In November 2017, the 15th Finance Commission (Chair: Mr N. K. Singh) was constituted to give recommendations on the transfer of resources from the centre to states for the five year period between 2020-25. In recent times, there has been some discussion around the role and mandate of the Commission. In this context, we explain the role of the Finance Commission.
What is the Finance Commission?
The Finance Commission is a constitutional body formed every five years to give suggestions on centre-state financial relations. Each Finance Commission is required to make recommendations on: (i) sharing of central taxes with states, (ii) distribution of central grants to states, (iii) measures to improve the finances of states to supplement the resources of panchayats and municipalities, and (iv) any other matter referred to it.
Composition of transfers: The central taxes devolved to states are untied funds, and states can spend them according to their discretion. Over the years, tax devolved to states has constituted over 80% of the total central transfers to states (Figure 1). The centre also provides grants to states and local bodies which must be used for specified purposes. These grants have ranged between 12% to 19% of the total transfers.
Over the years the core mandate of the Commission has remained unchanged, though it has been given the additional responsibility of examining various issues. For instance, the 12th Finance Commission evaluated the fiscal position of states and offered relief to those that enacted their Fiscal Responsibility and Budget Management laws. The 13th and the 14th Finance Commissionassessed the impact of GST on the economy. The 13th Finance Commission also incentivised states to increase forest cover by providing additional grants.
15th Finance Commission: The 15th Finance Commission constituted in November 2017 will recommend central transfers to states. It has also been mandated to: (i) review the impact of the 14th Finance Commission recommendations on the fiscal position of the centre; (ii) review the debt level of the centre and states, and recommend a roadmap; (iii) study the impact of GST on the economy; and (iv) recommend performance-based incentives for states based on their efforts to control population, promote ease of doing business, and control expenditure on populist measures, among others.
Why is there a need for a Finance Commission?
The Indian federal system allows for the division of power and responsibilities between the centre and states. Correspondingly, the taxation powers are also broadly divided between the centre and states (Table 1). State legislatures may devolve some of their taxation powers to local bodies.
The centre collects majority of the tax revenue as it enjoys scale economies in the collection of certain taxes. States have the responsibility of delivering public goods in their areas due to their proximity to local issues and needs.
Sometimes, this leads to states incurring expenditures higher than the revenue generated by them. Further, due to vast regional disparities some states are unable to raise adequate resources as compared to others. To address these imbalances, the Finance Commission recommends the extent of central funds to be shared with states. Prior to 2000, only revenue income tax and union excise duty on certain goods was shared by the centre with states. A Constitution amendment in 2000 allowed for all central taxes to be shared with states.
Several other federal countries, such as Pakistan, Malaysia, and Australia have similar bodies which recommend the manner in which central funds will be shared with states.
Tax devolution to states
The 14th Finance Commission considerably increased the devolution of taxes from the centre to states from 32% to 42%. The Commission had recommended that tax devolution should be the primary source of transfer of funds to states. This would increase the flow of unconditional transfers and give states more flexibility in their spending.
The share in central taxes is distributed among states based on a formula. Previous Finance Commissions have considered various factors to determine the criteria such as the population and income needs of states, their area and infrastructure, etc. Further, the weightage assigned to each criterion has varied with each Finance Commission.
The criteria used by the 11th to 14thFinance Commissions are given in Table 2, along with the weight assigned to them. State level details of the criteria used by the 14th Finance Commission are given in Table 3.
Grants-in-Aid
Besides the taxes devolved to states, another source of transfers from the centre to states is grants-in-aid. As per the recommendations of the 14th Finance Commission, grants-in-aid constitute 12% of the central transfers to states. The 14th Finance Commission had recommended grants to states for three purposes: (i) disaster relief, (ii) local bodies, and (iii) revenue deficit.
