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Finance Commission
6.1 Constitutional Basis
Article 280 mandates the President to constitute a Finance Commission every five years (or earlier). Its function is to recommend:
- Distribution of net tax proceeds between Centre and States (vertical devolution)
- Allocation of states' share among individual states (horizontal devolution)
- Grants-in-aid to states in need of assistance (Art. 275)
- Any other financial matter referred by the President
The FC is a constitutional body, not a statutory body, and its recommendations are generally accepted by the government — though not legally binding.
6.2 Finance Commissions — Key Facts
| FC | Chairman | Period | State Share (Devolution) | Key Feature |
|---|---|---|---|---|
| 1st FC | K.C. Neogy | 1952-57 | 55% income tax | First FC; established principles |
| 10th FC | K.C. Pant | 1995-00 | 26% | Introduced principle grants |
| 12th FC | C. Rangarajan | 2005-10 | 30.5% | Revenue deficit grants for states |
| 13th FC | Vijay Kelkar | 2010-15 | 32% | GST transition roadmap |
| 14th FC | Y.V. Reddy | 2015-20 | 42% (highest ever) | Record devolution; States' autonomy |
| 15th FC | N.K. Singh | 2020-25 | 41% | Minus 1% for J&K; performance grants |
| 16th FC | Arvind Panagariya | 2026-31 | TBD | Constituted Dec 2023; report by Oct 2025 |
6.3 Horizontal Devolution Criteria (15th FC)
How the 41% is distributed among states:
| Criterion | Weight |
|---|---|
| Income Distance (poverty proxy) | 45% |
| Population (2011 Census) | 15% |
| Area | 15% |
| Forest & Ecology | 10% |
| Tax & Fiscal Effort | 2.5% |
| Demographic Performance (TFR reduction) | 12.5% |
The "Demographic Performance" criterion rewards states that controlled population growth — favoring south Indian states (Kerala, Tamil Nadu, Andhra) over north Indian states (UP, Bihar). This created political controversy as south Indian states argued they were being penalised for development.
6.4 Vertical Devolution and Fiscal Federalism
Vertical Devolution Issues:
- States receive 41% of divisible pool — but Central schemes (Centrally Sponsored Schemes) come with matching conditions, reducing fiscal autonomy
- Central taxes outside the divisible pool (cesses, surcharges) have grown significantly — in 2022-23, cesses constituted ~22% of gross tax revenue but are NOT shared with states
- States and Finance Commissions have called for ending the practice of diverting revenue into cesses
Grants vs. Devolution:
- Statutory Grants (Art. 275): FC recommends grants for states that need financial assistance for adequate public services — based on assessed revenue gap
- Discretionary Grants (Art. 282): Central government's own scheme grants — not based on FC recommendations; can be conditional