TOPIC

Finance Commission

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Contents
1 The need for a body like Finance Commission .....................................................................................................3
2 APPOINTMENT ....................................................................................................................................................4
3 COMPOSITION OF FINANCE COMMISSION ..........................................................................................................4
4 ROLES & RESPONSIBILITIES ..................................................................................................................................5
5 PROCEDURES & FUNCTIONING ............................................................................................................................5
6 FINANCE COMMISSIONS CONSTITUTED TILL DATE...............................................................................................6
7 14th Finance Commission .....................................................................................................................................7
7.1 Broad Parameters in recommendation: .......................................................................................................8
7.2 Vertical Distribution to States: .....................................................................................................................8
7.3 Tax devolution to be primary route of transfer: ...........................................................................................9
7.4 Grants to States for Local Bodies: ................................................................................................................9
7.5 Use of SDRF Funds: ................................................................................................................................... 10
8 15th Finance Commission .................................................................................................................................. 10
8.1 Composition of the commission:............................................................................................................... 10
8.2 Operational Period of recommendations: ................................................................................................. 11
8.3 Recommendations of the 15th Finance Commission ................................................................................. 11
Vertical Devolution........................................................................................................................................... 11
Horizontal Devolution ...................................................................................................................................... 11
Grants in Aid .................................................................................................................................................... 12
Empowering Local Bodies ................................................................................................................................. 13
Disaster Risk Management ............................................................................................................................... 13
8.4 Recommendation of 15th Finance Commission Report 2021-26 ................................................................. 14
8.4.1 Administrative/ Operational Changes................................................................................................ 14
8.4.2 Tax Policy Changes ............................................................................................................................ 14
8.4.3 Tax Policy Changes ............................................................................................................................ 15
8.4.4 Institutional and Tax Policy Changes.................................................................................................. 15
8.4.5 Towards Cooperative Federalism ...................................................................................................... 16
8.4.6 Empowering Local Government ........................................................................................................ 17
8.4.7 Disaster Risk Management ................................................................................................................ 19
8.4.8 Pandemic and Beyond: Building Resilience in Health Sector .............................................................. 19
8.4.9 Performance Based Incentives and Grants ........................................................................................ 20
8.4.10 Defence and Internal Security ........................................................................................................... 21
8.4.11 Fiscal Consolidation Roadmap ........................................................................................................... 22

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

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

1. Levy of duties by the Centre but collected and retained by the States (Article 268)

2. Taxes and duties levied and collected by the Centre but assigned in whole to the States (Article 269).

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

4. Statutory grants-in-aid of the revenues of States (Article 275)

5. Grants for any public purpose (Article 282).

6. Loans for any public purpose (Article 293).

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

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

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2 APPOINTMENT
Article 280 of the Indian Constitution reads:

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

3 COMPOSITION OF FINANCE COMMISSION

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

(a) are, or have been, or are qualified to be appointed as Judges of a High Court; or
(b) have special knowledge of the finances and accounts of Government; or
(c) have had wide experience in financial matters and in administration; or
(d) have special knowledge of economics.
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4 ROLES & RESPONSIBILITIES
Under the Constitution, the main responsibilities of a Finance Commission are the following:

• The distribution between the Union and the States of the net proceeds of taxes which are to be
divided between them and the allocation between the States of the respective shares of such
proceeds.
• Determination of principles and quantum of grants-in-aid to States which are in need of such
assistance.
• Measures needed to augment the Consolidated Fund of a State to supplement the resources of
the Panchayats and Municipalities in the State on the basis of the recommendations made by the
Finance Commission of the State.

The last function was added following the 73rd and 74th amendments to the Constitution in 1992
conferring statutory status to the Panchayats and Municipalities.

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

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

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

5 PROCEDURES & FUNCTIONING

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

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

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

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

Each commission benefits by the work of previous commission.

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

The two specific matters are as follows:

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

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

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

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

6 FINANCE COMMISSIONS CONSTITUTED TILL DATE

• The first finance commission was established in 1951.

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

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

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7 14th Finance Commission
• The 14th Finance Commission was constituted in January 2014. Commission chairman was
former RBI governor Y V Reddy and its members were Sushma Nath, M. Govinda Rao, Abhijit
Sen and Sudipto Mundle. In December 2014, Commission had submitted its report to the then
President Pranab Mukherjee.

