Finance Commission: Role, Composition, and 15th FC Recommendations

Introduction

The Finance Commission is a constitutional body established under Article 280 of the Indian Constitution. It is constituted by the President of India every five years (or earlier if needed) to recommend the distribution of financial resources between the Union and the States, and among the States inter se. The Finance Commission is central to India's fiscal federalism, ensuring that revenue is equitably distributed in a federal polity where fiscal power is predominantly Union-centric while expenditure responsibilities are shared.

4.1 Constitutional Provisions

Article 280 mandates that the President shall constitute a Finance Commission within two years of the Constitution coming into force, and thereafter at the expiration of every fifth year or at such earlier time as the President considers necessary. The Commission consists of a Chairman and four members. Parliament by law determines the qualifications requisite for appointment and the manner of selection.

Article 281 requires the President to cause every recommendation made by the Finance Commission to be laid before each House of Parliament.

4.2 Functions of the Finance Commission

The Finance Commission makes recommendations on the following:

• Distribution of the net proceeds of taxes between the Centre and the States, and among the States themselves (vertical and horizontal devolution).

• Principles governing grants-in-aid to States from the Consolidated Fund of India.

• Measures to augment the Consolidated Fund of a State to supplement PRIs and ULBs based on State Finance Commission recommendations.

• Any other matter referred by the President in the interests of sound finance.

4.3 Vertical and Horizontal Devolution

Vertical devolution refers to the share of the total divisible pool of central taxes allocated to states collectively. Horizontal devolution refers to the criteria used to distribute this pool among individual states. The 15th FC retained the 41% share for states (slightly lower than the 42% recommended by the 14th FC, with 1% accounting for the newly formed Union Territories of J&K and Ladakh).

For horizontal devolution, the 15th FC used the following criteria:

• Income distance (45% weight) — states with lower per capita income get higher share.

• Population based on 2011 Census (15% weight).

• Area (15% weight).

• Forest and ecology (10% weight).

• Demographic performance (12.5% weight) — rewards states that reduced fertility rates.

• Tax and fiscal effort (2.5% weight).

4.4 Grants Recommended by the 15th Finance Commission

Post-devolution deficit grants: For states with deficit even after devolution.

Sector-specific grants were recommended for:

• Health: Rs 70,051 crore for 2021-26 for primary healthcare strengthening.

• Education: Rs 4,800 crore (2022-26) for improving learning outcomes.

• Agriculture: Rs 45,000 crore for sector transformation.

• Local Bodies: Rs 4.36 lakh crore for rural and urban local bodies.

• Disaster Risk Management: Continued the National and State Disaster Response Funds.

• Defence and Internal Security: First time, Rs 1.54 lakh crore recommended for modernisation over 2021-26 (non-lapsable fund).

4.5 Key Departures and Innovations of the 15th FC

The 15th FC introduced several notable innovations:

• Performance-linked grants for Million-Plus Cities tied to air quality improvement and urban service delivery.

• Urban local body grants: Only cities with population under 1 million get basic grants; larger cities must earn performance grants.

• Revenue deficit grants phased out — 17 states recommended for such grants with declining trajectory.

• Recommended a Medium-Term Expenditure Framework and Fiscal Consolidation Roadmap for states post-COVID.

• Recommended no grants to states that fail to constitute State Finance Commissions by March 2024.

Important Concepts

5.1 Divisible Pool

The divisible pool is the pool of central tax revenues (excluding cesses and surcharges) that is shared between the Centre and the States. Cesses and surcharges are retained entirely by the Centre, which is a major grievance of states. The growing proportion of cesses (e.g., Health and Education Cess, GST Compensation Cess) effectively reduces the divisible pool.

5.2 Fiscal Federalism and the Finance Commission

India follows an asymmetric federal structure where revenue-raising powers are concentrated with the Centre while spending responsibilities are shared. The Finance Commission corrects this vertical imbalance. Additionally, the horizontal imbalance among states (due to differences in per capita income, area, development indicators) is addressed through the devolution formula and grants.

5.3 State Finance Commissions

Article 243-I and 243-Y require states to constitute State Finance Commissions to recommend devolution to Panchayats and Urban Local Bodies. The 15th FC conditioned grants on states acting upon SFC recommendations, reinforcing the three-tier fiscal structure.

Current Relevance

The 15th Finance Commission period (2021-26) is ongoing. The 16th Finance Commission is likely to be constituted in 2025 and will cover the period from 2026-27 onwards. Key debates include:

• States' demand for 50% devolution from the divisible pool.

• Concerns over rising cesses and surcharges that bypass the divisible pool.

• The role of GST in reshaping Centre-State fiscal relations — states lost significant independent revenue sources post-GST.

• Fiscal stress on states post-COVID and the need for enhanced grants.

• Balancing equity (supporting poorer states) with efficiency (rewarding performing states).