The Finance Commission Report and Action Taken by Central Government

K.B. Saxena

Constitution of 15th Finance Commission

The most important aspect of Indian federalism which impacts the development and the economy is the distribution of resources (taxes and other revenues) between the union government and states. This being a conflictual matter, the Constitution assigns this task to an independent body, called the Finance Commission, the recommendations of which, by convention, are accepted by the union government and the states. Article 280 of the Constitution of India establishes the institution of a Finance Commission to define the financial relations between the union and the states after the completion of every fifth year or an earlier time. It consists of a chairman and four other members. Its function is to make recommendations to the President about the distribution of the net proceeds of taxes between union and states and also allocation of the same among states themselves as per their respective contribution to the corpus of taxes, define the grounds on which the government should allocate grants-in-aid of the revenues out of the consolidated fund of India, the measures needed to augment the fund of a state to supplement the resources of the municipalities and panchayats in the state on the basis of the recommendations made by the finance commission of the state, and any other matter referred to the Commission by the President in the interest of sound finance. The first Finance Commission was established in 1951. The Fifteenth Finance Commission was constituted on the 27th November, 2017 under the chairmanship of N.K. Singh. Its terms of reference (ToR) included a long list. The ToR that are mandatory in nature as per the Constitution are devolution of proceeds of taxes between centre and states (vertical devolution) and between states themselves, (horizontal devolution) the grants in aid of the revenues to states out of the consolidated fund of India, to local bodies and for disaster risk management and any other matter referred to it. The non-mandatory ToR for consideration of the Commission included measures to augment the consolidated fund of a state to supplement the resources of the pancha- yats and the municipalities in the State, review of the current status of finance, deficit, debt-levels and cash balance and fiscal discipline efforts of the union and the states, a fiscal consolidated road map, taking into account responsibility of the central government and state governments to adhere to appropriate debt and deficit levels and measures to foster higher inclusive growth. Other key issues for consideration which were assigned to the Commission included impact of enhanced tax devolution to states on the fiscal situation of the union government, impact of GST on the finances of centre and states, progress made by states in expansion and deepening of tax net under GST, efforts made in moving towards replacement rate of population growth, progress made in increasing tax revenues, promoting savings by adoption of direct benefit transfer and public finance management system and digital economy and progress made in sanitation and solid waste management. An additional ToR was given to the Commission in February, 2020 mandating it to suggest ways for allocation of a non lapsable fund for defence and internal security for which the tenure of the Commission was extended till November, 30, 2020.

Controversy Over Terms of Reference

The terms of reference (ToR) of the Finance Commission itself generated a lot of controversy even before it got down to work. This controversy centred around primarily three issues. The most important among them was that the Fifteenth Finance Commission was asked to use the 2011 census data while the 14th Finance Commission was required to use the 1971 census data for determining devolution of taxes, duties and grants-in-aid. The protest came from southern states as this was perceived to penalise them since they had achieved considerable success in population control. Use of 2011 census data, it was argued, would result in lower resources allocation to them and deny them reward for progress made in areas such as literacy, health, education and infrastructure. These states were also unhappy that distribution of resources would be based on performance in areas like deepening of GST net, boosting tax and non-tax revenues, promoting the digital economy and controlling expenditure on the populist measures which is difficult to define (Vikra- man, 2018). Socially disadvantaged states like Bihar with a higher load of population justified using 2011 census data as the use of population data of 1971 would ignore current reality and serve as a punishment to them. They also argued that not only southern states but other states were also trying to achieve a demographic transition and have made progress in this regard. In any case, the ToR already provides incentive for progress made by states in moving towards replacement rate of population growth which would reward southern states. Besides, principles of equity, efficiency and transparency which guide finance commission awards would demand using latest population figures to enable all geographical regions and segments of populations to get opportunities for improving their economic conditions (Ganguli & Sinha, 2020). Secondly, states were also critical of inclusion in the ToR performance based incentives in respect of implementing various programmes efficiently beyond those relating to fiscal responsibility, population and devolution to local bodies. This, in their view,is an attempt to micro-manage the fiscal domain of the states and impose the ideological agenda of the central government (Vijayan, 2021). Backward states like Bihar felt that given their poor infrastructure and the unskilled human resources, this would penalise them. It was argued that achievement of measurable performance should be applicable to not only state governments but also the central government (Ganguli and Sinha, 2020). The third issue was the mandate given to the Commission to suggest ways for allocation of non-lapsable fund for defence and internal security. This addition to ToR was opposed as it sought a separate allocation out of the total resources for defence and internal security before money is divided between the centre and states. This would reduce the fiscal space for states (Economic Times, 2017). It was an attempt by the union government to occupy more fiscal space and shrink the divisible pool of resources and squeeze the resources that states would get as untied funds (CBGA, 2021).

