Comprehensive Study Material

Introduction to Finance Commission

The Finance Commission (FC) is a constitutional body established under Article 280 of the Indian Constitution. It is formed every five years (or earlier if needed) to address fiscal imbalances between the Centre and the States, ensuring equitable distribution of financial resources. The FC acts as a mechanism for cooperative federalism by recommending how taxes and grants should be shared. Its recommendations are advisory but hold significant weight and are generally implemented. The first FC was constituted in 1951, and as of 2025, the 16th FC is operational under Chairman Arvind Panagariya.

Key Constitutional Provision: The President constitutes the FC to make recommendations on:

• Distribution of net proceeds of taxes between Union and States.
• Principles governing grants-in-aid to States.
• Measures to augment the Consolidated Fund of States.
• Any other fiscal matter referred by the President.

This body plays a crucial role in maintaining fiscal federalism, especially in a diverse economy like India’s.

Appointment of Finance Commission

• The Finance Commission is appointed by the President of India under Article 280.
• It is typically constituted every five years, but the President can appoint it earlier if deemed necessary.
• The appointment is formalized through a Presidential Order, specifying the Terms of Reference (ToR).
• Members are selected based on qualifications outlined in the Finance Commission (Miscellaneous Provisions) Act, 1951.
• The Chairman and members hold office for the period specified in the Presidential Order and are eligible for re-appointment.
• The process is executive-driven, leading to occasional debates on potential partisanship, as the Centre influences selections. However, the Act ensures members are eminent experts to maintain impartiality.

Exam Tip: Remember the mnemonic P-A-R-T-Y for appointment: President Appoints, Recommendations every 5 years, Terms of Reference, Year-specific order.

Composition of Finance Commission

As per the Finance Commission Act, 1951:

• Chairman: A person with experience in public affairs (often a former bureaucrat, economist, or RBI Governor).
• Four Other Members:
• One qualified to be a High Court Judge.
• One with specialized knowledge of government finances and accounts.
• One with wide experience in financial matters and administration.
• One with special knowledge of economics.
• The Commission may have a Secretary (usually a senior IAS officer) to assist.
• All members are appointed by the President and can be reappointed.

Key Fact: The composition ensures a balance of legal, financial, administrative, and economic expertise for unbiased recommendations.

Position	Qualification/Requirement
Chairman	Experience in public affairs
Member 1	Qualified as High Court Judge
Member 2	Knowledge in finance/accounts of government
Member 3	Experience in financial matters and administration
Member 4	Special knowledge of economics

Exam Tip: Focus on the diversity in expertise—questions often test if you know the Act’s provisions.

Roles and Functions of Finance Commission

The FC’s primary role is to recommend fiscal transfers to reduce vertical (Centre-State) and horizontal (among States) imbalances. Key functions (Article 280):

1. Tax Devolution: Recommend the share of net proceeds of Union taxes to be distributed between Centre and States, and allocation among States.
2. Grants-in-Aid: Principles for grants from the Union’s Consolidated Fund to States needing assistance (under Article 275).
3. Augmentation of State Funds: Measures to supplement resources of Panchayats and Municipalities based on State Finance Commissions’ recommendations (post-73rd and 74th Amendments).
4. Other Matters: Any additional fiscal issues referred by the President, e.g., disaster relief, debt management.
5. Review and Advice: Assess fiscal health of Union and States, suggest reforms for sustainable finances.

Non-Roles: FC does not deal with Plan/Non-Plan distinctions (abolished post-2017) or permanent changes to tax structures—that’s for Parliament/GST Council.

Exam Tip: Distinguish from Planning Commission (now NITI Aayog)—FC is constitutional and quasi-judicial, while NITI is advisory.

Procedures of Finance Commission

• Formation: President issues an order with ToR; Commission starts work immediately.
• Consultations: Holds meetings with Union/State governments, experts, and stakeholders. Visits States for on-ground assessment.
• Data Analysis: Uses data from Census, economic surveys, and fiscal reports to devise formulas (e.g., population, income distance, area, forest cover for horizontal devolution).
• Report Submission: Submits a report to the President, who tables it in Parliament with an Action Taken Report (ATR).
• Implementation: Recommendations effective from the date specified (usually April 1). Centre accepts most, but can modify via Parliament.
• Duration: Operates for 1-2 years; report covers 5 years.
• Transparency: Proceedings are public; reports are published on the official website (fincomindia.nic.in).

