Key Guidelines of the 12th Finance Commission

The 12th Finance Commission, constituted in 2002 and chaired by Dr. C. Rangarajan, provided recommendations crucial for fiscal federalism in India for the period 2005-2010. Its guidelines aimed to improve resource distribution between the Union and the States, incentivize fiscal prudence, and address critical developmental challenges. Here are twelve significant guidelines from its report:

1. Devolution of Taxes: The Commission recommended maintaining the States’ share in the net proceeds of shareable Central taxes at 30.5%. This was consistent with the 11th Finance Commission, ensuring stability in resource transfers. The focus remained on a formula-based approach to distribute this share among the States.
2. Distribution Formula: While retaining the 30.5% share, the Commission modified the distribution formula. The weights assigned to different factors were: income distance (50%), population (25%), area (10%), tax effort (7.5%), and fiscal discipline (7.5%). This formula aimed to balance equity, efficiency, and fiscal performance.
3. Debt Consolidation and Relief Facility: Recognizing the burden of debt on state finances, the Commission proposed a debt consolidation and relief facility linked to fiscal performance. States that enacted fiscal responsibility legislation and committed to specified deficit reduction targets were eligible for debt restructuring and waiver of interest payments.
4. Calibrated Fiscal Adjustment: The Commission emphasized the need for States to reduce their revenue deficits to zero by 2008-09. They suggested a calibrated approach involving increased revenue mobilization, expenditure rationalization, and improved public debt management.
5. Local Body Grants: A significant portion of the grants was earmarked for local bodies. The Commission recommended grants for both rural and urban local bodies, to be distributed based on population, area, and an index of backwardness. This aimed to strengthen local governance and service delivery.
6. Disaster Management: The Commission made specific recommendations for disaster management, recognizing the vulnerability of several states to natural calamities. It suggested creating a National Calamity Contingency Fund (NCCF) and State Disaster Response Funds (SDRF) with specific allocation norms.
7. Grant for Elementary Education: Recognizing the importance of education, the Commission recommended grants to states specifically for improving elementary education infrastructure and quality. This was crucial for achieving universal elementary education goals.
8. Grant for Environment Protection: The Commission emphasized the need for environmental protection and recommended grants to states for specific environmental projects, including afforestation, pollution control, and water resource management.
9. Grant for Health Sector: Improving healthcare infrastructure and services was another priority. The Commission recommended grants for strengthening the health sector, focusing on primary healthcare, disease control programs, and improving public health infrastructure.
10. Grant for Heritage Conservation: Recognizing the cultural and historical significance of heritage sites, the Commission recommended grants for their conservation and preservation. This aimed to promote tourism and cultural heritage.
11. Fiscal Responsibility Legislation: The Commission stressed the importance of enacting and implementing fiscal responsibility legislation at the state level. This was seen as crucial for ensuring fiscal discipline and sustainable public finances. They linked debt relief to the enactment and adherence to FRL targets.
12. Monitoring and Evaluation: The Commission emphasized the need for effective monitoring and evaluation of the utilization of grants and the impact of fiscal reforms. They suggested strengthening institutional mechanisms for monitoring and evaluation at both the central and state levels.

These guidelines of the 12th Finance Commission played a significant role in shaping the fiscal landscape of India, promoting fiscal prudence, incentivizing reforms, and addressing critical developmental challenges.