FIFTEENTH FINANCE

COMMISSION
 SUMMARY ON FINANCE COMMISSION IN INDIA

• The Finance Commission in India is a constitutional body established under

Article 280 of the Indian Constitution. It plays a crucial role in the fiscal
federalism of the country. Here's a summary:
• Constitutional Mandate: The Finance Commission is constituted every five years
or at intervals specified by the President. Its primary mandate is to make
recommendations on the distribution of tax revenues between the Central and
State governments.
• Composition: The Commission typically comprises a Chairman and four other
members, all of whom are experts in finance, economics, or public administration.
• Functions:
• Tax Devolution: One of the primary functions of the Finance Commission is to
recommend the share of central taxes that should be allocated to the states. This is
known as tax devolution.
 CONTD…
• Special Assistance: In certain cases, the Finance Commission may also recommend measures for special assistance to
states.

• Debt Consolidation: The Commission may suggest measures to improve te fiscal health of states, including debt
consolidation and relief.

• Criteria for Allocation: The Commission uses various criteria to determine the distribution of resources, including
population, area, income disparities, forest cover, and more recently, demographic performance and ecology.

• Special Category States: While not explicitly defined in the Constitution, the Finance Commissions have historically
identified certain states as "Special Category States" due to factors like hilly terrain, low resource base, and other
unique characteristics. These states receive special treatment in terms of financial assistance.

• Challenges and Debates: The recommendations of Finance Commissions are often a subject of intense debate and
negotiation between the Central and State governments. Issues like the weightage given to different criteria, the
overall share of taxes, and the grants provided are often contentious.

• Implementations: The recommendations of the Finance Commission are not binding, but they are usually accepted
by the government with certain modifications. They form the basis for the distribution of finances between the
Centre and the States.

• Role in Fiscal Federalism: The Finance Commission plays a crucial role in maintaining a balance between the fiscal
powers of the Central and State governments, ensuring that both levels of government have adequate resources to
 CRITICISM OF FINANCE COMMISSIONS IN INDIA

1.Population Criterion
2.Treatment of Special Category States
3.Static Criteria
4.Lack of Accountability
5.Overemphasis on Population
6.Discretionary Grants
7.Inadequate Focus on Performance Indicators
8.Lack of Mechanism for Feedback
9.Limited Scope for Local Governments
 Thirteenth Finance Fourteenth Finance Fifteenth Finance
Aspect Commission Commission Commission
Term 2010-2015 2015-2020 2020-2025
Chairman Dr. Vijay Kelkar Dr. Y. V. Reddy N. K. Singh
Strengthening Fiscal Balancing needs and
Objective Fiscal Consolidation
Federalism resources
Recommended Grants to
32.0% 42.0% 41.0%
States (%)
Weightage for Population
25.0% 17.5% 15.0%
(%)
Weightage for Area (%) 10.0% 10.0% 15.0%
Income Distance Criteria Yes No No
Forest and Ecology Grant Included Included Excluded
Local Bodies Grants Included Included Included
Disaster Management
Not Included Included Included
Grant
Performance-Based
Yes Yes Yes
Incentives
Debt and Fiscal
Emphasized Moderately Emphasized Emphasized
Consolidation
Recommendations Yet to be fully
Largely accepted Mostly accepted
Recommendation
Area Summary of Fifteenth FC Recommendation
Recommended 41.0% of the divisible pool of taxes to be devolved to
Tax Devolution the states. This was an increase from the 42.0% recommended by the
Fourteenth Finance Commission.
Population was an important criterion for tax devolution, with a
Population
weightage of 15.0%.
The weightage for area was increased to 15.0% from the previous
Area
10.0%.
Forest and Introduced as a new criterion, giving importance to the forest and
Ecology ecology cover in determining the share of states.
Introduced a new criterion based on demographic performance,
Demographic
aiming to reward states that have been successful in controlling
Performance
population growth.
Disaster Recommended providing a grant for disaster management,
Management recognizing the importance of preparedness and mitigation in the face
Grant of natural calamities.
Emphasized the importance of healthcare, recommending grants to
Health Sector states for strengthening the health infrastructure and addressing
 Highlighted the need for quality education, recommending
Education Sector grants to states for improving access to and quality of
education, with a focus on school education.
Continued the practice of providing grants to local bodies to
Local Bodies Grants empower them for better governance and service delivery at the
grassroots level.
Grants for Rural Emphasized the importance of rural infrastructure,
Infrastructure recommending grants to support the development of essential
Development infrastructure in rural areas.
Continued the practice of incentivizing states for efficient fiscal
Performance-Based
management, implementation of key programs, and achieving
Incentives for States
certain performance indicators.
Debt and Fiscal Emphasized the need for fiscal discipline and consolidation,
Consolidation recommending measures to improve states' fiscal health.
Recommendations The extent to which the recommendations were accepted and
Accepted by Government implemented by the Government of India varied, and some
of India recommendations were yet to be fully implemented.
Issues and Challenges
Population Criteria
Implementation of Forest and
Ecology Criteria
Demographic Performance
Criteria
Ensuring Effective Utilization of
Grants
Accountability and
Transparency in Local Bodies
Grants
Monitoring Disaster
Management Grant
Balancing Fiscal Consolidation
with Developmental Needs
Addressing State-Specific Issues
Description
Some states may feel that the reduced weightage on population might lead
to a decrease in their share of tax devolution, which could impact their
fiscal resources.
Implementing the forest and ecology criteria may pose challenges in terms
of accurately assessing and quantifying the forest and ecology cover of
each state.
Evaluating and measuring demographic performance may require a
robust system for data collection and monitoring, which can be
challenging to establish uniformly.
Ensuring that grants provided for specific sectors like health, education,
and disaster management are effectively utilized for their intended
purposes.
Ensuring that grants provided to local bodies are utilized efficiently, and
there is transparency and accountability in the allocation and utilization
of funds.
Ensuring that the disaster management grant is used effectively for
preparedness, response, and recovery in the face of natural disasters.
Balancing the need for fiscal consolidation with the requirement for funds
for developmental purposes, particularly in states facing fiscal challenges.
Addressing the unique challenges and specific requirements of each state
CRITICISM OF FIFTEENTH FINANCE COMMISSION IN
INDIA
6. Balance between Fiscal
1. Population Criterion
Discipline and Development
2. Impact on Southern
7. Concerns of Smaller
States
States
3. Demographic
8. Role in Regional
Performance Criterion
Disparities
4. Forest and Ecology
Criterion 9. Implementation
Challenges
5. Issues with Disaster
Management Grant 10. Transparency and
Consultation
 INTRODUCTION
• Constitutional body under Article 280
• President of India formed to give suggestions on centre-state
financial relations
• Chairman- Mr N. K. Singh- 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
submitted on February 2021
KEY RECOMMENDATIONS IN THE FIRST REPORT (2020-21 PERIOD) INCLUDE