Of the three issues, the use of 2011 census was more emotive. The central government denied the criticism that this would penalise southern states. The then finance minister, Arun Jaitley clarified that the Finance Commission uses both qualitative and quantities criteria. Population figures served as a good proxy for the needs of the people in a quantitative sense while income distance captures relative poverty to provide qualitative analysis. The ToR balanced both the ‘needs’ and ‘progress’ towards population control. It also recognises efforts of all the states which have done well in population control. (Jaitley, 2018) Finance Commission responded to the raging controversy by setting up a six members (experts) council to advise and assist it on the ToR and help in broadening the commission’s ambit and understanding. The council’s function was ‘to advise the commission’ on any issue or subject related to ToR of the Commission which may be of relevance’. (Financial Express, 2018)

Extended Tenure of the Commission

The Commission’s report was due on 31st December, 2019. However, a variety of reasons which included steady decline in investment and savings rates, increasing unemployment, stressed banking sector assets and reduced revenue resources to finance development spending, especially in the social sector, subdued collection of GST, bifurcation of J&K into two union territories, which required extra time to deliberate, inclusion in the ToR of additional point whether a separate non-lapsable fund can be created for defence and internal security, election code of conduct to the Lok Sabha election in May 2019 affected commission’s work (Isaae et al, 2020). The tenure of the commission was extended by almost a year and it was asked to submit two reports, first for 202021 and then for the five year period 2021-22 to 2025-26. The latter report was expected to take into account the impact of Covid - 19 on the economy and provide sufficient fiscal space to states for recovery. The Commission’s award thus covers six year period instead of five years. The Commission’s first report for 2020-21 is not an interim report but a part of the final report. The first report for 2020-21 was tabled in Parliament in February 2020 and the final report was tabled in Parliament on February 1, 2021.

Key Recommendation – Vertical Devolution

The key recommendations of the first report 2020-21 virtually convey the approach and thinking of the Commission on the most meaty aspects of union-state fiscal relations. These include 1) quantum of devolution i.e., share of states in taxes collected by the centre 2) criteria of devolution among states and share of devolution based on it 3) grants-in- aid covering revenue deficit grants, grants to local bodies and for disaster risk management 4) recommendations on the fiscal road map etc. The second report for 2021-22 to 2025-26 broadly confirms this assessment. (Saket Surya, Feb., 2021) On the most important issue of quantum of share of states in taxes collected by the centre, ToR of the Commission had created an apprehension that the Commission may review the enhanced level of fiscal devolution of 42% tax proceeds awarded by the 14th Finance Commission. This apprehension has been belied. The Commission has fixed tax devolution at 41% of the divisible pool of union taxes, (it was 42% in the 14th Finance Commission). The reduction of 1% is on account of bifurcation of Jammu and Kashmir State into two union territories. (P18, 2021) Thus, the level of the vertical tax devolution has not been changed by the Commission ‘in order to maintain the predictability and stability of resources, especially during the pandemic’. (Isaac et al, 2019) The Commission, however, did not accede to the demand of states for a 50% share of total taxes from divisible pool. But the central government has been trying to curtail state’s share of resources and to have a higher share of taxes for itself by imposing cesses and surcharges which are not included in the divisible pool. In recent years, these cesses and surcharges account for more than 12% of gross tax revenue of the centre. Thus, in real terms, states are getting only 34% of the gross tax revenue against the awarded 41% of the divisible pool by the Finance Commission. (PIB, 2021) States resent use of these cesses and surcharges to collect revenues by the central government as it deprives them of their rightful share of national resources. States expected a higher share of devolution (more than 10%) by taking these cesses and surcharges into account. The commission, however, has ignored this concern. Thus, the Finance Commission award has ended up by giving central government 66% of the estimated gross revenue receipts to spend on national development priorities. It is for this reason that the states, faced with paucity of resources, keep asking for central funds to meet their development needs and other contingencies.

