Recommendation Of Finance Commission

The Finance Commission (FC) in India is a constitutional body established every five years to recommend principles governing the distribution of tax revenues between the Union and the States (vertical devolution) and the allocation of revenue among the States themselves (horizontal devolution). These recommendations have a significant impact on the fiscal health of both the central and state governments. The FC also reviews the state of finances of the Union and the States and suggests measures to maintain a stable and sustainable fiscal environment.

Key recommendations typically cover several areas:

Tax Devolution: This is the most critical aspect. The FC recommends the percentage of the divisible pool of central taxes (primarily income tax and central goods and services tax) that should be devolved to the States. This percentage is determined based on factors such as population, income distance (the gap between a state’s per capita income and that of the state with the highest per capita income), area, demographic performance (fertility rate), forest and ecology, and tax effort. The weights assigned to these factors vary across different FCs, reflecting evolving priorities and policy objectives. Higher weightage to income distance aims to reduce regional disparities, while emphasis on demographic performance incentivizes states to control population growth. Weightage to forest and ecology promotes environmental conservation.

Grants-in-Aid: Beyond tax devolution, the FC recommends grants-in-aid to the States under Article 275 of the Constitution. These grants are provided to address specific needs, such as revenue deficit grants to States that face a gap between their revenue and expenditure, special grants for specific sectors like health or education, and grants to local bodies (Panchayats and Municipalities). These grants supplement the devolved tax revenues and provide targeted support to States facing specific fiscal challenges.

Disaster Management: The FC makes recommendations regarding disaster management, including the constitution of the National Disaster Response Fund (NDRF) and State Disaster Response Funds (SDRF), and the allocation of resources to these funds. This is particularly important in a country like India, which is prone to natural disasters.

Fiscal Consolidation Roadmap: The FC often provides a fiscal consolidation roadmap for both the Union and the States, outlining targets for reducing fiscal deficits and debt levels. This helps ensure fiscal sustainability and macroeconomic stability. This roadmap may include recommendations on improving tax revenue mobilization, managing expenditure effectively, and reducing borrowing.

Other Recommendations: The FC can also make recommendations on any other matter referred to it by the President. This might include issues related to public sector undertakings, the Goods and Services Tax (GST) regime, or any other aspect of fiscal management. These recommendations can provide valuable insights and guidance for policymakers in addressing complex fiscal challenges.

The acceptance of the FC’s recommendations is not mandatory, but successive governments have generally accepted and implemented a significant portion of them, recognizing their importance in ensuring a fair and equitable distribution of resources and promoting fiscal stability in the country. While the Union government usually accepts the core recommendations regarding tax devolution, it may modify some of the supplementary recommendations or implementation strategies based on its own assessment and priorities.