officer in the Ministry of Finance could be
expected to show greater understanding and prudence in sanctioning needed
Studies than a high powered composite body like the Finance Commission.
If the distribution of federal resources between the Centre and States and
States inter-se could be safely entrusted to this august body, surely its
discretion in selecting and awarding relevant ‘Studies’ or appointment of
suitable Consultants need not be subjected to the approval of a Financial
Adviser !
 
 
4.15 The States too would have to maintain a corresponding set up to
interact with the permanent set up of the Commission. The basic format in
which the information has been collected by the XIIth Finance Commission
may be continued to be used in the interregnum, leaving changes to be
introduced if and when a new Commission may so desire. This would allow
for consistent set of information to be developed and updated at all times
facilitating all contributors to make use of the data. Institutional
arrangements in this regard need to be built up, strengthened and kept on a
permanent footing.
 
4.16 It may be of interest to note here that in Canada, even though there
is no permanent Commission, there are several other institutional aids to
help decide Federal–Provincial Fiscal Relations, among other things. The
Ministry of Finance there has a Federal-Provincial Relations Branch (which
deals not only with financial relations but also with social policy issues and
their economic and fiscal implications). It has two divisions: Federal-
Provincial Relations Division and Social Policy Division. The Federal policy
Division administers major federal transfer programmes. It also focuses,
inter-alia, on the direction of fiscal federalism and federal-provincial fiscal
and financial relations. In addition to conducting in-depth research and
analysis and developing sound policy advice, the Division serves as a
liaison between the Department and its Provincial counterparts, and
coordinates meetings of the federal and provincial ministers of finance and
treasuries and their deputies.
 
4.17 The other intergovernmental institutions and arrangements include :
 
        Statistics Canada – a federal government agency but with a reputation
for providing accurate and unbiased demographic, economic and
fiscal data. The final sets of data, relating to fiscal arrangements, is
used to calculate transfer payments entitlements to the Provinces.
        Federal-Provincial Committee on Economic and Fiscal Data. This
Committee meets twice a year and plays an important role in ensuring
that the framework for collecting and analysing data is applied on a
consistent basis throughout Canada.
        Federal and Provincial finance departments maintain a number of
joint committees to produce technical and policy options with respect
to fiscal arrangement.
        There are also government funded agencies and non-governmental
agencies, with representation of academia based institutes, which play
an influential part in evolving technical and policy options.
 
 
4.18 What the Canadian experience underlines is the need for an effective
cooperation between the Federal and Provincial Governments in creating a
framework for collecting and analysing on a continuing basis consistent data
and evolving technical and policy options for bringing about balanced
inter-governmental fiscal relations. Utilising the services of independent
academic and professional institutions, to study and analyse complex fiscal
issues, is also an integral part of resolving intergovernmental financial
relations.
 
4.19 If one were to take the reply of our Union Ministry of Finance to the
Sarkaria Commission on its face value, its Finance Commission Division
should also have been doing all those things mentioned above in the context
of Canada. The reality has been far, far short of promise; almost to the point
of non-existence. If, therefore, any alternate arrangement is suggested to
ensure implementation of the intended and accepted functions of the
 Finance Commission Division, it should find ready acceptance. Ideally,
these functions should be the responsibility of a permanent core of the
Finance commission itself, as suggested earlier in Para 3.28. Until then, a
semi-autonomous strengthened permanent office of the Finance
Commission, under the aegis of the Inter-State Council, should be entrusted
to discharge these duties.
 
4.20 The Union Ministry of Finance, like the States, is one of the parties
before the Finance Commission. The policies pursued by the Union Ministry
of Finance as well as the Planning commission have a significant bearing on
the fiscal situation of the States. Since the Finance Commission deals with
inter-governmental financial relations, it should be serviced by the
secretariat of the Inter-State Council, which is supposed to look after all
matters connected with Centre-State relations. This should also facilitate
greater constructive cooperation between the Centre and the States in fin!
alising the terms of reference of a Finance Commission. The Inter-State
Council could also facilitate more active participation of States, working
along side with the Centre, in ensuring implementation of needed fiscal
discipline and carrying forward of the reforms suggested by the Finance
Commission.
 
 
5. The need for a neutral institutional arrangement for the for the
evaluation of performance
 
 
 5.1 As suggested earlier in para 3.36, a permanent Finance Commission
would be an ideal neutral, expert institution to carry out the evaluation of
fiscal performance of both the Centre and the States. The Commission
would also be the end beneficiary of the review as it would help mould its
next round of recommendations, whenever so called for by the President. It
is to be expected that even a permanent Commission would take the help of
academic, professional institutions to examine and explore time consuming,
complex issues requiring special expertise. The institutions, in turn, would
also benefit immensely in the discharge of their allotted task given the
umbrella support of an expert, independent, Constitutional body like the
finance Commission.
 
5.2 In the alternative, it might be necessary to search for a neutral, expert
body, with strong enough reputation to carry all round conviction of any
review undertaken by it of the fiscal performance of Centre and States.
Given the status and reach of the Reserve Bank of India, as also the expertise
available to it, it could well be entrusted with the job.
 