Horizontal Devolution

As for horizontal devolution, i.e., division of resources from state pool among states to determine their individual share, the Commission has adopted seven criteria. (Saket Surya, 2021) These are income distance [i.e. the difference of income of a state from the state with highest income] , area, population (2011 census), demographic, performance, forest and ecology, tax and fiscal efforts. Two new criteria have been added compared to the 14th Commission report. One is demographic performance, defined as the inverse of total fertility rate compared to that of the 1971 population. This mechanism has been devised to reward a state for successful implementation of the family planning policy and also to reduce the extent of loss in share due to use of 2011 population instead of 1971 population (Issac et al, 2020). This silences the critics of ToR of the Fifteenth Finance Commission that by using 2011 census data (rather than 1971 census data), southern states would be penalised. The second new criterion is tax and fiscal efforts. This criterion has been used to reward states which have achieved higher tax collection. The important aspect of criteria relates to the weightage given to each criterion. Though equity remains the dominant consideration in the assignment of weightage as 45% weightage has been given to income distance criterion, compared to the 14th Finance Commission, it is 5 points less. Weightage given to other criteria include 15% for population, 15% to the area, 10% for forest and ecology, 12.5% for demographic performance and 2.5% for tax efforts. In assignment of weightage, the Commission has sought to achieve a balance between fiscal needs - population, area, forest (at 40%) and fiscal capacity (income distance, tax efforts) (at 47.5%). The increase in assignment of weight to forest and ecology from 7.5% in the 14th Finance Commission to 10% and expansion of its ambit to cover ecology which would in include besides forests, preserving water bodies and coastal zones, biodiversity hotspots indicates Commission’s effort towards ‘checking degradation of environment resources leading to climate change’ (Isaac et al, 2020). Based on this exercise, the share of taxes recommended by the 15th Finance Commission as compared to the 14th Finance Commission for eight states has reduced. These states are AP, Assam, Karnataka, Kerala, Odisha, Telangana, and Uttar Pradesh. In some of these states, the decline in share is marginal but for Karnataka, Telangana and Kerala, the decline is significant. (around 22% in respect of Karnataka and Kerala and 12% for Telangana) (Saket Surya, 2021)

Grants-in-aid for Revenue Deficit States

The second category of financial devolution is grants-in-aid to states which are over and above the horizontal devolution of central taxes. One of these grants is Revenue Deficit Grants which are given to states to cover the shortfall in assessed post devolution deficit of states. Central government had asked the Commission to review usefulness of continuing with this grant. Even the 14th FC was also in favour of reducing this grant and had questioned the need to retain it. But the 15th Finance Commission has continued to allocate this grant and has given at to 17 States as against 5 by the 14th Commission. This was justified in order to prevent deterioration of fiscal position of these states (Isaac, et al, 2020). However, it has laid out a road map for decline of this grant from 17 states in 2020-21 to six in 2025-26 as also to reduce the grant amount. But this reduction in revenue deficit grant is contingent on the recovery of the economy.

The commission had also recommended ‘special grant’ to three states - Karnataka, Mizoram and Telangana to cover absolute shortfall in 2020-21 from total amount of tax devolution and revenue deficit grants in 2019-20 as such decline was not observed in the dispensation of any commission in the past. But in an unprecedented move, this recommendation was not accepted by the central government and was sent to back to the Commission for review on the ground that it introduced a new principle of devolution of resources from those laid down by the Constitution and the previous commissions. It was not appreciated that such a situation had not arisen by any commission earlier. This action of central government is unfair and unjustified and breaks the convention of accepting the recommendations of the Commission and undermines the stature of the institution’. (Reddy, 2021) it also does injustice to the three states.

Sector Specific Grants

The Commission also recommended grant amounting to Rs. 7,735 crore to all states for 2020-21 to augment their efforts for towards reducing and ultimately eliminating malnutrition. This recommendation too was not accepted and the central government asked the commission to review it and consider to as part of performance based incentivises for states as per the ToR. However, performance based incentive grants is not among the mandated functions of the Commission in terms of Art 280 and is only ‘ in the nature of the consideration’ which the Commission may consider or ignore. Therefore, the action of the central government of sending back the recommendation for review erodes the credibility of the institution and is viewed as a pressure on the Commission to change its approach. (Reddy, 2020) That this was so is evident from the fact that this recommendation was not included in the final report.

