Finance Commission is a constitutional body under Article 280. The President of India is mandated to appoint a Finance Commission every five years or sooner. It sets the mechanism and formula for allocating tax revenues between the Centre and states, as well as among states, in accordance with the Constitution and current needs. In November 2017, the President of India appointed the 15th Finance Commission, under the chairmanship of NK Singh. It will make suggestions for a five-year period, from 2021-22 to 2025-26. 

There have been questions on the topic of the Finance Commission in the UPSC exams earlier. This article is useful for Prelims 2023 preparation and UPSC Mains 2023 as well.

Finance Commission

• Article 280 of the Constitution of India provides for a Finance Commission as a quasi judicial body. 
• It is constituted by the president of India every fifth year or at such an earlier time as he considers necessary.
• Role of Finance Commission: To give its recommendations on distribution of tax revenues between the Union and the States and amongst the States themselves. 
• Article 281 of the Indian Constitution related to the recommendation of the Finance Commission.
• Two distinctive features of the Finance Commission:
  • Redressing the vertical imbalances between the taxation powers and expenditure responsibilities.
  • Equalisation of all public services across the States.
• Note: State Finance Commission for the States of India are constituted under the Constitution 73rd Amendment Act, 1992 to look after the matter of local governments.

Finance Commission - Composition

• The Finance Commission is made up of a chairman and four additional members appointed by the president. 
• They serve for the duration set by the president in his order. They are eligible for re- appointment. 
• Qualification: The Constitution empowers Parliament to set the qualifications of commission members and the way in which they should be chosen. 
• As a result, the qualifications of the chairman and members of the commission have been set by Parliament.
• The chairperson should be someone with public affairs expertise, and the four other members should be chosen from the following:
  • A judge of the high court or one qualified to be appointed as one.
  • A person who has specialised knowledge of finance and accounts of the government.
  • A person who has wide experience in financial matters and in administration.
  • A person who has special knowledge of economics.
• Disqualification: Members may be disqualified if they are found to be of unsound mind, have committed a heinous act, or have a conflict of interest.

Tenure of Finance Commission

• The President of India specifies the term of office for Members of the Finance Commission, they are normally appointed for five years, and in some situations, the members are re-appointed.
• The members must contribute part-time or volunteer service to the Commission as the President directs.
• Before the five-year period expires, the President can appoint a Finance Commission if he deems it essential.

Functions of the Finance Commission

It is the duty of the Commission to make recommendations to the President as to:

• The distribution between the Union and the States of the net proceeds of taxes which are to be, or maybe, divided between them and the allocation between the States of the respective shares of such proceeds.
• The principles which should govern the grants-in-aid of the revenues of the States out of the consolidated fund of India.
• The measures needed to augment the Consolidated Fund of a state to supplement the resources of the Panchayat in the State on the basis of the recommendation made by the Finance commission of these states.
• The measures needed to augment the Consolidated Fund of a state to supplement the resources of the Municipalities in the State on the basis of the recommendation made by the Finance commission of these states.
• Any other matters referred to the Commission by the President in the interests of sound finance.
• The Commission determines its procedure and has such powers in the performance of their functions as Parliament may by law confer on them.

Implementation of the Recommendations of Finance Commission

• The Finance Commission submits its report to the President. The report of the Finance Commission is then led by the President before each the House of Parliament for its consideration. The recommendations of the Finance Commission are implemented as under:
• These to be implemented by an order of the President: The recommendations relating to distribution of union taxes and duties and grants-in-aid fall in this category.
• Those to be implemented by Executive orders: The recommendations in respect of sharing of profit Petroleum, Debt relief, mode of central assistance, etc.
• The recommendations made by the Finance Commission are of an advisory nature only and therefore, not binding upon the government. It is up to the Government to implement its recommendations on granting money to the states.

Finance Commission - Historical Background

• The basic draft of the provisions of the finance commission of India was made in the early 1920s, to consolidate the business dominance of the British Rule in India.
• Dr. B.R. Ambedkar, the then-law minister, established the first Finance Commission under the Chairmanship of Shri K.C. Neogy in 1952 to rectify these inequalities.
• It was established based on the drafted Acts and Rules.
• Several measures in the Indian Constitution were previously incorporated to bridge the fiscal divide between the Centre and the States, including Article 268, which allows the Centre to impose duties but empowers the States to collect and retain them.

List of the Finance Commission

Conclusion

The role of Finance Commission had been subordinated with the establishment of Planning Commission, for planning commission, apart from planning the development layouts of the country, has taken the role of financial allocation to the states. To correct this anomaly, the Union Cabinet institutionalized NITI Aayog replacing the erstwhile Planning Commission. Shutting down the Planning Commission and greater acceptance of recommendation of 15th Finance Commission to devolve 41% of the taxes to the States is a positive move towards the decentralisation of finance.