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

7.2 Vertical Distribution to States:

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

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

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

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

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

7.3 Tax devolution to be primary route of transfer:

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

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

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

7.4 Grants to States for Local Bodies:

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

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

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

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

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

8 15th Finance Commission

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

The Fifteenth Finance Commission was constituted on 27 November 2017 against the backdrop of the
abolition of Planning Commission (as also of the distinction between Plan and non-Plan expenditure)
and the introduction of the goods and services tax (GST), which has fundamentally redefined federal
fiscal relations.

8.1 Composition of the commission:

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

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

However Ajay Narayan Jha was appointed replacing Shaktikanta Das who resigned from the commission
to serve as the governor of the Reserve Bank of India.

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8.2 Operational Period of recommendations:
The 15th Finance Commission (Chair: Mr N. K. Singh) was required to submit two reports. The first
report, consisting of recommendations for the financial year 2020-21, was tabled in Parliament on
February 1, 2020. The final report with recommendations for the 2021-26 period will be submitted by
October 30, 2020.

8.3 Recommendations of the 15th Finance Commission

The 15th Finance Commission proposed recommendations for both vertical and horizontal devolution.

Vertical Devolution

• 41% of the divisible pool to be devolved to the States in the year 2020-21.

• FC-XIV which had recommended 42%, had a view that tax devolution should be the primary route
of transfer of resources to States as they are a more objective form of transfer of resources as
compared to other forms. The XV-FC also agrees with this view but reduced the States’ share to
41% because of the re-organization of the State of Jammu & Kashmir into UTs of Ladakh and
Jammu & Kashmir through the Jammu & Kashmir Re-organization Act, 2019.

• UTs are the responsibilities of the Union and their demands have to be met from the Union
Government’s resources.

Horizontal Devolution

Horizontal devolution is done primarily to enable the States to provide basic public goods and services
with equivalent tax effort. The various criteria to be considered for horizontal devolution are classified
into three broad groups as follows.

• Need-based criteria: Population, area and forest & ecology form the need-based criteria. This is
needed to address the fiscal gap of States existing due to the structural mismatch between the
States’ resources and their expenditure liabilities.
• Equity-based criterion: Income distance forms the equity-based criterion to ensure fiscal
equalization given the large differences in the resource base available and status of development
within the country.
• Performance-based criteria: Demographic performance and tax effort are part of the
performance-based criteria that is framed to reward and incentivize States to perform better, in
terms of utilization of resources available to them.

Horizontal Devolution Criteria

14th FC 15th FC
Criteria
2015-20 2020-21
Income Distance 50.0 45.0
Population (1971) 17.5 -
Population (2011) 10.0 15.0
Area 15.0 15.0

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 Forest Cover 7.5 -
Forest and Ecology - 10.0
Demographic Performance - 12.5
Tax Effort - 2.5
Total 100 100

• Population: Only 2011 Census numbers are used as per the ToR. Population criterion is assigned
a weight of only 15 per cent as some of the other criteria will also be scaled by it.
• Area: A moderate weight of 15 per cent for the area criterion is assigned larger area incurs some
additional administrative costs but it may not lead to a proportional increase in the cost of
providing services.
• Forest and Ecology: This criterion is for the ecological services being provided by a State’s forest
cover to the country as a whole and is arrived at by calculating the share of the dense forest of
each State in the aggregate dense forest of all the States. A weight of 10 per cent is assigned for
the forest and ecology criterion.
• Income Distance: Distance of per capita income is the criteria used to make the devolution
formula more equalizing and progressive, and provides higher devolution to States with lower per
capita income and lower own tax capacity. The XV-FC retained the income distance criterion with
a weight of 45 per cent.
• Demographic Performance: An abrupt change from 1971 Census data to 2011 Census data should
not unfairly penalize some States which have performed well on population control. Hence, the
commission recommended introducing a new performance-based criterion to reward States who
have performed well on the demography front. This criterion of demographic performance is
computed by using the reciprocal of TFR of each State, scaled by the population data of Census
1971. States which have achieved lower TFR will be scored higher and vice versa. This criterion is
assigned a weight of 12.5 per cent.
• Tax Effort: The inclusion of tax effort as a performance-based criterion will reward the States with
higher tax collection efficiency and encourage all States to be more tax efficient. It is computed by
taking the ratio of the average of per capita own tax revenue of a State over three years and its
per capita GSDP and scaling this ratio by the population of the State. Total weight of 2.5 per cent
has been assigned to this criterion.