We wrote a piece for ibnlive.com on the major differences between the government’s Lok Pal Bill, 2011 and the Jan Lok Pal Bill drafted by Anna Hazare’s group. The note is reproduced below. The streets are witnessing a demand that the government’s Lok Pal Bill be replaced by the Jan Lok Pal Bill (JLP) as drafted by the team led by Anna Hazare. There are several significant differences between the two bills. In this note, we describe the some of these differences. (See here for more on the Lok Pal Bill). First, there is a divergence on the jurisdiction of the Lok Pal. Both bills include ministers, MPs for any action outside Parliament, and Group A officers (and equivalent) of the government. The government bill includes the prime minister after he demits office whereas the JLP includes a sitting prime minister. The JLP includes any act of an MP in respect of a speech or vote in Parliament (which is now protected by Article 105 of the Constitution). The JLP includes judges; the government bill excludes them. The JLP includes all government officials, while the government bill does not include junior (below Group A) officials. The government bill also includes officers of NGOs who receive government funds or any funds from the public; JLP does not cover NGOs. Second, the two Bills differ on the composition. The government bill has a chairperson and upto 8 members; at least half the members must have a judicial background. The JLP has a chairperson and 10 members, of which 4 have a judicial background. Third, the process of selecting the Lok Pal members is different. The JLP has a two stage process. A search committee will shortlist potential candidates. The search committee will have 10 members; five of these would have retired as Chief Justice of India, Chief Election Commissioner or Comptroller and Auditor General; they will select the other five from civil society. The Lok Pal chairperson and members will be selected from this shortlist by a selection committee. The selection committee consists of the prime minister, the leader of opposition in Lok Sabha, two supreme court judges, two high court chief justices, the chief election commissioner, the comptroller and auditor general, and all previous Lok Pal chairpersons. The government bill has a simpler process. The selection will be made by a committee consisting of the prime minister, the leaders of opposition in both Houses of Parliament, a supreme court judge, a high court chief justice, an eminent jurist, and an eminent person in public life. The selection committee may, at its discretion, appoint a search committee to shortlist candidates. Fourth, there are some differences in the qualifications of a member of the Lok Pal. The JLP requires a judicial member to have held judicial office for 10 years or been a high court or supreme court advocate for 15 years. The government bill requires the judicial member to be a supreme court judge or a high court chief justice. For other members, the government bill requires at least 25 years experience in anti-corruption policy, public administration, vigilance or finance. The JLP has a lower age limit of 45 years, and disqualifies anyone who has been in government service in the previous two years. Fifth, the process for removal of Lok Pal members is different. The government bill permits the president to make a reference to the Supreme Court for an inquiry, followed by removal if the member is found to be biased or corrupt. The reference may be made by the president (a) on his own, (a) on a petition signed by 100 MPs, or (c) on a petition by a citizen if the President is then satisfied that it should be referred. The President may also remove any member for insolvency, infirmity of mind or body, or engaging in paid employment. The JLP has a different process. The process starts with a complaint by any person to the Supreme Court. If the court finds misbehaviour, infirmity of mind or body, insolvency or paid employment, it may recommend his removal to the President. Sixth, the offences covered by the Bills vary. The government bill deals only with offences under the Prevention of Corruption Act. The JLP, in addition, includes offences by public servants under the Indian Penal Code, victimization of whistleblowers and repeated violation of citizen’s charter. Seventh, the government bill provides for an investigation wing under the Lok Pal. The JLP states that the CBI will be under the Lok Pal while investigating corruption cases. Eighth, the government bill provides for a prosecution wing of the Lok Pal. In the JLP, the CBI’s prosecution wing will conduct this function. Ninth, the process for prosecution is different. In the government bill, the Lok Pal may initiate prosecution in a special court. A copy of the report is to be sent to the competent authority. No prior sanction is required. In the JLP, prosecution of the prime minister, ministers, MPs and judges of supreme court and high courts may be initiated only with the permission of a 7-judge bench of the Lok Pal. Tenth, the JLP deals with grievance redressal of citizens, in addition to the process for prosecuting corruption cases. It requires every public authority to publish citizen’s charters listing its commitments to citizens. The government bill does not deal with grievance redressal. Given the widespread media coverage and public discussions, it is important that citizens understand the differences and nuances. This may be a good opportunity to enact a law which includes the better provisions of each of these two bills.