Performance Based Grants

Though the ToR of the Fifteenth Finance Commission enjoined it to propose performance based incentive grants in nine areas, and had chosen only six different areas in its report for 2020-21 for these incentives, however, in the final report, no separate category of performance based grants has been provided. Only sector specific grants has been provided a portion of which will be performance linked. The sector-specific grants and performance based grants have been clubbed together and Rs. 1.3 lakh crore has been allocated for this purpose. (PIB, 2021) Eight sectors have been identified for these grants. These are 1), health, 2), school education 3), higher education 4), implementation of agricultural reforms 5), maintenance of PMGSY (Pradhan Mantri Gram Sadak Yojna) roads, 6, judiciary, 7, Statistics, and 8, aspirational districts and blocks. In terms of resources allocated, of all the eight sectors included, health, agricultural reforms and maintenance of rural roads have received more than 3/4th of this grant.

State Specific Grants

Besides Sector specific grants, State specific grants of Rs. 49,559 has been provided. These will be given for i) social needs, ii) administrative governance and infrastructure, iii) water and sanitation iv) preservation of culture and historical monuments v) high cost physical infrastructure, and vi) tourism. The commission has recommended a high-level committee at state level to review and monitor utilisation of state specific and sector specific grants. While the intention in providing sector specific and state specific grants is to provide attention and resources for areas which remain neglected, experience has shown that whenever conditionalities are attached to release of grants, utilisation is low and funds remain with the central government. Besides, resources for conditional grants have the effect of reducing resources for tax devolution which is the primary mode of resources transfer to the states. (Issac et al, 2020). Therefore, from the view point of states, what is important is increase in the share of tax devolution which ensures fiscal autonomy to states and permits them to utilise the resources as per their needs and priorities. In any case, union government has remained non-committal in respect of these grants and has neither accepted sector specific grants nor state specific grants.

Grants to Local Bodies

One of the constitutionally mandated areas of resources transfer is grants to local bodies which have been allocated Rs. 4.36 lac crore. A portion of these grants is to be performance linked. Urban local bodies have been allocated A the amount given to rural local bodies. This is unfair as the rural local bodies need much higher portion of resources since they cater to larger area and population and also because urban local bodies have more resources of their own than rural local bodies. In the rural local bodies, as against the approach of the 14th FC to give these grants to Panchayats, 15th FC has given this grant to all three tiers of local bodies. While this would help better utilisation of funds (CBGA, 2021). The danger is that grass root level small projects may be neglected and Block / District level bodies may corner higher share due to larger projects. In urban local bodies, basic grants have been provided only for towns with less than 1 million population. For cities with more than one million population, grants are performance based. In the grant given to local bodies,Rs. 70,051 cr has been allocated specifically for strengthening of primary level health infrastructure such as conversion of rural sub centres & primary health centres (PHCs) to health and wellness centres (HWCS) ii) support for diagnostic infrastructure for primary health activities and iii) for urban health units. Grants to local bodies (other than health grants), will be distributed among states with 90% weightage given to population and 10% to the area. This weightage formula has ignored the importance of incentivising devolution from state governments to local bodies. This amount will be released subject to auditing of accounts and improvements in collection of property taxes by notification of a floor rate by 2021-22 with year wise improvement from 2022-23 onwards. States have also to constitute a State Finance Commission and act on its recommendations.

In respect of disaster risk management, the Commission has not changed the existing cost sharing pattern between centre and states which is 75: 25 for all states except for north eastern and Himalayan states which is 90:10. The corpus of disaster management fund would be 1.6 lakh crore.