Uttar Pradesh and Bihar have received the largest devolutions for 2020-21 while Karnataka and Kerala
saw the largest decreases in the share of the divisible pool.

Grants in Aid
Revenue Deficit Grants: 14 states are estimated to face a revenue deficit post-devolution. The
Commission has recommended revenue deficit grants worth Rs 74,341 crore to these 14
states. Furthermore, the three states of Karnataka, Mizoram, and Telangana received special grants to
make up the shortfall between untied transfers received by these States in the form of tax devolution
plus revenue deficit grant in 2020-21 vis-a-vis the corresponding amount in 2019-20.

Sectoral Grants: The XV-FC is considering recommending sectoral grants for nutrition, health, pre-
primary education, judiciary, rural connectivity, railways, statistics and police training, and housing
during its tenure. Of these, grants for nutrition, to augment the efforts of the States towards reducing
and ultimately eliminating malnutrition, is specifically recommended even in 2020-21.

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Performance-based Incentives: Six broad areas are identified to provide performance-based incentives
to States.

• Implementation of Agriculture Reforms

• Development of Aspirational Districts and Aspirational Blocks
• Power Sector Reforms
• Enhancing Trade including Exports
• Incentives for Education
• Promotion of Domestic and International Tourism

Empowering Local Bodies

Some significant changes made by XV-FC compared to previous Finance Commissions:

• To recommend grants to all tiers of the Panchayati Raj to enable pooling of resources to create
durable community assets and improve their functional viability.
• To give grants to the Fifth and Sixth Schedule areas and Cantonment Boards.
• To provide for tied grants in the critical sectors of sanitation and drinking water to ensure
additional funds to the local bodies over and above the funds allocated for these purposes under
the centrally sponsored schemes (CSS), Swachh Bharat and Jal Jeevan Missions.
• To account for increasing urbanization the share of urban local bodies in Finance Commission
grants to local bodies should be gradually increased to 40 per cent over the medium term.
• Since larger cities will tend to grow faster with the agglomeration effect, the fifty Million-Plus cities
in the country need differentiated treatment, with special emphasis on meeting the challenges of
bad ambient air quality, groundwater depletion and sanitation.

Grants to Local Bodies:

• The Commission has recommended a total of Rs 90,000 crore for grants to the local bodies in
2020-21.
• This amounts to 4.31% of the divisible pool.
• These grants will be made available to all three tiers of Panchayat- village, block, and district.
• The inter-se distribution of grants for local bodies among the States may be based on population
and area in the ratio of 90:10.
• For 2020-21, the proportion of grants between rural and urban local bodies recommended by the
XV-FC is in the ratio of 67.5:32.5.
• For all urban bodies, the distribution of grants for 2020-21 is based on population.

Disaster Risk Management

• To promote local-level mitigation activities, mitigation funds shall be set up at both national and
state levels in the form of NDMF and State Disaster Mitigation Funds (SDMF), following
the Disaster Management Act.
• The Commission recommended the creation of funds for disaster mitigation along with disaster
response, which will now together be called as National Disaster Risk Management Fund (NDRMF)
and State Disaster Risk Management Funds (SDRMF).