Devolution of taxes to states:

• The share of states in the centre’s taxes is recommended to be
decreased from 42% during the 2015-20 period to 41% for 2020-21
• The 1% decrease is to provide for the newly formed union
territories of Jammu and Kashmir, and Ladakh from the resources
of the central government
 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
Forest Cover 7.5 -
Forest and Ecology - 10.0
Demographic Performance - 12.5
Tax Effort - 2.5
Total 100 100
GRANTS-IN-AID
In 2020-21, the following grants will be provided to states:
• (i) revenue deficit grants
• (ii) grants to local bodies
• (iii) disaster management grants
• The Commission has also proposed a framework for sector-
specific and performance-based grants
• State-specific grants has been provided in the final report.
Revenue deficit grants:
• In 2020-21, 14 states are estimated to have an aggregate revenue deficit of Rs
74,340 crore post-devolution
• The Commission recommended revenue deficit grants for these states
Special grants:
• In case of three states, the sum of devolution and revenue deficit grants is
estimated to decline in 2020-21 as compared to 2019-20
• These states are Karnataka, Mizoram, and Telangana
• The Commission has recommended special grants to these states aggregating
to Rs 6,764 crore
SECTOR-SPECIFIC GRANTS:
THE COMMISSION HAS RECOMMENDED A GRANT OF RS 7,375 CRORE FOR
NUTRITION IN 2020-21

SECTOR-SPECIFIC GRANTS FOR THE FOLLOWING SECTORS HAS

BEEN PROVIDED IN THE FINAL REPORT:
• i) nutrition • (v) rural connectivity
• ii) health • vi) railways
• iii) pre-primary education • (vii) police training
• iv) judiciary • (viii) housing
• Performance-based grants:
Guidelines for performance-based grants include:
• (i) implementation of agricultural reforms
• ii) development of aspirational districts and blocks
• iii) power sector reforms
• iv) enhancing trade including exports
• v) incentives for education
• (vi) promotion of domestic and international tourism
• The grant amount has been provided in the final report
• Grants to local bodies:
• The total grants to local bodies for 2020-21 has been fixed at Rs 90,000 crore,
• of which Rs 60,750 crore is recommended for rural local bodies (67.5%) and
• Rs 29,250 crore for urban local bodies (32.5%)
• This allocation is 4.31% of the divisible pool
• This is an increase over the grants for local bodies in 2019-20, which
amounted to 3.54% of the divisible pool (Rs 87,352 crore)
• The grants will be divided between states based on population and area in the
ratio 90:10
• The grants will be made available to all three tiers of Panchayat- village,
block, and district
• Disaster risk management:
• The Commission recommended setting up National and State Disaster
Management Funds (NDMF and SDMF) for the promotion of local-level
mitigation activities
• The Commission has recommended retaining the existing cost-sharing patterns
between the centre and states to fund the SDMF (new) and the SDRF (existing).
• The cost-sharing pattern between centre and states is-
• (i) 75:25 for all states, and
• ii) 90:10 for north-eastern and Himalayan states
• For 2020-21, State Disaster Risk Management Funds have been allocated Rs
28,983 crore, out of which the share of the union is Rs 22,184 crore.
• The National Disaster Risk Management Funds has been allocated Rs 12,390
crore
Funding Windows National corpus States’ corpus

