• Quasi-judicial
• Constituted by prez every 5 year
• Composition
  • Chairman and 4 members
  • Prez decides tenure
  • Eligible for reappointment
  • Qualification decided by parliament
    • Chair - Experience in public affairs
    • Members - High court judge or qualified, knowledge in finance, experience in finance, knowledge in economics
  • Function - revenue distribution
    • Distribution between centre and state
    • Distribution between states
    • Grand in aids
    • Measure to augment LSB funds
    • Any other matter referred by prez
    • Submits recommendations and actions taken to prez who then submits it in parliament
  • Advisory role
    • Not binding
  • Impact on PC
    • Undermined by non constitutional PC

Finance commission

//notes for mains and optionals

FC's are appointed in a country which has a federal setup and there is fiscal imbalance since the division of resources generally favours centre, so as to achieve macroeconomic stability and growth. However, later on, the problem of distribution comes up. Therefore this imbalance has to be corrected both vertically and horizontally i.e allocation between C&S and S&S.

In India as per A280 F.C's are appointed once in 5 years. They do not work permanently. Their magic lies in their disappearance. Its work is quasi-judicial (they need to judge what criteria needs to be taken in consideration, deliberate what weightage needs to be given, they need to strike a balance between equity and efficiency. Therefore F.C's composition reflects its diverse and broad based character. Members are drawn from judicial backgroudn, public finance and knowledge of economics.

In Indian context F.C's challenges are more because of regional disparities. e.g Bihar GSDP is around 4000 crores while Punjab's GSDP is around 23000 crores. Therefore F.C being a constitutional body has to balance equity and efficiency. i.e fairness and objective and economic rationality.

Earlier F.C's use to have a gap-filling approach. i.e greater the underdevelopment greater the allocation. This was opposed by performing states. Therefore every F.C comes up evolves a unique formula and allocation design which is in sync with contemporary realities. People's aspirations and financial position.

Additional terms of reference can be given to F.C by President. F.C's basic functions are vertical allocation, horizontal allocation and reviewing financial positions of LSG (Post 73^rd and 74^th amendments) and recommend grants to states.

Planning Commission and Finance Commission

Chronologically P.C originated before F.C. It was a high power body headed by P.M and therefore enjoyed significant power although it was not a constitutional body. It was concerned with planning initially but it slowly took the role of agency recommending discretionary grants to states. Therefore F.C voluntarily restricted itself to consumption expenditure/revenue expenditure and statutory grants. This lead to an artificial distinction between planned and non-planned i.e capital expenditure by PC and current expenditure by FC. This blurred accountability and performance measurement. Also, the PC was a permanent body while FC came once in 5 years. Therefore PC exercised a dominant role while FC comparatively a lesser role. States were critical of this approach. Since PC's transfers were politicised but centre justified P.C's role in recommending grants to state that it is a technical and expert body and Hence it is competent to advise on transfers from Centre to state in form of grants, giving support to states, planned activities.

14th Finance Commission

It was required to take up a comprehensive view on C & S financial Relations - Review and reform existing allocations and transfers including the design of transfers to minimize discretion, avoid duplication and promote co-operative federalism. Since PC was dismantled, it would undertake a comprehensive review without any plan and non-plan distinction.

Analyse C & S financial position and borrowing requirements. Has given emphasis to symmetry, trust, comprehensiveness and continuity with change. Recognized although three levels - C,S,LSG differ w.r.t scope and perspective - all three are equally endowed with wisdom, knowledge, effectiveness and integration in sync with tasks given to them by constitution.

Recognise the need for increasing trust cooperation and competition among the three levels, has recognised centre is in position to enforce fiscal rules on states but there is no effective institutional arrangement to enforce fiscal responsibility and make them stick to targets and achieve outcomes.

Comprehensively reviewed all transfers including those made outside FC(e.g CSS and discretionary grands which were given on the basis of PC's recommendations and has commented on the multiplicity, duplicity and restrictive nature of transfers.

Vertical Allocation

Recognised the need for more fiscal space to states which had been a traditional demand yet it had to balance fiscal space of centre also. Therefore allocation is equal to 42% to states and 58% to centre.

Even in this tax devolution is the primary mode of allocation - taxes are formula-based and predictable while grants are generally lump sum and tied to conditionalities imposed by the centre.

Effectively 68% = 42% + 26%(other forms) of resources are to be transferred to states. But more than a quantum shift, it is more of a quality shift since the max allocation is through tax and not through grants. It also addresses state grievances w.r.t non-sharing of cess.