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 • Recommended grants for the State Disaster Risk Management Fund is Rs 28,983 crore. Out of this,
the share of SDRF shall be 80 per cent and the share of SDMF 20 per cent. The allocation for the
National Disaster Risk Management Fund is Rs 12,390 crore.
• Allocations for NDRF / SDRF will be further sub-divided into
o Response and Relief – 40 per cent
o Recovery and Reconstruction – 30 per cent
o Capacity Building – 10 per cent

8.4 Recommendation of 15th Finance Commission Report 2021-26

We will cover the major recommendations of the 15th Finance Commission Report for 2021-26 under
various subhead as highlighted below:

8.4.1 Administrative/ Operational Changes

• The IT platform of GST needs to be rectified.
• Strict compliance ensured with the timelines of filing GST returns, which should lead to seamless
invoice-matching and identification of frauds.
• Tax authorities need to overcome technical impediments and operationalise the tax information
system efficiently.
• States will need to step up field efforts for expanding the GST base and for ensuring compliance,
commensurate with their field strength and infrastructure for VAT and GST collection.
• To reduce excessive dependence on income tax on salaried incomes, it is important to
expeditiously expand coverage of provisions relating to TDS and TCS to more transactions and
incomes, which will leave behind an audit trail that acts as a deterrent to tax evasion.

8.4.2 Tax Policy Changes

• The inverted duty structure between intermediate inputs and final outputs present in the GST
for many items should be resolved by streamlining its multiple rate structure.
Inverted Duty Structure
Meaning:
An inverted duty structure comes up in a situation where import duties on input goods are higher
than on finished goods. In other words, the GST rate paid on purchases is more than the GST rate
payable on sales.

What Problem it Causes?

• Taxpayers who face an inverted duty structure will always have Input Tax Credit (ITC) in their GST
electronic credit ledger even after paying off the output tax liability.
• This creates working capital issues for the taxpayers, as crucial resources remain blocked in the
form of ITC.
• While the GST law provides the option to claim the unutilized ITC as a refund, there are other
complications.
• From the government's standpoint, because of the current anomaly, many administrative-level
issues have cropped up.
A complicated refund process under GST creates additional compliance requirements and finally leads
to more cost of compliance.

How feasible is the inverted duty structure in the context of trade policy?
• Experts broadly agree that the structure currently raises the cost of procuring input goods,
which makes manufacturing more expensive, and higher costs ultimately makes businesses less
competitive in the cutthroat world of global export orders.
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 • Industry bodies like the Confederation of Indian Industry (CII) have pointed out that to maintain
the razor thin profit margins as well as consistently secure global buyers, businesses need a
regime where lower or minimal duties on intermediates and raw materials is a must.
• Higher duties on finished goods would counterbalance this and stop the market being flooded
with foreign-manufactured items, as has been the case in India in most sectors.
• The current system also incentivizes the export of raw materials and not value-added products.

8.4.3 Tax Policy Changes

• The myriad exemptions under different direct tax laws that breeds tax evasion, especially by the
richer groups, will need to be reduced.
• The threshold limits may be kept a the current level for some time to build stability in the tax
regime and to ensure greater predictability and better tax planning for the taxpayer.
• The Union Government may initiate action for a Constitutional amendment to effect a change
that enables periodic revision of the limits of professions tax upon the recommendations of the
President of India, after taking into cognisance a recommendation to this effect by the Finance
Commission.
Professional Tax
• Professional tax is a tax that is levied by a state government on all individuals who earn a living
through any medium.
• This should not be confused with the definition of professionals that indicates people such as
doctors. This is a tax that is to be paid by every single earning individual.
• The calculation and amount collected may differ from one state to another but it has a limit of
Rs. 2500 per year.

8.4.4 Institutional and Tax Policy Changes

• It is important to restore the revenue neutrality of the GST rate, which was compromised by the
multiple rate structure and several downward adjustments of rates.
• Multiple rate changes since the introduction of the GST regime in July 2017 have brought the
effective GST rate to 11.6% from the original revenue neutral rate of 15.5%.
• The rate structure can be rationalised by merging the rates of 12 per cent and 18 per cent. The
system can be operated with a three-rate structure of a merit rate, standard rate and demerit
rate.
• Efficiency and revenue gains require that exemptions be minimised.
• Over-reliance on consumption-based taxes by the general government, which reduces the
progressivity of the tax system, should be reduced by widening the net of income and asset-
based taxation.
• Wherever inadequate devolution of taxation powers hinders resource mobilisation at the third
tier of Government, especially in asset-based taxes, such devolution should be immediately
undertaken, and local administrative capacity strengthened

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 Three Rate GST Structure
• The Government can rationalise the GST rate
structure without losing revenues by rejigging
the four major rates of 5%, 12%, 18% and 28%
with a three-rate framework of 8%, 15% and
30%, as per a National Institute of Public
Finance and Policy (NIPFP) study.
• The nature of rate changes has also meant
that over 40% of taxable turnover value now
falls in the 18% tax slab, thus any move to
dovetail that slab with a lower rate will trigger
losses to the tax kitty that need to be offset by
marginal hikes in other remaining major
rates — 5% and 28%.