Mitigation (20%) 2,478 5,797

Response (80%) 9,912 23,186

(i) Response and Relief (40%) 4,956 11,593

(ii) Recovery and Reconstruction (30%) 3,717 8,695

(iii) Capacity Building (10%) 1,239 2,998

Total 12,390 28,983

• Recommendations on fiscal roadmap
• Fiscal deficit and debt levels:
• The Commission noted that recommending a credible fiscal and debt trajectory roadmap remains
problematic due to uncertainty around the economy. It recommended that both central and state
governments should focus on debt consolidation and comply with the fiscal deficit and debt levels as
per their respective Fiscal Responsibility and Budget Management (FRBM) Acts.
• Off-budget borrowings:
• The Commission observed that financing capital expenditure through off-budget borrowings detracts
from compliance with the FRBM Act. It recommended that both the central and state governments
should make full disclosure of extra-budgetary borrowings. The outstanding extra-budgetary liabilities
should be clearly identified and eliminated in a time-bound manner.
• Statutory framework for public financial management:
• The Commission recommended forming an expert group to draft legislation to provide for a statutory
framework for sound public financial management system. It observed that an overarching legal fiscal
framework is required which will provide for budgeting, accounting, and audit standards to be followed
at all levels of government.
• Tax capacity:
• In 2018-19, the tax revenue of state governments and central government together stood at around 17.5%
of GDP
• The Commission noted that tax revenue is far below the estimated tax capacity of the country
• Further, India’s tax capacity has largely remained unchanged since the early 1990s
• In contrast, tax revenue has been rising in other emerging markets
• The Commission recommended:
• i) broadening the tax base
• ii) streamlining tax rates
• iii) and increasing capacity and expertise of tax administration in all tiers of the government.
• GST implementation: The Commission highlighted some challenges with the
implementation of the Goods and Services Tax (GST)
• These include:
• i) large shortfall in collections as compared to original forecast
• ii) high volatility in collections
• iii) accumulation of large integrated GST credit
• iv) glitches in invoice and input tax matching
• v) delay in refunds
• The Commission observed that the continuing dependence of states on compensation
from the central government (21 states out of 29 states in 2018-19) for making up for
the shortfall in revenue is a concern.
• It suggested that the structural implications of GST for low consumption states need
to be considered.
• Other recommendations
• Financing of security-related expenditure:
• The ToR of the Commission required it to examine whether a separate funding mechanism for
defence and internal security should be set up and if so, how it can be operationalised
• In this regard, the Commission intends to constitute an expert group comprising representatives
of the Ministries of Defence, Home Affairs, and Finance
• The Commission noted that the Ministry of Defence proposed following measures for this
purpose:
• ) setting up of a non-lapsable fund
• ii) levy of a cess
• iii) monetisation of surplus land and other assets
• iv) tax-free defence bonds
• V) utilising proceeds of disinvestment of defence public sector undertakings.
• The expert group is expected to examine these proposals or alternative funding mechanisms
 VERTICAL DEVOLUTION
• In order to maintain predictability and stability of resources, especially during the pandemic, XVFC
has recommended maintaining the vertical devolution at 41 per cent – the same as in our report for
2020-21. It is at the same level of 42 per cent of the divisible pool as recommended by FC-XIV.
However, it has made the required adjustment of about 1 per cent due to the changed status of the
erstwhile State of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and
Kashmir.
• In XVFC’s assessment, gross tax revenues for 5-year period is expected to be 135.2 lakh crore. Out of that,
Divisible pool (after deducting cesses and surcharges & cost of collection) is estimated to be 103 lakh crore.
• States’ share at 41 per cent of divisible pool comes to 42.2 lakh crore for 2021-26 period.
• Including total grants of Rs. 10.33 lakh crore (details later) and tax devolution of Rs. 42.2 lakh crore,
aggregate transfers to States is estimated to remain at around 50.9 per cent of the divisible pool during 2021-
26 period.
• Total XVFC transfers (devolution + grants) constitutes about 34 per cent of estimated Gross Revenue
Receipts of the Union leaving adequate fiscal space for the Union to meet its resource requirements and
spending obligations on national development priorities.
 HORIZONTAL DEVOLUTION
• Based on principles of need, equity and performance, overall devolution formula is as follows
Criteria Weight (%)

Population 15.0
Area 15.0
Forest & ecology 10.0
Income distance 45.0
Tax & fiscal efforts 2.5
Demographic performance 12.5
Total 100

On horizontal devolution, while XVFC 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, XVFC
has assigned a 12.5 per cent weight to the demographic performance criterion