Key Procedure Insight: The FC uses a formula-based approach for fairness, e.g., 15th FC used 2011 Census data.

Exam Tip: Questions may ask about ToR evolution—recent ones include demographic performance, disaster funds.

14th Finance Commission (2015-2020)

• Chairman: Dr. Y.V. Reddy (former RBI Governor).
• Members:
• Prof. Abhijit Sen (Economist, Planning Commission member).
• Ms. Sushma Nath (Former Finance Secretary).
• Dr. M. Govinda Rao (Economist, NIPFP Director).
• Dr. Sudipto Mundle (Economist, former NIPFP).
• Secretary: Ajay Narayan Jha.

Key Recommendations:

• Tax Devolution: Increased States’ share from 32% (13th FC) to 42%—highest ever jump to empower States.
• Horizontal Devolution Formula: Population (17.5%), Demographic Change (10%), Income Distance (50%), Area (15%), Forest Cover (7.5%).
• Grants: ₹2.87 lakh crore for local bodies (Panchayats: 90%, Municipalities: 10%); revenue deficit grants to 11 States.
• Other: No sector-specific grants; encouraged fiscal discipline; suggested restructuring Centrally Sponsored Schemes.
• Impact: Boosted State autonomy; reduced dependence on Centre. Covered period amid GST introduction (though GST was post-report).

Exam Tip: Highlight the 10% increase in devolution—key for UPSC questions on fiscal federalism.

15th Finance Commission (2021-2026)

• Chairman: N.K. Singh (Former IAS, Expenditure Secretary).
• Members:
• Ajay Narayan Jha (Former Finance Secretary).
• Prof. Anoop Singh (Adjunct Professor, Georgetown).
• Dr. Ashok Lahiri (Economist, former Chief Economic Adviser).
• Prof. Ramesh Chand (NITI Aayog member, part-time).
• Secretary: Arvind Mehta.

Key Recommendations:

• Tax Devolution: States’ share at 41% (adjusted from 42% due to J&K reorganization; 1% for UTs).
• Horizontal Devolution Formula: Population (15%, using 2011 Census), Demographic Performance (12.5%), Income Distance (45%), Area (15%), Forest/Ecology (10%), Tax Effort (2.5%).
• Grants: ₹2.94 lakh crore for local bodies; revenue deficit grants to 17 States (₹2.94 lakh crore); sector-specific grants for health, education; disaster management funds.
• Other: Recommended high-powered group to review FRBM Act; performance-based incentives for States; focus on post-COVID recovery.
• Extension: Originally 2020-2025; extended to 2026 due to pandemic.

Impact: Emphasized demographic management and ecology; addressed urban/rural funding gaps.

Exam Tip: Note the introduction of ‘Demographic Performance’ criterion to reward States controlling population growth.

Comparison Between 14th and 15th Finance Commissions

Aspect	14th FC (2015-2020)	15th FC (2021-2026)
Chairman	Y.V. Reddy	N.K. Singh
States’ Share in Taxes	42%	41% (1% for UTs)
Population Weight in Formula	17.5% (1971 Census) + 10% change	15% (2011 Census) + 12.5% performance
Key New Criterion	Forest Cover (7.5%)	Tax Effort (2.5%), Forest/Ecology (10%)
Local Body Grants	₹2.87 lakh crore	₹4.36 lakh crore (including performance grants)
Revenue Deficit Grants	To 11 States	To 17 States
Focus Areas	State empowerment, fiscal consolidation	Post-COVID recovery, health, disaster resilience
Major Innovation	No conditional grants	Sector-specific and performance incentives

Exam Tip: Use this table for quick revision—questions often compare devolution percentages and criteria shifts.

Key Takeaways for Competitive Exams (e.g., UPSC, SSC)

• Mnemonic for Functions: T-G-A-M (Tax devolution, Grants-in-aid, Augmentation of funds, Matters referred).
• Trend: Devolution increasing over time (13th: 32%, 14th: 42%, 15th: 41%).
• Criticisms: Perceived Centre bias in appointments; horizontal formula debates (e.g., Southern States vs. population-based Northern).
• Current Relevance: 16th FC (2026-2031) focuses on new challenges like AI, climate change—stay updated via official site.
• Practice Questions:

1. Discuss the role of FC in cooperative federalism.
2. Compare tax devolution in 14th vs. 15th FC.
3. Explain horizontal devolution criteria evolution.

For more updates, visit fincomindia.nic.in. “
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