Additional Information
Revenue neutrality of GST Rate
• Revenue neutral rate (RNR) is a structure of different rates established in order to match the
current revenue generation with revenue under GST.
Consumption Tax:
• A consumption tax is a tax on the purchase of a good or service. Consumption taxes can take the
form of sales taxes, tariffs, excise, and other taxes on consumed goods and services.
• A consumption tax can also refer to a taxing system as a whole in which people are taxed based
on how much they consume rather than how much they add to the economy (income tax).
Income Tax:
• The term income tax refers to a type of tax that governments impose on income generated by
businesses and individuals within their jurisdiction. By law, taxpayers must file an income tax
return annually to determine their tax obligations.
Wealth Tax:
• Wealth tax is a tax based on the market value of assets owned by a taxpayer. Although many
developed countries choose to tax wealth, the United States has historically relied on taxing annual
income to raise revenue.

8.4.5 Towards Cooperative Federalism

• Commission recommends retaining the vertical share of 41 per cent of the divisible pool of taxes
for the States during the award period of this Commission.
• To arrive at the inter se shares of States in the devolution, we have retained the horizontal
devolution formula recommended in our report for the year 2020-21.
• On horizontal devolution, while commission agreed that the Census 2011 population data
better represents the present need of States, to be fair to, as well as reward, the States
which have done better on the demographic front, commission has assigned a 12.5 per
cent weight to the demographic performance criterion.
• Income distance:
• Income distance is the distance of a state’s income from the state with the highest
income.

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 • Income of a state has been computed as average per capita GSDP during the three-year
period between 2016-17 and 2018-19.
• A state with lower per capita income will have a higher share to maintain equity among
states.
• Forest and ecology:
• This criterion has been arrived at by calculating the share of the dense forest of each
state in the total dense forest of all the states.
• Tax and fiscal efforts:
• This criterion has been used to reward states with higher tax collection efficiency.
• It is measured as the ratio of the average per capita own tax revenue and the average per
capita state GDP during the three years between 2016-17 and 2018-19.

Overall Criteria for Devolution

8.4.6 Empowering Local Government

• The total size of grant to the local government should be 4,36,361 crore for the period 2021-26
period 2021-26.
o Commission favour a fixed amount rather than a proportion of the divisible pool of taxes
to ensure greater predictability of the quantum and timing of fund flow.
o Of these total grants, Rs. 8,000 crore is performance-based grants for incubation of new
cities and Rs. 450 crore is for shared municipal services. A sum of Rs. 2,36,805 crore is
earmarked for rural local bodies, Rs. 1,21,055 crore for urban local bodies and Rs. 70,051
crore for health grants through local governments.