XVFC has re-introduced tax effort criterion to reward fiscal performance

• Revenue deficit grants:
• Based on uniform norms of assessing revenues and expenditure of the States and the
Union,

• XVFC has recommended total revenue deficit grants (RDG) of Rs 2,94,514 crore
over the award period for seventeen States.
• Local Governments:
• The total size of the grant to local governments should be Rs. 4,36,361 crore for the
period 2021-26.
• 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.
• 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. Basic grants are proposed only for cities/towns having a
population of less than a million. For Million-Plus cities, 100 per cent of the grants are
performance-linked through the Million-Plus Cities Challenge Fund (MCF).
• Health:
• XVFC has recommend that health spending by States should be increased to more than 8 per cent of their budget
by 2022.
• 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.
• The total grants-in-aid support to the health sector over the award period works out to Rs. 1,06,606 crore, which
is 10.3 per cent of the total grants-in-aid recommended by XVFC. The grants for the health sector will be
unconditional.
• XVFC has recommend health grants aggregating to Rs. 70,051 crore for urban health and wellness centres
(HWCs), building-less sub centre, PHCs, CHCs, block level public health units, support for diagnostic
infrastructure for the primary healthcare activities and conversion of rural sub centres and PHCs to HWCs. These
grants will be released to the local governments.
• Out of the remaining grant of Rs. 31,755 crore for the health sector (total of Rs. 1,06,606 crore minus Rs. 70, 051
crore through local bodies and Rs.4800 crore state-specific grants), XVFC has recommended 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.
• XVFC has recommended 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.
• Performance incentives and grants:
• XVFC has recommended grants of Rs. 4,800 crore (Rs. 1,200 crore each year) from
2022-23 to 2025-26 for incentivising the States to enhance educational outcomes.
• XVFC has recommended Rs. 6,143 crore for online learning and development of
professional courses (medical and engineering) in regional languages (matribhasha)
for higher education in India.
• XVFC has recommended that Rs. 45,000 crore be kept as performance-based
incentive for all the States for carrying out agricultural reforms
• for amending their land-related laws on the lines of NITI Aayog’s model law
• incentive-based grants to States that maintain and augment groundwater stock.
• growth in agricultural exports
• production of oilseeds, pulses and wood and wood-based products
APART FROM ABOVE, FOLLOWING IS THE SNAPSHOT OF GRANTS
S.no. Grant Components 2021-26

1 Revenue Deficit grants 294514

2 Local governments grants 436361

3 Disaster management grants 122601

4 Sector-specific grants 129987

i Sectoral grants for Health 31755

ii School Education 4800

iii Higher Education 6143

iv Implementation of agricultural reforms 45000

v Maintenance of PMGSY roads 27539

vi Judiciary 10425

vii Statistics 1175

viii Aspirational districts and blocks 3150

5 State-specific 49599

Total 1033062
• Defence and Internal Security
• Keeping in view the extant strategic requirements for national defence in the global context, XVFC has, in its approach, re-
calibrated the relative shares of Union and States in gross revenue receipts. This will enable the Union to set aside resources
for the special funding mechanism that XVFC has proposed.
• The Union Government may constitute in the Public Account of India, a dedicated non-lapsable fund, Modernisation
Fund for Defence and Internal Security (MFDIS). The total indicative size of the proposed MFDIS over the period
2021-26 is Rs. 2,38,354 crore.

• Disaster Risk Management:

• 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.
• For SDRMF, XVFC has recommended the total corpus of Rs.1,60,153 crore for States for disaster management for the
duration of 2021-26, of which the Union’s share is Rs. 1,22,601 crore and States’ share is Rs. 37,552 crore.
• XVFC has recommended six earmarked allocations for a total amount of Rs. 11,950 crore for certain priority areas, namely,
two under the NDRF (Expansion and Modernisation of Fire Services and Resettlement of Displaced People affected by
Erosion) and four under the NDMF (Catalytic Assistance to Twelve Most Drought-prone States, Managing Seismic and
Landslide Risks in Ten Hill States, Reducing the Risk of Urban Flooding in Seven Most Populous Cities and Mitigation
Measures to Prevent Erosion).
• Fiscal consolidation
• Provided range for fiscal deficit and debt path of both the Union and States.
• Additional borrowing room to States based on performance in power sector reforms.
• A threshold amount of annual appropriation should be fixed below which the funding for a CSS may be stopped.
Below the stipulated threshold, the administrating department should justify the need for the continuation of the
scheme. As the life cycle of ongoing schemes has been made co-terminus with the cycle of Finance Commissions, the
third-party evaluation of all CSSs should be completed within a stipulated timeframe. The flow of monitoring
information should be regular and should include credible information on output and outcome indicators.
• In view of the uncertainty that prevails at the stage that XVFC have done its analysis, as well as the contemporary
realities and challenges, 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. This High-powered Group can craft the new FRBM framework and oversee its implementation. 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. This
High-powered Inter-Governmental Group could also be tasked to oversee the implementation of the 15th Finance
Commission’s diverse recommendations.
• State Governments may explore formation of independent public debt management cells which will chart their
borrowing programme efficiently.
FINANCE
COMMISSION
 QUESTIONS TO BE ANSWERED
• 1.) what is the Finance Commission?
• 2.) What is the role of Finance Commission?
• 3.) What is the importance of the Finance Commission?
• 4.) What are the basic concepts adopted by FFC?
• 5.) How do the Finance Commission try to achieve Vertical Equity among The
Centre and States?
• 6.) How do the Finance Commission try to achieve Horizontal Equity among the
States?
• 7.) what are the Recommendations of Fourteenth Finance Commission?
• 8.) what are the implications of these recommendations on the Centre-State
Financial Relationship?
•The Fourteenth Finance
Commission (FFC) – Implications
for Fiscal Federalism in India?
• “I feel more and more that we must function more from below than
from the top… too much of centralization means decay at the roots
and ultimately a withering of branches, leaves and flowers.”
- Prime Minister Pandit Jawaharlal
Nehru
• “We want to promote co-operative federalism in the country. At the
same time, we want a competitive element among the states. I call
this new form of federalism Co-operative and Competitive
Federalism”
- Prime Minister Narendra Modi
 INTRODUCTION
The Finance Commission is a Constitutional body formulated under
Article 280 of the Indian Constitution.
It is constituted every five years by the President of India to review-
 1.) the state of finances of the Union and the States and
2.) suggest measures for maintaining a stable and sustainable fiscal
environment
3.) to make recommendations
It consists of a chairman and four other members to be appointed by the
president.
 RECOMMENDATIONS REGARDING-

Devolution of taxes
Distribution of the net proceeds of taxes
Principles that should govern the grants-in-aid
Measures needed to augment the consolidated
fund of states
Any other method referred to it by the President
It makes recommendations regarding -
• 1.) the devolution of taxes between the Center and the States
• from the divisible pool which includes all central taxes excluding surcharges and cess
• which the Centre is constitutionally mandated to share with the States.
• 2.) The distribution of the net proceeds of taxes between the Centre and the states and the allocation
between the states of the respective shares of such proceeds
• 3.) The principles that should govern the grants-in-aid to the states by the Centre
• 4.) The measures needed to augment the consolidated fund of states to supplement the resources of
the local governments in the states on the basis of the recommendations made by the State Finance
Commissions.
• 5.) Any other method referred to it by the President in the interests of the sound finance.
• The recommendations made by finance commission are only advisory in nature and hence, are not
binding on the government.
 FOURTEENTH FINANCE COMMISSION
• The Fourteenth Finance Commission(FFC) was appointed on 2nd January, 2013 under
the chairmanship of Dr. Y. V. Reddy.
• In addition to the primary objectives mentioned,
• the terms of reference for the commission sought suggestions regarding
the principles which would govern
the quantum and distribution of grants-in-aid (nonplan grants to states),
the measures, if needed, to augment State government finances to supplement the
resources of local government and
to review the state of the finances, deficit and debt conditions at different levels of
government.
• The FFC has submitted its recommendations for
the period 2015-16 to 2020-21.
• They are likely to have major implications for
center-state relations, for budgeting by, and the
fiscal situation of, the center and the states.
Box 10.1 : Finance Commission - Concepts and definitions
Tax Devolution

