Agenda of the 16th Finance Commission

What’s in today’s article?

• Why in the News?
• Background
• About Finance Commission
• Composition of the Finance Commission
• Functions of the Finance Commission
• Are Recommendations Made by the Commission Binding?
• News Summary
• About Urban Areas
• Need for Increase in IGTs
• Need for the Updated Census Data

Why in the News?

• The 16th Finance Commission (FC), under the chairmanship of Dr. Arvind Panagariya, focuses on devolution to local bodies, highlighting challenges in urban fiscal devolution in India.

Background

• Article 270 of the Constitution provides for the scheme of distribution of net tax proceeds collected by the Union government between the Centre and the States.
• The taxes that are shared between the Centre and the States include corporation tax, personal income tax, Central GST, the Centre’s share of the Integrated Goods and Services Tax (IGST) etc.
• This division is based on the recommendation of the Finance Commission (FC) that is constituted every five years as per the terms of Article 280.
• Apart from the share of taxes, States are also provided grants-in-aid as per the recommendation of the FC.
• The divisible pool, however, does not include cess and surcharge that are levied by the Centre.

About Finance Commission

• The FC is constituted every five years and is a body that is exclusively constituted by the Union Government.
• It consists of a chairman and four other members who are appointed by the President.
• The Finance Commission (Miscellaneous Provisions) Act, 1951, has specified the qualifications for chairman and other members of the commission.
• The Union government has notified the constitution of the 16th Finance Commission under the chairmanship of Dr. Arvind Panagariya for making its recommendations for the period of 2026-31.

Composition of the Finance Commission

• Chairman: The Commission is headed by a Chairman who is selected from among individuals with experience in public affairs.
• Members: There are four other members who are appointed by the President of India. The qualifications for these members include:
  • A person who is or has been a judge of a High Court or qualified to be appointed as one.
  • A person with knowledge of finance and accounts of the government.
  • A person with experience in financial matters and administration.
  • A person with special knowledge of economics.

Functions of the Finance Commission

• Distribution of Net Proceeds: Recommend how the net proceeds of taxes should be distributed between the Centre and the states, and the allocation of the same among the states.
• Grants-in-Aid: Determine the principles governing the grants-in-aid to the states by the Centre from the Consolidated Fund of India.
• Improving Fiscal Management: Suggest measures needed to augment the Consolidated Fund of a state to supplement the resources of the Panchayats and Municipalities in the state.
• Any Other Matter: Address any other matter referred to it by the President in the interests of sound finance.

Are Recommendations Made by the Commission Binding?

• The recommendations made by the Finance Commission are of an advisory nature only and therefore, not binding upon the government.
• It is up to the Government to implement its recommendations on granting money to the states.

News Summary

• The 16th Finance Commission (FC) has begun its work, primarily focusing on the devolution of the consolidated fund.
• Since the 73rd and 74th constitutional amendments, local bodies have gained significant recognition within the federal system.
• These amendments introduced sub-clauses 280(3)(bb) and (c), which mandate the FC to recommend measures to augment State consolidated funds for supporting panchayats and municipalities.

About Urban Areas

• Cities, contributing around 66% of India’s GDP and 90% of government revenues, are crucial for national development.
• Despite their importance, financial support for urban areas remains insufficient.
• The World Bank estimates $840 billion is needed for urban infrastructure over the next decade.
• Intergovernmental transfers (IGTs) to Urban Local Bodies (ULBs) in India are only about 0.5% of GDP, significantly lower than in other developing countries.
• This inadequate financial devolution hampers city productivity and quality of life. IGTs, although vital, need to be more predictable and equitable to support ULBs effectively.

Need for Increase in IGTs

• The introduction of the Goods and Service Tax (GST) has reduced ULBs’ tax revenue (excluding property tax) from about 23% in 2012-13 to around 9% in 2017-18.
• IGTs from States to ULBs are very low, with State Finance Commissions recommending only about 7% of States’ own revenue in 2018-19. Increasing the quantum of IGTs as a percentage of GDP is necessary.

Need for the Updated Census Data

• Without the 2021 Census, relying on 2011 data for fiscal planning is inadequate.
• India has about 4,000 statutory towns, an equal number of Census towns, and around 23,000 villages that are essentially urban.
• The 16th Finance Commission must consider this and the migration to Tier-2 and 3 cities.
• The 15th FC’s principles need revisiting, particularly regarding property tax, GST alignment, pollution mitigation, primary healthcare, and essential services.

The 16th FC should aim to double IGTs to urban areas.

Q1. What do you mean by Tax Devolution?

Tax devolution refers to the distribution of tax revenues between the central government and the state governments. It is a constitutional mechanism established to allocate the proceeds of certain taxes among the Union and the states in a fair and equitable manner.

Q2. Is the GST Council a Constitutional Body?

The Goods and Services Tax (GST) Council is a constitutional body in India. It has been established to make decisions and recommendations to the Union and State Governments on all issues related to the Goods and Services Tax (GST).

Source: What is on the agenda for the 16th Finance Commission? | Explained

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