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• For inter se distribution among States for rural and urban local bodies, weightage of 90 per cent
should be given to population and 10 per cent to the area of the State.
• We recommend that all States which have not done so, must constitute SFCs, act upon their
recommendations and lay the explanatory memorandum as to the action taken thereon before
the State legislature on or before March 2024.
• After March 2024, no grants should be released to a State that has not complied with the
Constitutional provisions in respect of the SFC and these conditions.
• The MoPR will certify the compliance of all Constitutional provisions by a State in this respect
before the release of their share of grants for 2024-25 and 2025-26.
• To supplement the resources needed to fulfil national priorities, 60 per cent of the grants to rural
local bodies should be tied to supporting and strengthening the delivery of two categories of
basic services:
a) sanitation and maintenance of ODF status; and
b) drinking water, rain water harvesting and water recycling.
• Urban local bodies have been categorised into two groups, based on population, and different
norms have been used for flow of grants to each, based on their specific needs and aspirations.
o For cities with million-plus population (Million-Plus cities), 100 per cent of the grants are
performance linked through the million plus cities challenge fund.
o Basic grants are proposed only for cities/towns having a population of less than a million.
o Category I cities (urban agglomerations with a population of more than one million) will
be treated as a single unit for monitoring of performance indicators of ambient air
quality and service level benchmarks.
o One-third of the total MCF of each city is earmarked for achieving ambient air quality.
o The balance two-third of the city-wise MCF is earmarked for achieving service level
benchmarks for drinking water (including rainwater harvesting and recycling) and solid
waste management.
o Sixty per cent of the basic grants for urban local bodies in non-Million-Plus cities should
be tied to supporting and strengthening the delivery of:
a) sanitation and solid waste management and attainment of star ratings as
developed by the MoHUA, and
b) drinking water, rainwater harvesting and water recycling.
• Commission recommends that for the five-year award period (2021-22 to 2025-26) grants should
go to all the three tiers of panchayati raj institutions.
• Since no resident of India should be denied a share of the local body grants, these should be
distributed to even those areas which are not required to have panchayats (Fifth and Sixth
Schedule areas and Excluded Areas) for augmenting their resources to provide basic services by
similar local level bodies.
• The grants recommended by us for rural local bodies and non-Million-Plus cities shall be released
in two equal instalments each year in June and October.
• The States shall transfer grants-in-aid to the local bodies within ten working days of having
received them from the Union Government.
• Any delay beyond ten working days will require the State Governments to release the same with
interest.
• A sum of rs 8000 crore is recommended to states as grants for incubation of new cities and rs
400 crore for facilitating shared municipal services.

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8.4.7 Disaster Risk Management
• The ratio of contribution by Union and States to the State-level allocations for disaster
management recommended by FC-XIII should be maintained.
• Thus, States are to contribute 25 per cent of funds of SDRF and SDMF except the NEH States
which shall contribute 10 per cent, and the rest is to be provided by the Union Government.
• Mitigation Funds should be set up at both the national and State levels, in line with the
provisions of the Disaster Management Act.
• The Mitigation Fund should be used for those local level and community-based interventions
which reduce risks and promote environment-friendly settlements and livelihood practices.
• Allocation of disaster management funds to SDRMFs should be based on factors of past
expenditure, area, population and disaster risk index (which reflect States' institutional capacity,
risk exposure and hazard and vulnerability respectively).
o Assuming an annual increase of 5 per cent, we arrive at the total corpus of Rs. 1,60,153
crore for States for disaster management for the duration of 2021-26, of which the Union
share is Rs. 1,22,601 crore and States share is Rs. 37,552 crore.
• Total States allocation for SDRMF should be subdivided into funding windows that encompass
the full disaster management cycle.
• Thus, the SDRF should get 80 per cent of the total allocation and the SDMF 20 per cent.
• The SDRF allocation of 80 per cent should be further distributed as follows: Response and Relief-
40 per cent, Recovery and Reconstruction-30 per cent; and Preparedness and Capacity-building
- 10 per cent.
• The allocation for the NDRMF should be based on expenditure in previous years.
o Assuming an annual increase of 5 per cent, the total national allocation for disaster
management is estimated to be Rs. 68,463 crore for the duration of 2021-26.
• To discourage excessive and unsubstantiated demands from States, all Central assistance
through the NDRF and NDMF should be provided on a graded cost-sharing basis.
• States should contribute 10 per cent for assistance up to Rs. 250 crore, 20 per cent for assistance
up to Rs. 500 crore and 25 per cent for all assistance exceeding Rs. 500 crore.
• A Recovery and Reconstruction Facility should be set up within the NDRF and SDRF.
• Assistance for recovery and reconstruction is generally a multi-year programme, and the
assistance, shared between the Union and States, needs to be released annually against
expenditures and only as a percentage of total cost.
• In the event of SDRMF and NDRMF assistance falling short of the required assistance, the Union
and States should have recourse to other financial instruments.
o These instruments are identified as reconstruction bonds, contingent credit/stand-by
facility with international financial institutions, crowdfunding platforms and corporate
social responsibility.
• Insurance mechanisms, which act as a social safety net and supplement the existing financial
mechanisms, need to be introduced in partnership with insurance companies after due diligence
is done.
o These mechanisms are: national insurance scheme for disaster-related deaths,
synchronising relief assistance with crop insurance, risk pool for infrastructure protection
and recovery, and access to international reinsurance to the outlier hazard events