One of the core tasks of a Finance Commission as stipulated in

Article 280 (3) (a) of the Constitution is to make recommendations
regarding-
 the distribution between the Union and the states of the net
proceeds of taxes.
This is the most important task of any Finance Commission, as the
share of states in the net proceeds of Union taxes is the predominant
channel of resource transfer from the Centre to states.
 Finance Commission - Concepts and definitions
Divisible Pool
The divisible pool is that portion of gross tax revenue which is distributed between the Centre
and the States.
The divisible pool consists of all taxes, except surcharges and cess levied for specific purpose,
net of collection charges.
Prior to the enactment of the Constitution (Eightieth Amendment) Act, 2000, the sharing of the
Union tax revenues with the states was in accordance with the provisions of articles 270 and
272, as they stood then.
The eightieth amendment of the Constitution altered the pattern of sharing of Union taxes in a
fundamental way.
Under this amendment, article 272 was dropped and article 270 was substantially changed.
The new article 270 provides for sharing of all the taxes and duties referred to in the Union
list, except the taxes and duties referred to in articles 268 and 269, respectively, and surcharges
on taxes and duties referred to in article 271 and any cess levied for specific purposes.
Finance Commission - Concepts and definitions
Grants-in-aid
Horizontal imbalances are addressed by the Finance Commission through-
the system of tax devolution and
 grants-in-aid,
 the former instrument used more predominantly.
Under Article 275 of the Constitution, Finance Commissions are mandated to-
recommend the principles as well as
the quantum of grants to those States which are in need of assistance and
that different sums may be fixed for different States.
Thus one of the pre-requisites for grants is the assessment of the needs of the
States.
Fiscal capacity/Income distance
The income distance criterion was first used by Twelfth FC,
measured by per capita GSDP as a proxy for the distance between
states in tax capacity.
When so proxied, the procedure implicitly applies a single average
tax-to-GSDP ratio to determine fiscal capacity distance between
states.
The Thirteenth FC changed the formula slightly and recommended
–
the use of separate averages for measuring tax capacity,
one for general category states (GCS) and
another for special category states (SCS).
• Fiscal discipline
• Fiscal discipline as a criterion for tax devolution was used by
Eleventh and Twelfth FC to provide an incentive to states managing
their finances prudently.
• The criterion was continued in the Thirteenth FC as well without
any change.
• The index of fiscal discipline is arrived at-
 by comparing improvements in the ratio of own revenue receipts of
a state to its total revenue expenditure relative to the corresponding
average across all states.
Special Category States (SCS) and General Category States (GCS)
The concept of a special category state was first introduced in 1969 when the Fifth Finance
Commission sought to-
provide certain disadvantaged states with
preferential treatment in the form of
central assistance and
tax breaks.
Initially three states Assam, Nagaland and Jammu & Kashmir were granted special status
but since then eight more have been included (Arunachal Pradesh, Himachal Pradesh,
Manipur, Meghalaya, Mizoram, Sikkim, Tripura and Uttarakhand).
All other states barring these are treated as General Category States.
The rationale for special status is that these states because of -
inherent features,
have a low resource base and
cannot mobilize resources for development.
•Some of the features required for special status are:
•(i) hilly and difficult terrain;
•(ii) low population density or sizeable share of tribal
population;
•(iii) strategic location along borders with neighboring
countries;
•(iv) economic and infrastructural backwardness; and
•(v) non-viable nature of state finances.
The First Commission had laid down five broad principles for determining the eligibility
of a State for grants.
1.) The first was that the Budget of a State was the starting point for examination of a
need.
2.) The second was the efforts made by States to realize the potential and
3.) The third was that the grants should help in equalizing the standards of basic services
across States.
4.) Fourthly, any special burden or obligations of national concern, though within the
State's sphere, should also be taken into account.
5.) Fifthly, grants might be given to further any beneficent service of national interest to
less advanced States.
Grants recommended by the Finance Commissions are predominantly in the nature of
general purpose grants meeting the difference between the assessed expenditure on the
non-plan revenue account of each State and the projected revenue including the share of
a State in Central taxes.
These are often referred to as 'gap filling grants'.
Over the years, the scope of grants to States was extended further to
cover special problems.
Following the seventy-third and seventy-fourth amendments to the
Constitution,-
Finance Commissions were charged with the additional responsibility
of recommending measures to augment the Consolidated Fund of a
State to supplement the resources of local bodies.
This has resulted in further expansion in the scope of Finance
Commission grants.
The Tenth Commission was the first Commission to have recommended
grants for rural and urban local bodies.
Thus, over the years, there has been considerable extension in the scope
of grants-in-aid.
 MAJOR RECOMMENDATIONS OF FFC
• Some of the major recommendations are as follows;
• The FFC has radically enhanced the share of the states in
the central divisible pool from the current 32 percent to 42 per
cent which is the biggest ever increase in vertical tax
devolution.
• The last two Finance Commissions recommended viz.
Twelfth (period 2005-10) had a state share of 30.5 per
cent (increase of 1 percent)
and Thirteenth (period 2010-15) had a state share of 32
The FFC has also proposed a new horizontal formula (Table 10.1) for
the distribution of the states’ share in divisible pool among the states.
There are changes both in the variables included/excluded as well as
the weights assigned to them.
• Relative to the Thirteenth Finance Commission, the FFC has
incorporated two new variables:
• 1.) 2011 population/Demographic change and
• 2.) forest cover; and
• 3.) excluded the fiscal discipline variable.
• Thirteenth Finance Commission
• Table 8.1:
• Criteria and Weights for Tax Devolution
• (per cent)
• Criteria Weight
• 1. Population (1971) 25.0
• 2. Area 10.0
• 3. Fiscal Capacity Distance 47.5
• 4. Fiscal Discipline 17.5
• Fourteenth Finance Commission
• Table 8.1:
• Criteria and Weights
Criteria Weight (per cent)
Population 17.5
Demographic Change 10
Income Distance 50
Area 15
Forest Cover 7.5
 MAJOR RECOMMENDATIONS OF FFC
Several other types of transfers have been proposed,
Including grants to rural and urban local bodies,
A performance grant along with grants for disaster relief and
revenue deficit.
These transfers total to approximately 5.3 lakh crore for the period
2015-2020
The FFC has not made any recommendation concerning sector
specific-grants unlike the Thirteenth Finance Commission.
 MAJOR RECOMMENDATIONS
OF FFC
Sharing of Union Taxes
Increasing the share of tax devolution to 42 per cent
• The divisible pool would serve the twin objectives of-
• 1.) increasing the flow of unconditional transfers to the States and
• 2.) yet leave appropriate fiscal space for the Union to carry out specific
purpose transfers to the States.
• No minimum guaranteed devolution to the States.
• As service tax is not levied in the State of Jammu & Kashmir,
proceeds cannot be assigned to this State.
 LOCAL GOVERNMENTS
• Local bodies should be required to spend the grants only on-
 the basic services within the functions assigned to them under relevant
legislations.
• Distribution of grants to the States using
o2011 population data with weight of 90 per cent and
oarea with weight of 10 per cent.
• The grant to each state will be divided into two-
• 1.) a grant to duly constituted Gram panchayats and
• 2.) a grant to duly constituted Municipalities,
• on the basis of urban and rural population of that state using the data of
 THE GRANTS TO BE DIVIDED IN TWO PARTS –
• 1.) a basic grant and
• 2.) a performance grant
 for duly constituted gram panchayats and municipalities.
• In the case of gram panchayats,
 90 per cent of the grant will be the basic grant and 10 per cent will be the performance
grant.
• In the case of municipalities,
the division between basic and performance grant will be on an 80:20 basis.
The grants should go only to those gram panchayats-
which are directly responsible for the delivery of basic services,
without any share for other levels using the formula given by the recent SFC.
 MAJOR RECOMMENDATIONS OF FFC