Financial Management

On the subject of financial management, the Commission has provided a range of fiscal deficit and debt for both the union and states. For centre, it is 4% of GDP by 2025-26 and for states, it is 4% of GSDP in 2021-22, 3.5% in 2022-23, it is 3% during 2023-26. Unutilised sanctioned borrowing can be availed of in subsequent years. Additional borrowing of 6.5% of GSDP is permitted based on performance in power sector reforms. (Saket Surya, 2021) This condition attached to additional borrowing would prevent states to make use of this facility. Power sector reforms are a complex problem and insistence on their compliance is not helpful to states. The pressure to undertake suggested reforms is unlikely to work. As a result, states would be deprived of additional borrowing facility to have a higher deficit. The Commission has also recommended a new FRBM (Fiscal Responsibility and Budget Management Act) which prescribes mandatory ceiling on fiscal deficits and debt-to-GDP ratio for centre as well as states. While the existing FRBM law technically restricts the ability of both the centre and states to access borrowed resources, the central government has made use of an escape clause introduced through the 2018 FRBM amendment. But the states do not enjoy this liberty and their borrowing powers is tightly controlled by the central government. (Isace et al, 2020) This adversely impacts their spending ability and is particularly hurting in a situation of sharply decelerating growth, industry in recession, agriculture growth not picking up, high rates unemployment and loss of income when there is need for a larger fiscal space for development expenditure and more redistributive polices. Therefore, mandatory ceiling on fiscal deficits and debt-to-GDP ratios should give way to more liberalised framework of fiscal policies rather than resorting to fiscal conservatism. In view of the COVID severely damaging economy, stagnant consumption and declining investment along with moderate inflation, caused by Covid-19, relief has to be given to the poor and fiscal stimulus is required which cannot be financed with increasing taxes and financing expenditure by borrowing is the only option. This would also stimulate growth by boosting demand. The Commission’s recommendation for a new FRBM framework for centre and states would, it is hoped, provide for greater accommodation to the view point of states. A high powered inter-government group has been suggested to work out this new framework and oversee its implementation.

Centrally Sponsored Schemes

Another important recommendation of the Commission in respect of financial management relates to centrally sponsored schemes (CSS). The Commission was critical of proliferation of centrally sponsored schemes and their continuation without evaluation. Most of the schemes are in areas listed under the state list of the Constitution and therefore, violate the spirit of the Constitution. It recommended review of these schemes and their rationalisation so as to limit them to certain key sectors which have nationwide importance. It has made four specific suggestions 1) a threshold should be fixed for annual allocation to CSS below which funding for a CSS should be stopped with a view to phasing out CSSs which have outlived their utility. 2) third party evaluation of all CSSs should be completed within a stipulated time frame 3) funding pattern should be fixed upfront in a transparent manner and be kept stable 4) monitoring should be regular and include output and outcome indicators. (Saket Surya, 2021; PIB, 2021) In fact, as per union government’s decision of February, 2014 on-going centrally sponsored central sector schemes were made coterminous with Fourteenth Finance Commission and their continuation would be based on outcome review. It is not only the 15th Finance Commission but even the state governments have been opposing ever increasing number of centrally sponsored schemes. Yet almost every budget contains some new schemes. While the review, evaluation and rationalisation of these schemes is welcome, it would be unrealistic to expect a scheme to register impact within the life time of a finance commission since it takes a long time from the date of announcement of a scheme to start delivering. Therefore, there should be fewer schemes in key sectors as recommended by the Commission but their implementation would have to be watched over a longer period than the life time of a Finance Commission.

Non Lapsable Fund for Defence and Internal Security

As mentioned earlier, States were apprehensive that Union Government’s notification of an additional ToR in July 2019 about a separate mechanism for funding of defence and internal security implied earmarking of funds for these two items from the divisible pool of taxes before devolution to states resulting in reducing share of states. As defence and internal security are subjects in the union list of the Constitution, central government is empowered to create a dedicated fund for this purpose from the consolidated fund of India which does not impact on tax devolution. It can allocate more resources from out of this fund as it has access to much larger pool of resources than the states. If this was the intention, the notification of an additional ToR was not required. It is evident that the intention was to create a fund from divisible pool of central taxes before earmarking share of the states. If this arrangement had been accepted by the Commission this would have resulted in reducing the share of tax devolution of states. What Finance Commission has done is to reduce grants component of tax devolution by one per cent for funding such expenditure while keeping total share of tax to devolution at the same level as the 14th Finance Commission. The central government nonetheless gains this 1% grant to its share. As for the mechanism of operation of this arrangement, it has recommended a fund for modernisation of defence and internal security of Rs. 2.4 lakh crore over 5 years of which Rs. 1.5 lakh crore will be transferred from the consolidation fund of India and the rest would be generated from divestment of defence public sector enterprises and monetisation of defence lands. (Saket Surya, 2021)

