About Finance Commission 

• The Finance Commission is a constitutional body set up under Article 280 of the Constitution. 
• Under Article 280, the President of India is required to constitute a Finance Commission at an interval of five years or earlier. 

What are the qualifications for Members?

• The Finance Commission has a chairman and four members appointed by the President.
• The Chairman of the Commission is selected from among persons who have had experience in public affairs, and the four other members are selected from among persons who–
  • are, or have been, or are qualified to be appointed as Judges of a High Court; or
  • have special knowledge of the finances and accounts of Government; or
  • have had wide experience in financial matters and in administration; or
  • have special knowledge of economics

What are the functions of the Finance Commission?

• It is the duty of the Commission to make recommendations to the President as to—  
  • the distribution of tax proceeds between the Union and the States and the share of each state.
  • the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India;
  • the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats in the State on the basis of the recommendations made by the Finance Commission of the State;
  • the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State;
  • any other matter referred to the Commission by the President in the interests of sound finance.

Why in News?

• The government is set to start the process to set up the Sixteenth Finance Commission, tasked with recommending the revenue sharing formula between the Centre and States and their distribution among States.
• The Fifteenth Finance Commission (Chair: Mr. N. K. Singh) was set up in November 2017 with a mandate to make recommendations for the five-year period from 2020-21. 
• While the Constitution requires a Finance Commission to be set up every five years, the 15th FC’s mandate was extended by a year till 2025-26, breaking the cycle. 
• In late 2019, the Commission was asked to give a standalone report for 2020-21 and another report for an extended five-year period till 2025-26.

Key recommendations in the report for 2021-26 include:

Share of states in central taxes

• The share of states in the central taxes for the 2021-26 period is recommended to be 41%, same as that for 2020-21. This is less than the 42% share recommended by the 14th Finance Commission for 2015-20 period.  
• The adjustment of 1% is to provide for the newly formed union territories of Jammu and Kashmir, and Ladakh from the resources of the centre. 

Criteria for devolution

• Income distance: It is the distance of a state’s income from the state with the highest income. Income of a state has been computed as average per capita GSDP during the three-year period between 2016-17 and 2018-19. A state with lower per capita income will have a higher share to maintain equity among states.
• Demographic performance: The Commission used 2011 population data for its recommendations. The demographic performance criterion has been used to reward efforts made by states in controlling their population. States with a lower fertility ratio will be scored higher on this criterion. 
• Forest and ecology: This criterion has been arrived at by calculating the share of the dense forest of each state in the total dense forest of all the states. 
• Tax and fiscal efforts: This criterion has been used to reward states with higher tax collection efficiency. It is measured as the ratio of the average per capita own tax revenue and the average per capita state GDP during the three years between 2016-17 and 2018-19.

Grants

• Over the 2021-26 period, the following grants will be provided from the centre’s resources.
• Revenue deficit grants: 17 states will receive grants worth Rs 2.9 lakh crore to eliminate revenue deficit.
• Sector-specific grants: Sector-specific grants of Rs 1.3 lakh crore will be given to states for eight sectors: (i) health, (ii) school education, (iii) higher education, (iv) implementation of agricultural reforms, (v) maintenance of PMGSY roads, (vi) judiciary, (vii) statistics, and (viii) aspirational districts and blocks.  A portion of these grants will be performance-linked.
• State-specific grants: The Commission recommended state-specific grants of Rs 49,599 crore.  These will be given in the areas of: (i) social needs, (ii) administrative governance and infrastructure, (iii) water and sanitation, (iv) preservation of culture and historical monuments, (v) high-cost physical infrastructure, and (vi) tourism.  
• Grants to local bodies: The total grants to local bodies will be Rs 4.36 lakh crore (a portion of grants to be performance-linked) including: (i) Rs 2.4 lakh crore for rural local bodies, (ii) Rs 1.2 lakh crore for urban local bodies, and (iii) Rs 70,051 crore for health grants through local governments.  
• Grants to local bodies (other than health grants) will be distributed among states based on population and area, with 90% and 10% weightage, respectively. 
• Disaster risk management: The Commission recommended retaining the existing cost-sharing patterns between the centre and states for disaster management funds.  The cost-sharing pattern between centre and states is: (i) 90:10 for north-eastern and Himalayan states, and (ii) 75:25 for all other states. 

Fiscal roadmap

• Fiscal deficit and debt levels: The Commission suggested that the centre bring down the fiscal deficit to 4% of GDP by 2025-26. For states, it recommended the fiscal deficit limit (as % of GSDP) of: (i) 4% in 2021-22, (ii) 3.5% in 2022-23, and (iii) 3% during 2023-26. 
• Extra annual borrowing worth 0.5% of GSDP will be allowed to states during first four years (2021-25) upon undertaking power sector reforms including: (i) reduction in operational losses, (ii) reduction in revenue gap, (iii) reduction in payment of cash subsidy by adopting direct benefit transfer, and (iv) reduction in tariff subsidy as a percentage of revenue.
• The Commission observed that the recommended path for fiscal deficit for the centre and states will result in a reduction of total liabilities of: (i) the centre from 62.9% of GDP in 2020-21 to 56.6% in 2025-26, and (ii) the states on aggregate from 33.1% of GDP in 2020-21 to 32.5% by 2025-26.  
• It recommended forming a high-powered inter-governmental group to: (i) review the Fiscal Responsibility and Budget Management Act (FRBM), (ii) recommend a new FRBM framework for centre as well as states, and oversee its implementation.
• GST: GST rate structure should be rationalised by merging the rates of 12% and 18%. States need to step up field efforts for expanding the GST base and for ensuring compliance.
• Financial management practices: A comprehensive framework for public financial management should be developed. An independent Fiscal Council should be established with powers to assess records from the centre as well as states. The Council will only have an advisory role.  
• The centre as well as states should not resort to off-budget financing or any other non-transparent means of financing for any expenditure. 
• States may form an independent debt management cell to manage their borrowing programmes efficiently. 

Other recommendations

• Health: Primary healthcare expenditure should be two-thirds of the total health expenditure. All India Medical and Health Service should be established.
• Funding of defence and internal security: A dedicated non-lapsable fund called the Modernisation Fund for Defence and Internal Security (MFDIS) will be constituted to primarily bridge the gap between budgetary requirements and allocation for capital outlay in defence and internal security. 

https://fincomindia.nic.in/