The Report of the Fifteenth Finance Commission

Why in News

Recently, the government accepted the 15^th Finance Commission’s recommendation to maintain the States’ share in the divisible pool of taxes to 41% for the five-year period starting 2021-22. The Commission’s Report was tabled in the Parliament.

15^th Finance Commission

• The Finance Commission (FC) is a constitutional body, that determines the method and formula for distributing the tax proceeds between the Centre and states, and among the states as per the constitutional arrangement and present requirements.
• Under Article 280 of the Constitution, the President of India is required to constitute a Finance Commission at an interval of five years or earlier.
• The 15^th Finance Commission was constituted by the President of India in November 2017, under the chairmanship of NK Singh. Its recommendations will cover a period of five years from the year 2021-22 to 2025-26.
• The Commission was asked to recommend performance incentives for States in many areas like power sector, adoption of DBT, solid waste management etc.
• Another unique ToR was to recommend funding mechanism for defence and internal security.
• Volume I and II, as in the past, contain the main report and the accompanying annexes.
• Volume III is devoted to the Union Government and examines key departments in greater depth, with the medium-term challenges and the roadmap ahead.
• Volume IV is entirely devoted to the States. We have analysed the finances of each State in great depth and have come up with State-specific considerations to address the key challenges that individual States face.
• In total, main report has 117 core recommendations. Vol-III and IV has numerous suggested reforms for the Union ministries and State governments respectively.

Key Highlights:

Vertical devolution:

• In order to maintain predictability and stability of resources, especially during the pandemic, 15^th FC has recommended maintaining the vertical devolution at 41 per cent – the same as in our report for 2020-21.
• It is at the same level of 42 per cent of the divisible pool as recommended by FC-14^th.
• However, it has made the required adjustment of about 1 per cent due to the changed status of the erstwhile State of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir.
• Total 15^th FC transfers (devolution + grants) constitutes about 34 per cent of estimated Gross Revenue Receipts of the Union leaving adequate fiscal space for the Union to meet its resource requirements and spending obligations on national development priorities.

Horizontal devolution:

• Based on principles of need, equity and performance, overall devolution formula is as follows.

• For horizontal devolution, it has suggested 12.5% weightage to demographic performance, 45% to income, 15% each to population and area, 10% to forest and ecology and 2.5% to tax and fiscal efforts.

Revenue Deficit Grants to States:

• Revenue deficit grants emanate from the requirement to meet the fiscal needs of the States on their revenue accounts that remain to be met, even after considering their own tax and non-tax resources and tax devolution to them.
• Revenue Deficit is defined as the difference between revenue or current expenditure and revenue receipts, that includes tax and non-tax.
• It has recommended post-devolution revenue deficit grants amounting to about Rs. 3 trillion over the five-year period ending FY26.
  • The number of states qualifying for the revenue deficit grants decreases from 17 in FY22, the first year of the award period to 6 in FY26, the last year.

Grants to Local Governments:

• Along with grants for municipal services and local government bodies, it includes performance-based grants for incubation of new cities and health grants to local governments.
• In grants for Urban local bodies, basic grants are proposed only for cities/towns having a population of less than a million. For Million-Plus cities, 100% of the grants are performance-linked through the Million-Plus Cities Challenge Fund (MCF).
  • MCF amount is linked to the performance of these cities in improving their air quality and meeting the service level benchmarks for urban drinking water supply, sanitation and solid waste management.

Health:

• 15^th FC has recommend that health spending by States should be increased to more than 8 per cent of their budget by 2022.
• Given the inter-State disparity in the availability of medical doctors, it is essential to constitute an All India Medical and Health Service as is envisaged under Section 2A of the All-India Services Act, 1951.
• The total grants-in-aid support to the health sector over the award period works out to Rs. 1,06,606 crore, which is 10.3 per cent of the total grants-in-aid recommended by 15^th FC. The grants for the health sector will be unconditional.
• 15^th FC has recommend health grants aggregating to Rs. 70,051 crore for urban health and wellness centres (HWCs), building-less sub centre, PHCs, CHCs, block level public health units, support for diagnostic infrastructure for the primary healthcare activities and conversion of rural sub centres and PHCs to HWCs. These grants will be released to the local governments.
• Out of the remaining grant of Rs. 31,755 crore for the health sector (total of Rs. 1,06,606 crore minus Rs. 70, 051 crore through local bodies and Rs.4800 crore state-specific grants), 15^th FC has recommended Rs. 15,265 crore for critical care hospitals. This includes Rs. 13,367 crore for general States and Rs 1,898 crore for NEH States.
• 15^th FC has recommended Rs. 13,296 crore for training of the allied healthcare workforce. Out of this, Rs. 1,986 crore will be for NEH States and Rs. 11,310 crore for general States.