Special Focus on Health

The Commission’s tenure had witnessed the devastating Covid-19 pandemic, the pressure on public health infrastructure and its inadequacies. It has therefore devoted a whole section on building resilience in the health sector. Altogether 17 recommendations deal with health sector. (15th Finance Commission Vol I, 2020) The recommendations fall in two categories 1) prescriptive 2) allocative. Among the prescriptive recommendations, the most significant ones relate to increase in health spending by states to more than 8%, of their budgets by 2022, top priority given to primary health care as a fundamental commitment of each and every state on which expenditure should be increased to 2/3 of total expenditure, combined spending on public health both by union and state should be progressively increased to 2.5% of GDP by 2025. Other prescriptive recommendation include 1) flexibility to be given to states in centrally sponsored schemes to adapt and innovate so as to tailor their implementation modalities to local realities and shifting of focus from line items and activities towards outputs and outcomes 2) constitution of an All India Medical and Health Service 3) restructuring of the MBBS curriculum to include a certain degree of specialisation 4) utilisation of all public health facilities including district hospitals, private and corporate hospitals for starting specialist DNB courses for ensuring availability of specialists 5) enhanced role of nursing professionals to function as nurse practitioner, physician assistant and nurse anaesthetists. On the allocative side, the Commission has recommended a total grants-in-aid is Rs. 1, 06, 606 cr which is 10.3% of total grants-in-aid recommended by the Commission and is 0.1% of GDP. Out of this,Rs. 70,051 cr is allocated specifically to primary health infrastructure in rural areas and urban wellness centres to be released to local governments. No conditionalities are attached to release of this grant. Rs. 15,265 cr has been assigned for critical care hospitals to be distributed to states on the basis of per capita health expenditure distance method, Rs. 469 crore to states for building public health laboratories, Rs. 3296 cr for training of allied health care work force. This would work out to Rs. 3 crore per district and sub-divisional hospital and Rs. 2728 cr for starting DNB courses in district hospitals for overcoming shortfall of specialists. Inter-component transfer facility has been permitted within each state’s share as per the ground realities.

The importance given into health in the ambit of finance commission’s recommendation is welcome though it is inadequate compared to the massive need. Also welcome is its unconditional release of the grant with a view to giving autonomy to states to spend as per the situation existing there. Also appreciated is its prescriptive recommendation regarding increased public health spending and commitment to strengthen primary health care infrastructure. The commission’s allocation for the latter is to be distributed to local bodies on the assumption that the subject falls within the purview of local bodies as per constitutional arrangement. But the reality is that primary health care infrastructure in rural areas and even in urban areas in many states is directly administered by the state governments and their control has not been devolved on local bodies. To get access to these funds, some cosmetic mechanism may be devised by the state governments to involve local governments for utilisation of funds. However, taking advantage of the Commission’s recommendations, local bodies need to be mobilised and pressure exerted on the state governments to transfer function and functionaries to local bodies.

One inadequacy in the Commission’s prescriptive recommendations on health sector is that there is no mention of distribution of medicines which constitute a substantial part of out of pocket expenditure of the health seekers. Incentive based grant to state governments by the Commission for providing essential medicines free in primary health care units would have gone a long way in pushing this health care reform.

Besides giving Rs 70,05 cr grant to local bodies for strengthening primary level health infrastructure, the Commission also recommended sector specific grant of Rs. 31,755 cr for health. But the central government did not accept sector specific or state specific grants. But Rs. 70,05 cr grant allocated to local bodies for health has been saved from union government’s opposition because of mandatory nature of ToR about resource allocation to local bodies. Instead of tagging Rs. 70,051 cr to the local governments, if the Commission had allocated it to the health sector, even this grant would have been lost (Narayana, 2021).

