14th Finance Commission, Recommendations, Chairman, Devolution Formula

The 14th Finance Commission of India was set up to recommend how money should be shared between the Centre and the States. It was formed in 2013 under the chairmanship of Y. V. Reddy. Its recommendations (2015-2020) aimed to give States more financial independence and strengthen cooperative federalism.

About 14th Finance Commission

• The 14th Finance Commission of India was a constitutional body set up to decide how financial resources should be shared between the Central Government and the States.
• It was formed in 2013 under the chairmanship of Y. V. Reddy, and its recommendations were applicable from 2015 to 2020.
• The Commission mainly focused on giving more financial power and independence to States, so they could plan their own development according to their needs.
• Overall, it played an important role in improving Centre-State financial relations and strengthening cooperative federalism in India.

Major Recommendation – Increase in Tax Devolution

• The most important recommendation was the increase in States’ share in the divisible pool of central taxes from 32% to 42%, which was the highest increase ever recommended by any Finance Commission.
• This move provided States with a much larger share of untied funds, meaning they could use the money freely according to their own priorities rather than depending on centrally sponsored schemes.
• It reduced the dependence of States on conditional grants from the Centre and allowed them to design policies based on their specific developmental needs.
• This change marked a shift towards a more decentralized and state-driven model of governance.

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Horizontal Devolution Formula (Distribution Among States)

• The Commission adopted a formula to fairly distribute funds among States based on multiple factors:
  • Income distance (50%) to support poorer States and reduce regional inequalities.
  • Area (15%) to account for administrative and development challenges in larger States.
  • 1971 Population (17.5%) to maintain continuity with past practices.
  • 2011 Population (10%) to reflect current demographic realities.
  • Forest cover (7.5%) to encourage environmental conservation and sustainable development.
• This balanced approach ensured that both equity and efficiency were considered while distributing resources.

Grants-in-Aid to States

• The Commission recommended revenue deficit grants to States that would still face financial gaps even after receiving their share of taxes.
• A total of around ₹1.94 lakh crore was allocated for this purpose during the five-year period.
• These grants helped ensure that financially weaker States could meet their basic expenditure requirements without facing fiscal stress.

Grants to Local Governments

• A significant focus was placed on strengthening local governance institutions like Panchayats and Municipalities.
• The Commission recommended total grants of around ₹2.87 lakh crore for local bodies.
• These grants were divided into:
  • Basic grants, which formed the major portion and could be used for general purposes.
  • Performance grants, aimed at encouraging better financial management, transparency, and revenue generation by local bodies.
• This move strengthened grassroots democracy and reduced the financial burden on State governments for local development.

Fiscal Discipline and Deficit Targets

• The Commission recommended that States should maintain a fiscal deficit limit of 3% of their Gross State Domestic Product (GSDP) to ensure financial stability.
• It allowed additional flexibility of 0.25% to 0.5% under certain conditions, such as:
  • Low debt levels
  • Lower interest burden
• This ensured a balance between development spending and fiscal responsibility.

Reforms in Fiscal Framework (FRBM Act)

• The Commission suggested reforms in the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 to improve transparency and accountability.
• It recommended setting up an independent fiscal council to evaluate government budget proposals before implementation.
• It also proposed moving towards a debt-based fiscal framework, which would focus more on managing overall debt rather than just deficits.

GST Compensation to States

• The Commission recommended the creation of a separate GST Compensation Fund to support States in case of revenue loss due to the introduction of GST.
• It suggested compensation for a period of 5 years:
  • 100% compensation for the first 3 years
  • 75% compensation in the 4th year
  • 50% compensation in the 5th year
• This ensured a smooth transition to the GST regime and protected State revenues.

Impact of the 14th Finance Commission

• The Commission significantly improved the financial autonomy of States by giving them a larger and more predictable share of central taxes.
• It reduced the dependence of States on the Centre and allowed them to prioritize their own development needs.
• It strengthened cooperative federalism by promoting trust and partnership between the Centre and States.
• Increased funding to local bodies improved grassroots governance and service delivery.
• Overall, it played a crucial role in creating a more balanced, transparent, and efficient fiscal system in India.

Revenue-Sharing Formula in 14th vs 15th Finance Commission

The revenue-sharing formulas of the 14th and 15th Finance Commissions determine how financial resources are distributed among States. They use different criteria and weightages to ensure balanced and fair allocation. The key differences between these formulas are discussed below.