Horizontal allocation

No distribution made between special category and general category state. Before 14th FC general criteria was

• Needs of the state e.g based on area and population
• Capacity - Fiscal Capacity
• Caused disability e.g lack of infra
• Efficiency e.g fiscal discipline (Revenue-Expenditure)

14th Finance Commission criteria for horizontal allocation

• Population - As per 1971 census (TOR - Terms of reference) - 17.5% weightage
• Demographic change - ( so as to capture trends) e.g migration as per 2011 census - 10%
• Area of the state - 15%
• Forest Cover - 7.5% - TOR ecology was one of the consideration
  • Thus larger forest cover gives ecological benefits but it also imposed a disability on the state, since it reduces the area of economic activities. It is a public good and hence there is a need to pressure and expand it since it is also a part of India international obligations on part of environmental matters. It will also take care of some of the states losing revenue because of the withdrawal of special category states esp. NE states
• Backwardness / Income distance / Distance from the state with the highest per capita income = 50%
• Top 6 states in percentage allocation terms
  • UP - 17.9%
  • Bihar - 9.6%
  • MP - 7.5%
  • WB - 7.3%
  • MH - 5.5%
  • Rajasthan - 5.4%

Other recommendations of 14th FC

1. Three types of grants have been given
   • Revenue deficit Grants - ( Revenue minus Expenditure ) anticipated looking at post-2020 situation of the states. 11 states qualify for the grants - NE, HP, WB, Kerala, JK and AP
   • Local Body Grants
   • Disaster Management - For the creation of DM infra

There are no special category grants and no state-specific grants and no grants which are linked to conditions. State-specific grants and sector-specific grants are better identified by states themselves and in any case, the state wanted flexibility and greater allocation through tax. Also, there is time-lag between the announcement of grants and their disbursed which may alter the very nature of demand itself.

2. It has considered institutional arrangements between C&S and has recommended for evolving a new institutional arrangement for
   1. Identifying sector in states which need central grants
   2. Indicate criteria
   3. Help to design schemes with appropriate flexibility to states
   4. Identify and provide area-specific grants
   5. Identify and recommend resources for interstate infra in NE states
   6. Integration of economic and environmental decision making

Interstate council can be expanded to perform the above function - it is headed by PM and Union ministers and state CMs as members. Therefore it can become a forum for D3, strategizing, giving directions for the national economy. Set national priorities through negotiation bargaining, evolving consensus and exchanging experience and expertise. It will help the disadvantaged state to compete with other states. It can monitor and provide incentives which can strengthen their capabilities. It can induct domain experts and can have a consultation with them. Therefore expand energize interstate council.

3. Need an independent fiscal council to provide an advanced assessment of impact of fiscal policy and fiscal implication of budget which will improve the quality of fiscal decision making
4. Have suggested measures w.r.t pricing of public utilities (electricity, water, transport) have suggested measure for ring fencing (insulation)
5. Recommended measures for improving PFM - Public Finance Management esp public expenditure management. Has recommended measures w.r.t PSUs

Why is 14th FC a watershed ?

The tone and approach of 14th FC is cooperative federalism emphasizing trust competitiveness and collaboration, among different levels of govt.

Fiscally empowered states - 42% + 26%. Greater through tax and lesser through grants. Therefore freedom flexibility to states. Greater quality shifts rather than a quantum shift.

Comprehensive review - No plan and non-plan distinction. It has considered all kinds of transfers. PC has given way to NITI AAYOG

Greater predictability, consistency - assured flow of funds to states. Has not greatly reduced fiscal space with centre. Centre will compensate it through reducing its CSS expenditure. New criteria of forest cover -Green incentive.

No special category distinction - State gets more as entitlement rather than depend on discretionary grants by centre. Has captured new reality in Public Finance Management - LPG, fiscal responsibility and Budget Management Act, GST, Roel of PSUs and pricing of public utilities.

Suggested measures for cooperative federalism - expanding interstate council.

New trends in C&S Financial Relations

• The recommendation of 14^th FC and its acceptance by centre.
• PM in his letter to CM
  • Increased devolution should improve financial prudence and discipline
  • Take a fresh look at previous schemes and programmes
  • Promised central support for any additional requirements
  • Evaluate performance rigorously
  • Establish performance rigorously
  • Establish quality bench mark
  • Speedy execution
  • Resources are not and will not be a problem. The issue is direction and the intent of our policies and the capacity to implement.
  • Maximise the outcome of every rupee spent
  • Improve the ease of doing business
  • Have a apex level officer coordinate ensure single window clearance
  • Focus on employment generation, poverty elimination and skill development
• Creation of NITI AAYOG
• Revision of royalty rates of minerals ( to states where mined )
• Inclination to let the states reform laws .e.g (Rajastan took a lead on labour reforms)
• Team India approach - CM seen as partners in progress rather than passive recipients
• Emphasis on cooperation and competition. e.g New Index to rank states on ease of doing business. e.g Jharkhand traditionally considered as laggard has improved its governance and figures in top 5
• New found engagement between C&S show easing potential of states at global forum. ( WEF - World Economic Forum)
• GST - Opportunity for India to have one country, one market and one tax but it needs a golden / grand bargain (13th FC), which will bring Indian on par with Global best practices. It will improve smart, avoid dual taxes and bring C&S closer.

Public Finance Management

• Attempt to delink planning from budgeting
• Focussing on outcomes rather than outlays
• Real time info sharing (PRAGATI) among different level of government.

Read More of centre-state finances