Inadequate Tax Devolution

While 15th Finance Commission’s vertical devolution of 41% of divisible pool of taxes of states and grants in aid to revenue deficit states, local bodies and for disaster risk management at a level 59% higher than the 14th Finance Commission in absolute terms, the tax devolution from the centre has not even reached the level of Rs 76 trillion achieved in 2018-19. This will create a great deal of stress to states to manage their finances with this reduced level of resources (Roy and Nagar, 2021) and would inevitably curtail their expenditure effort. Union government’s non-acceptance of state specific and sector specific grants (adding up to 1.8 trillion) is also a sizable loss of resources for the states. Besides, even in respect of grants accepted by the centre, 57% of the Finance Commission’s grants are conditional. This is far higher than mere 17% of such conditional grants recommended by the 14th Finance Commission (Roy and Nagar, 2021). Expansion of conditional grants with a view to creating pressure on the states to undertake certain reforms, is a regressive measure and a virtual denial of resources. It should be emphasised that there may be genuine reasons why states are unable to undertake such reforms including ideological ones. These conditionalities curtail the policy making autonomy of states which is a distinguishing feature of a federal setup. On the centre not accepting state specific and sector specific grants, public pressure needs to be built up on the union government to maintain the sanctify and stature of the Finance Commission by adhering to the convention of accepting all recommendations (Reddy, 2021). Accepting recommendations was all the more necessary as states and centre are both affected by devastating impact of Covid-19 on the economy with lower resources and expanding obligations to spend for reviving the economy (Isaac, et al, 2020).

The foregoing would bring out tensions in centre-state financial relations rooted in distribution of taxes and revenues pronouncedly titled in favour of the centre, which corners 2/3 of them leaving the states perpetually short of them to discharge their responsibilities. Centre has also been expanding non-divisible taxes pool through surcharges and cesses to expand its share. It also disregards recommendation of the 15th Finances Commission on State specific and Sector specific grants. It also tightly controls their borrowing capacity. As a result, States, particularly the poorly resourced ones, face acute financial difficulties. This is the reason why they keep on asking central assistance to meet their needs. The unjust nature of distribution of resources between centre and states is particularly hurting because states share a larger responsibility for development expenditure as most of the social sector development schemes fall within the ambit of state list in the constitution. Distribution of special assistance from consolidated fund in critical situations by the centre is also not a transparent act and is allegedly governed by political considerations. Central government also pressures the Finance Commission to allocate grants to states based on performance of its agenda set by it and deprives autonomy to states in respect of development expenditure. All these factors weaken federal structure as states became financially dependent on the centre and cannot be politically assertive. To address this inequity the constitution of the Finance Commission should be decided on the basis of consensus between centre and states rather than appointed unilaterally by the central government so as to have the trust of the latter. A combined and sustained pressure from states should be built and a relentless campaign should be launched for just and equitable distribution of resources to strengthen the foundation of federal polity.


1 Roy, Jayanta and Aditi Nagar (2021). ‘Finance Commission Has Increased Proportion of Grants Conditional on Reforms by State.’ The Indian Express. February 23.

2 Isaac, TM Thomas, R. Mohan and Lekha Chakraborty (2020), ‘Fifteenth Finance Commission Award for 2020-21: Implications for the States.’ Economic and Political Weekly LV (45). November 7.

3 Surya, Saket (2021). ‘Report Summary: Report for the 15th Finance Commission for 2021-22. PRS Legislative Research. February 3.

4 Reddy, G. R. (2020). ‘Finance Commission Report for 2020-21: Has the Union Been Fair to the States?’ Economic and Political Weekly. LV (12). March 21.

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6 Press Information Bureau (2021). ‘The Report of the Fifteenth Finance Commission.’ Feb 1.

7 Pinari Vijayan cited in The Economic Times, E Paper (2020), ‘ToR of 15th Finance Commission against Progressive States: FMs of Kerala, Karnataka and Andhra’, March 31, 2021

8 Vikraman, Shaji (2018). ‘In Finance Commission’s Terms of Reference, A History of Disagreements.’ The Indian Express. May 14.

9 Ganguli, Barna and Bakshi Amit Kumar Sinha (2020). ‘Progressiveness of Finance Commission: A Critical Review of Bihar.’ Economic and Political Weekly. LV (43). October 24.

10 Financial Express Bureau (2018). ‘Row Over Terms of Reference: 15th Finance Commission Forms Panels to Quell Controversy.’ Financial Express. May 10.

11 The Economic Times (2021). ‘Change In Terms of Reference of 15th Finance Commission Opposed.’ The Economic Times. March 31.

12 Jaitley, Arun (2018). ‘Needless Controversy Created Over ToR of Fifteenth Finance Commission.’

13 Narayana, D. (2021). ‘Budget 2021-22 on Health Setting Us Back By A Few Years.’ Economic and Political Weekly. LVI (9). February 27.

14 Centre for Budget and Governance Accountability (2021). ‘Budget in the Time of the Pandemic.’ February 21.

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