 Performance Based Incentives and Grants to States:

• These grants revolve around four main themes.
• The first is the social sector, where it has focused on health and education.
• Second is the rural economy, where it has focused on agriculture and the maintenance of rural roads.
  • The rural economy plays a significant role in the country as it encompasses two-thirds of the country’s population, 70% of the total workforce and 46% of national income.
• Third, governance and administrative reforms under which it has recommended grants for judiciary, statistics and aspirational districts and blocks.
• Fourth, it has developed a performance-based incentive system for the power sector, which is not linked to grants but provides an important, additional borrowing window for States.

Fiscal Space for Centre:

• Total 15^th Finance Commission transfers (devolution + grants) constitutes about 34% of estimated Gross Revenue Receipts to the Union, leaving adequate fiscal space to meet its resource requirements and spending obligations on national development priorities.

Defence and Internal Security

• Keeping in view the extant strategic requirements for national defence in the global context, 15^th FC has, in its approach, re-calibrated the relative shares of Union and States in gross revenue receipts. This will enable the Union to set aside resources for the special funding mechanism that XVFC has proposed.
• The Union Government may constitute in the Public Account of India, a dedicated non-lapsable fund, Modernisation Fund for Defence and Internal Security (MFDIS). The total indicative size of the proposed MFDIS over the period 2021-26 is Rs. 2,38,354 crore.

Disaster Risk Management:

• Mitigation Funds should be set up at both the national and State levels, in line with the provisions of the Disaster Management Act. The Mitigation Fund should be used for those local level and community-based interventions which reduce risks and promote environment-friendly settlements and livelihood practices.
• For SDRMF, 15^th FC has recommended the total corpus of Rs.1,60,153 crore for States for disaster management for the duration of 2021-26, of which the Union’s share is Rs. 1,22,601 crore and States’ share is Rs. 37,552 crore.
• 15^th FC has recommended six earmarked allocations for a total amount of Rs. 11,950 crore for certain priority areas, namely, two under the NDRF (Expansion and Modernisation of Fire Services and Resettlement of Displaced People affected by Erosion) and four under the NDMF (Catalytic Assistance to Twelve Most Drought-prone States, Managing Seismic and Landslide Risks in Ten Hill States, Reducing the Risk of Urban Flooding in Seven Most Populous Cities and Mitigation Measures to Prevent Erosion).

Fiscal consolidation

• Provided range for fiscal deficit and debt path of both the Union and States.
• Additional borrowing room to States based on performance in power sector reforms.
• A threshold amount of annual appropriation should be fixed below which the funding for a CSS may be stopped. Below the stipulated threshold, the administrating department should justify the need for the continuation of the scheme. As the life cycle of ongoing schemes has been made co-terminus with the cycle of Finance Commissions, the third-party evaluation of all CSSs should be completed within a stipulated timeframe. The flow of monitoring information should be regular and should include credible information on output and outcome indicators.
• In view of the uncertainty that prevails at the stage that 15^th FC have done its analysis, as well as the contemporary realities and challenges, we recognise that the FRBM Act needs a major restructuring and recommend that the time-table for defining and achieving debt sustainability may be examined by a High-powered Inter-governmental Group. This High-powered Group can craft the new FRBM framework and oversee its implementation. It is important that the Union and State Governments amend their FRBM Acts, based on the recommendations of the Group, so as to ensure that their legislations are consistent with the fiscal sustainability framework put in place. This High-powered Inter-Governmental Group could also be tasked to oversee the implementation of the 15th Finance Commission’s diverse recommendations.
• State Governments may explore formation of independent public debt management cells which will chart their borrowing programme efficiently.

Horizontal Devolution Criteria

• Population:
  • The population of a State represents the needs of the State to undertake expenditure for providing services to its residents.
  • It is also a simple and transparent indicator that has a significant equalising impact.
• Area:
  • The larger the area, greater is the expenditure requirement for providing comparable services.
• Forest and Ecology:
  • By taking into account the share of dense forest of each state in the aggregate dense forest of all the states, the share on this criteria is determined.
• Income Distance:
  • Income distance is the distance of the Gross State Domestic Product (GSDP) of a particular state from the state with the highest GSDP.
  • To maintain inter state equity, the states with lower per capita income would be given a higher share.
• Demographic Performance:
  • It rewards efforts made by states in controlling their population.
  • This criterion has been computed by using the reciprocal of the total fertility ratio of each state, scaled by 1971 population data.
    • This has been done to assuage the fears of southern States about losing some share in tax transfers due to the reliance on the 2011 Census data instead of the 1971 census, which could penalise States that did better on managing demographics.
  • States with a lower fertility ratio will be scored higher on this criterion.
    • The Total Fertility Ratio in a specific year is defined as the total number of children that would be born to each woman if she/they were to pass through the childbearing years bearing children according to a current schedule of age-specific fertility rates.
• Tax Effort:
  • This criterion has been used to reward states with higher tax collection efficiency.
  • It has been computed as the ratio of the average per capita own tax revenue and the average per capita state GDP during the three-year period between 2016-17 and 2018-19.