5.3 An institution like the RBI might just be able to garner the requisite
cooperation of both the Centre and the States. It also has the necessary
flexibility to co-opt outside experts as deemed necessary. In fact, while its
findings would help a Finance Commission in its allotted task, it would also
be in line and support of its own functions.
 

 6.          Summary:
 
 
6.1 The temporary set up of Finance Commissions has decided
disadvantages. Each time a Finance Commission is set up it requires
altogether fresh time consuming exercise of assembling/recruiting staff on
temporary basis, finding suitable accommodation, making it serviceable,
organising work methods and work schedules, activating some
corresponding arrangements at State levels, and racing to meet its deadline;
overcoming all administrative, financial roadblocks. What is worse, the
benefit of information collected, details and results of studies organised by
one Finance Commission are usually not available to its successor. The
Finance Commission Division of the Union Ministry Of Finance, which was
intended to tide over some of these problems, has not delivered the intended
benefits.
 
6.2 This necessitates rethinking on the tenure of the Finance Commission
– whether it can be a permanent body.
 
6.3 The inter and intra governmental fiscal relations in a fast changing
economic scenario requires the attention of an independent, permanent,
expert body like the Finance Commission. As the Finance Commission is by
our Constitution obliged to recommend to the President, at least at the
intervals of five years if not before, how the inter-governmental transfer of
financial resources should take place, it is desirable and necessary that it
should be a continuing Commission. The continuity is needed to ensure
constant and consistent up gradation of requisite data, monitoring of fiscal
performance of both, the Centre and States, studied exploration of available
options as course correcting mechanism, and generally to ensure that when
the President calls for its recommendations under Article 280 of the
Constitution, it is able to give off its best.
 
6.4 The recent international experience also seems to support the desirability
of having a permanent Commission to deal with inter governmental fiscal
relations. Our own Constitution does not preclude the possibility of
continuing with a Commission until such time as it is replaced by another.
However, considering the clear advantages of having a permanent Finance
Commission, the
Constitution should be suitably amended to unambiguously provide for it. A
draft is appended – Annexure IV.
 
6.5 Until such a decision is taken, it would still be necessary to plug the
weaknesses which hamstrung the work of any newly set up Finance
Commission. This can be achieved to some extent by creating a core
permanent office of the Finance Commission under the charge of an
Additional Secretary to the Government of India. This should have a semi-
autonomous existence under the Inter-State Council outfit. The Inter-State
Council Secretariat, under the Union ministry of Home Affairs, as it deals
with Centre - State relations. As it is not involved with the finances of either
the Centre or the States and yet acts as a federation bridge, it could
appropriately be entrusted with the administrative responsibility for dealing
with both, the Finance Commission and the Finance Commission core
permanent office. This Office needs to operate from a premise of its own,
capable of housing the Finance Commission as soon as it is set up. Since
much of the Finance Commission’s work is in the nature of preparatory
work viz., collection, up gradation of data, monitoring and evaluation of
implementation of norms/targets set by the earlier Commission, carrying out
of relevant Studies etc., the permanent office of the Finance Commission
should be suitably and adequately staffed. Retained on a permanent basis, it
should work as the core staff of the Commission when it is set up. The
Finance Commission, being a high powered body, should be vested with
sufficient administrative, financial autonomy to enable it to make its
recommendations in the prescribed reasonable time frame.

6.6 In the absence of a permanent Finance Commission the task of reviewing

the fiscal performance of both the Centre and the States should be entrusted
to the Reserve Bank of India.
 
6.7 If a proposal for amendment of the Constitution, recommending setting
up of a permanent Finance Commission is considered favourably, it is
reiterated that it would be ideal in many ways. Besides putting across the
need for reform up front, it would also ensure discussion of the issue in
public and in the Parliament.
 
 
 
7. STATES’ RESPONSE :
 
 7.1            On 22.12.’03, a reference was made to Finance secretaries / Principal
Finance secretaries of twelve States eliciting their views on the question of
giving permanent status to the Finance Commission( Annexure V ). A
reminder was given on 12.1.’04. On 15.1.’04, Member Secretary, Finance
Commission was requeste! d to extend the time for submission of the report
as response from the States was still awaited. Finance Commission was also
requested to expedite the States ( Annexure-VI ).
 
 7.2 There have been responses from the governments of Uttar Pradesh,
Jharkhand, Tamil Nadu, Orissa, West Bengal and Jammu and Kashmir .
All, excepting West Bengal, have been of the view that the Finance
Commission should be made a perman! ent body. A permanent Commission,
it is generally said, would be able to take care of many fiscal issues that
currently arise in the interregnum but are ignored or are not attended to by
the Union Ministry of Finance. A permanent Commission would also help in
building up of continuing stream of consistent data. Even if the present
constitutional provisions come in the way of setting up a permanent
Commission, there should certainly be appointed a permanent Finance
Commission Secretariat. There is also a general endorsement of the position
that the nodal ministry / department for dealing with the Finance
Commission matters should not be the Ministry of Finance. Instead, it
should be dealt with by the Cabinet secretariat or the Inter-State Council.
The States are also strongly of the view that they should be effectively
consulted in the drafting of the terms of reference of the Finance
Commission.