•Similarly, the basic grant for urban local bodies will be

divided into tier-wise shares and distributed across each tier
namely-
•1.) the Municipal corporations,
•2.) Municipalities (the tier II urban local bodies) and
•3.) the Nagar panchayats (the tier III local bodies)
•using the formula given by the respective SFCs.
• In case the SFC formula is not available,
• then the share of each gram panchayat as specified above should be distributed
across the entities
using 2011 population with a weight of 90 per cent and area with a weight of 10
percent.
• In the case of urban local bodies,
• the share of each of the three tiers will be determined on the basis of
population of 2011 with a weight of 90 per cent and
area with a weight of 10 per cent and
then distributed among the entities in each tier in proportion to the population of
2011 and area in the ratio of 90:10.
• Performance grants are being provided to address the
following issues:
• (i) making available reliable data on local bodies' receipt and
expenditure through audited accounts; and
• (ii) improvement in own revenues.

• Comparison with 13th Finance Commission, Enhanced the share of the states
in the central divisible pool from 32% (by 13th FC) to 42% which is the
biggest ever increase in vertical tax devolution.
• It has not made any recommendation concerning sector-specific grants unlike
the 13th FC.
• Table 10.1 : Horizontal Devolution Formula in the 13th and 14th
Finance Commissions
• Variable Weights accorded 13th 14th
• Population (1971) 25 17.5
• Population (2011) 0 10
• Fiscal capacity/Income distance 47.5 50
• (See box-1)
• Area 10 15
• Forest Cover 0 7.5
• Fiscal discipline (See box-1) 17.5 0
 IMPLICATIONS OF FFC RECOMMENDATIONS FOR FISCAL FEDERALISM: A
WAY AHEAD

• Based on its recommendations and projections, the FFC has

assessed and quantified the implications for the revenues of states.
• In this analysis the revenue implications are reassessed based on
more recent data (for 2014/15) and
slightly differing assumptions about GDP growth, tax buoyancy
and other fiscal parameters.
• The estimated benefits (both from tax devolution and FFC grants
together), based on certain assumptions related to both FY2014-
15 and FY2015-16.
• All states stand to gain from FFC transfers in absolute terms.
• However, to assess the distributional effects, the increases should be scaled
by-
 population,
Net State Domestic Product (NSDP) at current market price, or
by states’ own tax revenue receipts.
The biggest gainers in absolute terms under GCS are Uttar Pradesh, West
Bengal and Madhya Pradesh while for SCS it is Jammu & Kashmir,
Himachal Pradesh and Assam.
A better measure of impact is benefit per capita.
• The major gainers in per capita terms turn out to be Kerala, Chhattisgarh
• In terms of the impact based on NSDP, the benefits of FFC transfers are
highest for-
Chhattisgarh, Bihar and Jharkhand among the GCS and
for states like Arunachal Pradesh, Mizoram and Jammu & Kashmir
among the SCS.
• While in terms of states’ own tax revenues, the largest gains accrue to-
GCS of Bihar, Jharkhand and Chhattisgarh and
SCS of Arunachal Pradesh, Mizoram and Nagaland.
• The FFC transfers have more favorable impact on the states (only among
the GCS) which are relatively less developed which is an indication that
the FFC transfers are progressive i.e. states with lower per capita NSDP
• The correlation between per capita NSDP and FFC is transfer per
capita is -0.72.
• This indicates that the FFC recommendations do go in the direction of
equalizing the income and fiscal disparities between the major states.
• However, FFC transfers are less progressive compared to the transfers
of Thirteenth Finance Commission (TFC).
• The correlation coefficient between the NSDP per capita and TFC
transfers per capita (average of 2011-12, 2012- 13 and 2013-14) per
capita is-0.84.
• A final interesting finding relates to the decomposition of the resource
transfers through tax devolution
due to the increase in the divisible pool per se and
due to the change in the horizontal devolution formula itself.
• The significant impact due to increase in the divisible pool is on
states like-
• Uttar Pradesh, Bihar, Madhya Pradesh, West Bengal and Andhra
Pradesh (United)
• while states like-
• Arunachal Pradesh, Chhattisgarh, Madhya Pradesh, Karnataka and
 BALANCING FISCAL AUTONOMY AND FISCAL SPACE

