Role of Finance Commission

Source– This post on the Role of Finance Commission has been created based on the article “What is the role of the Finance Commission?”  published in “The Hindu” on 18 July 2024.

1. The Finance Commission is a constitutional body established under Article 280 of the Indian Constitution to recommend the distribution of tax revenues collected by the Central government among the Centre and various States in India.

2. Its primary role is to ensure a fair allocation of financial resources, balancing the fiscal needs of both the Centre and the States.

Role of the Finance Commission

1. Distribution of Tax Revenues: The Finance Commission advises on the division of net proceeds of taxes between the Centre and the States (vertical devolution) and among the States (horizontal devolution). It aims to ensure that States have adequate funds to fulfill their responsibilities.

2. Principles Governing Grants-in-Aid: The Commission suggests principles that should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India. These grants are provided to help States manage fiscal deficits and undertake specific development projects.

3. Augmenting Local Bodies’ Resources: The Finance Commission also recommends measures to augment the revenues of municipalities and panchayats. This is crucial for ensuring that local bodies have sufficient funds to carry out their functions effectively.

4. Additional Financial Recommendations: It may also be tasked with other financial matters referred to it by the President of India, such as suggesting measures to improve the fiscal health of the States.

5.  Decision on Horizontal Devolution: 

The horizontal devolution, or the distribution of funds among States is determined by a formula devised by the Finance Commission. This formula takes into account various factors, including:

i) Population: A State’s population is a significant factor in determining its share of the tax revenue.

ii) Income Levels: The per capita income and overall economic condition of a State are considered to ensure equitable distribution.

iii) Geographical Area: The size of the State is factored in to address regional disparities.

iv) Fiscal Discipline: States demonstrating better fiscal management may receive additional incentives.

6. Duration of Recommendations: The recommendations of the Finance Commission are typically valid for five years.

UPSC Syllabus: Polity and nation