8.4.8 Pandemic and Beyond: Building Resilience in Health Sector

• Health spending by States should be increased to more than 8 per cent of their budget by 2022.
• Primary health care should be the number one fundamental commitment of each and every
State and that primary health expenditure should be increased to two-thirds of the total health
expenditure by 2022.
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 • Public health expenditure of Union and States together should be increased in a progressive
manner to reach 2.5 per cent of GDP by 2025.
• Centrally sponsored schemes (CSS) co-financed by the Government of India should be flexible
enough to allow States to adapt and innovate, Top-down mandates and strictures on
programme implementation are the antithesis of an open-source model CSS should grant States
significant latitude to tailor implementation modalities to local realities.
• Given the inter-State disparity in the availability of medical doctors, it is essential to constitute
an All India Medical and Health Service as is envisaged under Section 2A of the All-India Services
Act, 1951.
o For this purpose, the Union Public Service Commission (UPSC) would need to do annual
recruitments, based on the State-wise requisitions by each State Government.
• Finance commission urges the Union Government to implement this proposal in coordination
with State Governments.
• The MBBS curriculum should be restructured to make it competency based.
o A certain degree of specialisation should be included in the curriculum and the MCI/NMC
should develop small courses on wellness clinic, basic surgical procedures, anaesthesia,
obstetrics and gynaecology, eye, ENT etc. for MBBS doctors and encourage AYUSH as an
elective subject for medicine undergraduates.
• The asymmetric distribution of medical colleges needs to be corrected as most of them are
situated in the western and southern parts of India.
• All public health facilities including district hospitals, private sector facilities and corporate
hospitals should be utilised for starting specialist DNB courses.
• Measures should be taken to assign a larger role for nursing professionals and the concept of
nurse practitioner, physician assistant and nurse anaesthetist should be introduced for better
utilisation of nursing professionals. The early passage of this legislation should be fast-tracked
given its multiplier benefits.
• The total grants-in-aid support to the health sector over the award period works out to be Rs.
1,06,606 crore, which is 10.3 per cent of the total grants-in-aid recommended by commission.
This forms about 0.1 per cent of GDP. The grants for the health sector will be unconditional.
• Commission recommend Rs. 15,265 crore for critical care hospitals. This includes Rs. 13,367
crore for general States and Rs 1,898 crore for NEH States.
• The finance commission has recommended Rs 469 crore for states for building public health
laboratories.
• Commission recommend Rs. 13,296 crore for training of the allied healthcare workforce. Out of
this, Rs. 1,986 crore will be for NEH States and Rs. 11,310 crore for general States.
• Commission recommend Rs. 2,725 crore for starting DNB courses in district hospitals for
overcoming the shortfall of specialists.

8.4.9 Performance Based Incentives and Grants

• Commission recommends total revenue deficit grants of Rs. 2,94,514 crore over our award
period for seventeen States.
• Commission recommend grants of Rs. 4,800 crores (Rs. 1,200 crore each year) from 2022-23 to
2025-26 for incentivising the States to enhance educational outcomes.
• The performance grant received by the State will be utilised by the education department for
enhancing educational outcomes and not diverted for use by any other department by the
State.
• Commission recommend Rs. 6,143 crores for online learning and development of professional
courses in regional languages (matribhasha) for higher education in India.
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 • Commission recommends that Rs. 45,000 crores be kept as performance-based incentive for all
the States for carrying out agricultural reforms:
o States may appropriately amend their land-related laws on the lines of NITI Aayog's
model law to allow short-term and long-term lease of agricultural land both for
agricultural purpose as well as for agro-industry, logistics for agricultural trade and supply
chains.
o Incentive-based grants to States that maintain and augment groundwater stock and put
a check on any fall in the water table.
o Using growth in agricultural exports as a target indicator for the award on export
performance of a State.
o Increasing production of oilseeds, pulses and wood and wood-based products as an
indicator to make India self-reliant in pulses, edible oils and wood and wood products
• Commission recommended Rs. 27,539 crore for maintenance of PMGSY roads for the years
2021-26, out of which Rs. 14,743 crore is for the general States and Rs. 12,796 crore is for the
NEH States.
• Commission recommended grants of Rs. 10,425 crore for fast-track courts for speedier justice
delivery in cases of heinous crimes, civil cases of marginalised people, five-year-old property
cases and economic offences as well as special fast-track courts for POCSO cases.
• Commission recommended Rs. 3,150 crore for incentivising aspirational districts and blocks for
a period of five years from 2021-22 to 2025-26.
• Commission recommended an extra annual borrowing space for the States, of the magnitude of
0.50 per cent of their GSDP for each of the first four years of the award covering the period 2021-
22 to 2024-25, based on certain performance criteria in the power sector.

