Finance Commission

Finance Commission

The Finance Commission is a constitutional body established under Article 280, constituted every five years to ensure fiscal federalism through equitable distribution of tax revenues between the Centre and States, grants-in-aid recommendations, and measures to augment local body resources.

“The Constitution of India envisages the Finance commission as the balancing wheel of fiscal federalism in India”

Constitutional Foundation of Finance Commission

Constitutional Provisions

• Article 280: Establishes the Finance Commission as a constitutional body

• Article 281: Mandates the President to lay Commission recommendations before Parliament with explanatory memorandum

• President’s Role: President constitutes Finance Commission within two years of Constitution commencement and thereafter every fifth year or earlier as necessary

• Parliamentary Powers: Parliament determines member qualifications, selection manner, and confers powers on Commission

Constitutional Mandate and Functions

The Finance Commission makes recommendations on four core areas:

1. Tax Distribution: Distribution between Union and States of net proceeds of taxes and allocation between States of respective shares

2. Grants-in-Aid: Principles governing grants-in-aid to States from Consolidated Fund of India

3. Local Body Resources: Measures to augment Consolidated Fund of States to supplement Panchayats and Municipalities resources based on State Finance Commission recommendations

4. Sound Finance: Any other matter referred by President in interests of sound finance

Evolution from British Era to Constitutional Body

Colonial Origins (1919-1926)

• Government of India Act 1919: Section 96(C) provided for Public Service Commission establishment

• Lee Commission (1924): Royal Commission under Lord Lee recommended immediate establishment of Public Service Commission

• First Commission: October 1, 1926 – First Public Service Commission established under Sir Ross Barker

Post-Independence Development

• 1951: First Finance Commission constituted under K.C. Neogy as Chairman

• Constitutional Status: January 26, 1950 – Constitutional recognition under Article 280

• Regular Constitution: Every fifth year or earlier as deemed necessary by President

Composition of Finance Commission: 

Structure

• Membership: (1 + 4) Chairman + four other members appointed by President

• Tenure: Six years or until age 65, whichever is earlier

• Eligibility: Members eligible for reappointment

• Variable Composition: No fixed strength – President’s discretion

Member Qualifications based on Finance Commission Act, 1951

Chairman: Person with experience in public affairs

Four Members selected from:

• Judge of High Court or qualified to be appointed as one

• Person with specialized knowledge of government finance and accounts

• Person with wide experience in financial matters and administration

• Person with special knowledge of economics

Independence Safeguards

Security of Tenure

• Protected Removal: Members removable only on constitutional grounds through prescribed manner

• Defined Service Conditions: President determines conditions but cannot vary disadvantageously after appointment

• Post-Service Restrictions: Chairman not eligible for further government employment; members eligible only for UPSC Chairmanship or State PSC positions

Financial Independence

• Consolidated Fund: All expenses including salaries, allowances charged on Consolidated Fund of India

• Non-Votable: Expenses not subject to Parliamentary vote

• Procedural Autonomy: Commission determines own procedure and has powers conferred by Parliament

Powers and Functions

Quasi-Judicial Powers

• Civil Court Powers: All powers of Civil Court under Code of Civil Procedure 1908

• Evidence Collection: Can call witnesses, demand production of public documents or records

• Inquiry Powers: Authority to examine and investigate financial matters

Advisory Nature

• Non-Binding Recommendations: Recommendations are advisory, not binding on government

• Government Discretion: Government decides implementation of recommendations

• Explanatory Memorandum: President presents recommendations with action taken report to Parliament

Recent Finance Commissions and Recommendations

15th Finance Commission (2020-26)

Chairman: N.K. Singh
Key Recommendations:

• Vertical Devolution: 41% share of States in central taxes (reduced from 42% due to J&K reorganization)

• Horizontal Devolution: 12.5% demographic performance, 45% income, 15% each population and area, 10% forest and ecology, 2.5% tax efforts

• Fiscal Roadmap: Centre fiscal deficit reduction to 4% of GDP by 2025-26

• Health Spending: States allocate 8% budget to health by 2022

• Defense Fund: ₹2.4 lakh crore Modernisation Fund for Defence and Internal Security

16th Finance Commission (2026-31)

Chairman: Arvind Panagariya (former NITI Aayog Vice-Chairman)
Members:

• Ajay Narayan Jha (former 15th FC member)

• Annie George Mathew (former Special Secretary, Expenditure)

• Manoj Panda (former Director, Institute of Economic Growth)

• T. Rabi Sankar (Deputy Governor, RBI – part-time)

• Soumya Kanti Ghosh (SBI Chief Economic Advisor – part-time)

Timeline: Recommendations by October 31, 2025 for award period April 1, 2026 onwards

Relationship with State Finance Commissions

Constitutional Linkage

• Article 243-I: States must constitute State Finance Commissions every five years

• Three-Tier System: Union Finance Commission → State Finance Commission → Local Bodies

• Resource Flow: Finance Commission considers State Finance Commission recommendations for local body resource augmentation

Coordination Challenges

• Timing Mismatch: State Finance Commission periods don’t synchronize with central Finance Commission cycles

• Implementation Gaps: States selectively implement State Finance Commission recommendations

• Quality Issues: Poor quality of State Finance Commission reports affects central Commission assessments

Constitutional Amendments Impact

73rd and 74th Amendments (1992)

• Enhanced Role: Finance Commission mandated to suggest measures for Panchayats and Municipalities resource augmentation

• Local Governance: Strengthened three-tier fiscal federalism structure

• State Finance Commissions: Made State Finance Commission constitution mandatory for states

80th Amendment (2000)

• Shareable Pool: All central taxes brought into shareable pool, making sharing mandatory

• Enhanced Devolution: Increased scope of tax sharing between Centre and States

Contemporary Challenges and Evolution

Institutional Relationships

• GST Impact: Goods and Services Tax implementation affects traditional tax sharing arrangements

• Cooperative Federalism: Finance Commission role in promoting Centre-State cooperation

• Trust Deficit: Growing concerns about Centre-State financial relationships require Finance Commission intervention

Modern Relevance

• Fiscal Federalism: Ensures equitable resource distribution in federal structure

• Regional Balance: Addresses vertical and horizontal fiscal imbalances

• Development Needs: Balances growth requirements across diverse states

• Democratic Governance: Strengthens decentralized governance through local body resource support

Limitations and Scope

Excluded Matters

• High-Level Appointments: Commission/tribunal positions, diplomatic posts not under Finance Commission purview

• Reservation Issues: Backward class reservation appointments kept outside scope

• Administrative Functions: Day-to-day personnel management handled by separate departments

Advisory Nature

• Implementation Discretion: Government not bound to accept recommendations

• Political Considerations: Final decisions subject to political and administrative considerations

• Enforcement Mechanism: No direct enforcement powers over recommendations

The Finance Commission remains the cornerstone of India’s fiscal federal structure, ensuring constitutional balance between Centre and States while adapting to evolving governance needs and maintaining democratic decentralization principles.

Indian Polity