FAQs

Q1: What is the primary role of the Finance Commission in India?

Q2: How often is the Finance Commission constituted?

Q3: What factors does the Finance Commission consider in its recommendations?

Q4: Who appoints the members of the Finance Commission?

Q5: What are some key recommendations made by previous Finance Commissions?

MCQs

1. How frequently is the Finance Commission constituted in India?

(a) Every year

(b) Every two years

(c) Every five years

(d) Every ten years

2. Who has the authority to appoint the Finance Commission in India?

(a) Prime Minister

(b) Finance Minister

(c) President

(d) Chief Justice

3. What was a significant recommendation of the 14th Finance Commission?

(a) Decrease in state tax share

(b) Increase in central taxes

(c) Increase in state's share of central taxes to 42%

(d) Abolishing the Finance Commission

4. Which of the following factors is NOT considered by the Finance Commission in its recommendations?

(a) Population of states

(b) Income levels

(c) Political stability

(d) Economic disparities

5. What is one of the primary functions of the Finance Commission?

(a) Create new taxes

(b) Assess financial needs of states

(c) Appoint state governors

(d) Regulate the stock market

GS Mains Questions and Answers

Q1: Discuss the significance of the Finance Commission in maintaining fiscal federalism in India.

Answer: The Finance Commission plays a crucial role in maintaining fiscal federalism in India by ensuring equitable distribution of financial resources between the central and state governments. By assessing the financial needs of states and recommending tax revenue sharing, it helps in reducing economic disparities and fostering balanced regional development. This institutional framework enables states to function effectively by providing them with the necessary financial resources to implement developmental programs and services. Moreover, the Finance Commission's recommendations are vital in promoting cooperative federalism, as they encourage collaboration between different levels of government. Overall, the Finance Commission serves as a mechanism for promoting fiscal discipline and ensuring that fiscal responsibilities are managed effectively across the federation.

Q2: Analyze the challenges faced by the Finance Commission in its functioning.

Answer: The Finance Commission faces several challenges in its functioning, including the dynamic economic environment and changing fiscal needs of states. One significant challenge is the disparity in revenue-generating capacities among states, leading to unequal access to financial resources. Additionally, the commission must navigate political pressures from states advocating for greater financial support and the need to balance these demands with the fiscal constraints of the central government. Moreover, the rapidly evolving economic landscape, influenced by factors such as inflation, global economic shifts, and socio-political changes, complicates the commission's ability to provide accurate and timely recommendations. The increasing need for specialized knowledge to address emerging issues such as climate change, technological advancements, and health crises further adds to the complexity of its mandate.

Q3: Evaluate the impact of the recommendations of the Finance Commission on state economies.

Answer: The recommendations of the Finance Commission significantly impact state economies by shaping the financial framework within which states operate. By recommending the distribution of tax revenues and grants-in-aid, the commission enables states to finance essential services such as education, health, and infrastructure development. For instance, the increase in the share of central taxes, as recommended by the 14th Finance Commission, provided states with additional resources to address their fiscal needs and invest in development projects. These recommendations promote fiscal sustainability and encourage states to improve their tax collection efforts. Furthermore, the commission's focus on equity ensures that financially weaker states receive adequate support, thereby contributing to regional development and reducing disparities. Overall, the Finance Commission plays a vital role in enhancing the fiscal capacities of states, leading to improved economic outcomes and overall national development.

Previous Year Questions on  Finance Commission

1. UPSC CSE Prelims 2021

Question: Which of the following is a function of the Finance Commission in India?

(a) Determine the tax policy of the government

(b) Recommend the distribution of taxes between the Centre and the states

(c) Audit the accounts of the government

(d) Formulate the budget of the government

Answer: (b) Recommend the distribution of taxes between the Centre and the states

Explanation: One of the primary functions of the Finance Commission is to recommend the distribution of tax revenues between the central and state governments.

2. UPSC CSE Mains 2020

Question: "The Finance Commission is vital for fiscal federalism in India." Discuss this statement with examples.

Answer: The Finance Commission is essential for maintaining fiscal federalism in India, serving as a crucial link between the central and state governments in the financial framework. By assessing the revenue needs and recommending the distribution of resources, the Finance Commission ensures that states have adequate funding for essential services. For instance, the recommendations of the 14th Finance Commission, which raised the states' share of central taxes from 32% to 42%, significantly enhanced the fiscal capacity of state governments. This increase enabled states to invest in infrastructure, healthcare, and education, contributing to balanced regional development. Additionally, the Finance Commission addresses disparities in financial resources, ensuring that economically weaker states receive necessary support. This equitable distribution fosters cooperation between different levels of government, reinforcing the principles of fiscal federalism in India and enabling the country to address regional disparities effectively.