8.4.10 Defence and Internal Security

• The Union Government may constitute in the Public Account of India, a dedicated non lapsable
fund, Modernisation Fund for Defence and Internal Security (MFDIS), to bridge the gap between
projected budgetary requirements and budget allocation for defence and internal security.
• This may be called Rashtriya Suraksha Naivedyam Kosh or any other appropriate name. The
proceeds of the fund will be utilised for the following three purposes:
o capital investment for modernisation of defence services.
o capital investment for CAPFS and modernisation of state police forces as projected by
MHA; and
o a small component as welfare fund for our soldiers and para-military personnel.
• The fund shall have the standard notified rules for its administration, public reporting and audit
by the CAG.
• This Fund will have four specific sources of incremental funding:
o transfers from the Consolidated Fund of India;
o disinvestment proceeds of DPSES;
o proceeds from the monetisation of surplus defence land, including realisation of arrears
of payment for defence land used by State Governments and for public projects and cost
recovered of encroached land; and
o proceeds of receipts from defence land likely to be transferred to State Governments and
for public projects in future.
• The total indicative size of the proposed MFDIS over the period 2021-26 is Rs. 2,38,354 crore.
• Due to overall fiscal Constraints, The MoD should also take immediate measures to innovatively
bring down the salaries and pension liabilities.
• The commission also recommended that MOD shall reduce the dependence on defence imports
with a specific roadmap by corresponding enhancement in indigenous production at a faster rate
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8.4.11 Fiscal Consolidation Roadmap
• For the State Governments, commission recommended that the normal limit for net borrowing
may be fixed at 4 per cent of GSDP in 2021-22, 3.5 per cent in 2022-23 and be maintained at 3
per cent of GSDP from 2023-24 to 2025-26.
o The term 'normal' is used to clarify that we have not accounted for any additional
borrowing to be done by the State Governments to manage the shortfall in GST
compensation to them, or the incentive-based additional borrowing space that we have
recommended for power sector reforms.
• If a State is not able to fully utilise its sanctioned borrowing limit as specified above, in any
particular year during the first four years of our award period (2021-22 to 2024-25), it will have
the option of availing this unutilised borrowing amount (calculated in rupees) in any of the
subsequent years within our award period.
• Given the compulsions on the revenue account of the union government, including of lending
support to the budgets of sub-national government, they may have to follow an elevated path of
fiscal deficit with a terminal year (2025-26) target of 4% of the GDP.
• We recognise that the FRBM Act needs a major restructuring and recommend that the time-
table for defining and achieving debt sustainability may be examined by a High-powered Inter-
governmental Group.
o This High-powered Group can craft the new FRBM framework and oversee its
implementation.
o It is important that the Union and State Governments amend their FRBM Acts, based on
the recommendations of the Group, so as to ensure that their legislations are consistent
with the fiscal sustainability framework put in place.
• Disclosure of the financial positions of the States and their credit rating will help in broadening
the investor base.
o Credit rating will also reinforce self-discipline on the fiscal front and lead to better pricing
of SDLs.
• The States and the Union should define contingent liabilities transparently, estimate them and
assess the risks associated with them.
• States should have more avenues for short-term borrowings other than the ways and means
advances and over draft (WMA/OD) facility provided by RBI, which has monetary policy
implications.
• Such a facility may help States in meeting the temporary mismatches in their revenue flows at
market-determined cost.

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