The spirit behind the FFC recommendations is to

increase the automatic transfers to the states to give them
more fiscal autonomy and this is ensured by increasing
share of states from 32 to 42 per cent of divisible pool.
Assuming the recommendations of FFC were to be
implemented as it is, there is concern that fiscal space or
fiscal consolidation path of the Centre would be
adversely affected.
One immediately noteworthy fact is that CAS transfers per capita are only
mildly progressive: the correlation coefficient with state per capita NSDP is -0.29.
This is a consequence of plan transfers moving away from being Gadgil formula-
based to being more discretionary in the last few years. Greater central discretion
evidently reduced progressivity.
A corollary is that implementing the FFC recommendations would increase
progressivity because progressive tax transfers would increase and discretionary
and less progressive plan transfers would decline.
Balancing the enhanced fiscal autonomy of the states with preserving fiscal space
of the Centre entails reduction in CAS transfers.
But there are many ways of doing the latter from the totally discretionary to
formula-based.
 WITHIN THE LATTER TOO THERE ARE MANY
OPTIONS:
• (i) proportionate cuts across the states in CAS transfers;
• (ii) ensuring the implementation of
legally-backed/mandated schemes and then
proportionately cutting the residual;
• (iii) equal per capita distribution of CAS transfers;
• (iv) implementing the legally-backed schemes and then
distributing the remaining amount in line with the FFC
formula for tax devolution; and many more.
Essentially to answer the question of whether the states, if they wanted to,
can maintain the same level of spending on the programs financed by the
CAS especially the legally-backed schemes,? and
still have additional resources to finance their own new programs?
If they do not want to accept Centrally Sponsored Schemes, all the increase in
FFC transfers is new, unencumbered money.
All the GCS gain from FFC transfers net of CAS reduction.
The top three gainers in absolute terms under GCS are- Uttar Pradesh,
West Bengal and Madhya Pradesh while for SCS- it is Jammu & Kashmir,
Himachal Pradesh and Arunachal Pradesh.
The better way of measuring the surplus/ shortfall would be in per capita
• The surplus/shortfall as per cent of NSDP at current market price can
be reflected.
oThe states which add up maximum fiscal resources are Chhattisgarh,
Jharkhand and Bihar among the GCS while among the SCS it is
Arunachal Pradesh, Mizoram and Jammu & Kashmir.
oThe surplus is going to add significant amount to the states revenue.
oThere are nine states among the GCS which are expected to get
more than 25 per cent of their own tax revenue.
 CAVEATS
Some caveats or complications to this exercise must be noted.
1.) First, they are sensitive to the assumptions underlying GDP growth, revenue
and expenditure estimations/projections for 2014-15 and 2015-16.
• 2.) Secondly, assumptions are also made about CAS amounts in 2014-15 and
about reductions in CAS amounts in 2015-16.
• So, these must be treated as illustrative calculations.
• For example, another option would simply be to transfer those schemes that are
on State list back to the states.
• Also, estimates have only been presented for the year 2015-16.
• Thereafter, additional factors such as GST implementation and the next Pay
 CONCLUSION
•With these caveats, the main conclusions are that-
the FFC has made far-reaching changes in tax
devolution that will move the country toward greater
fiscal federalism,
conferring more fiscal autonomy on the states.
•This will be enhanced by the FFC-induced imperative
of having to reduce the scale of other central transfers
to the states.
• In other words, states will now have greater autonomy on the
revenue and expenditure fronts.
The numbers also suggest that this renewed impulse toward
fiscal federalism need not be to the detriment of the center’s fiscal
capacity.
A collateral benefit of moving from CAS to FFC transfers is that
overall progressivity will improve.
To be sure, there will be transitional costs entailed by the
reduction in CAS transfers.
But the scope for dislocation has been minimized because the
• In sum, the far-reaching recommendations of the FFC,
along with the creation of the NITI Aayog, will further the
Government’s vision of cooperative and competitive
federalism.
• The necessary, indeed vital, encompassing of cities and
other local bodies within the embrace of cooperative and
competitive federalism is the next policy challenge.