Functions and Responsibilities of the Union and the States, Issues and Challenges Pertaining to the Federal Structure, Devolution of Powers and Finances up to Local Levels and Challenges Therein
What factors influence the devolution decisions made by the finance commission? For what reason are the states and the centre at contradiction? Critically comment.
Recently, the sixteenth Finance Commission headed by Arvind Panagariya has begun its work by inviting suggestions from the public on the mandate set for it by the Centre. The latest Finance Commission is expected to submit its recommendations by October, 2025. Its recommendations will be valid for five years starting from April 1, 2026.
How the Commission does decide devolution?
- The Finance Commission decides what proportion of the Centre’s net tax revenue goes to the States overall (vertical devolution) and how this share for the States is distributed among various States (horizontal devolution).
- The horizontal devolution of funds between States is usually decided based on a formula created by the Commission that takes into account a State’s population, fertility level, income level, geography, etc.
- The vertical devolution of funds, however, is not based on any such objective formula. Nevertheless, the last few Finance Commissions have recommended greater vertical devolution of tax revenues to States.
- The 13th, 14th and 15th Finance Commissions recommended that the Centre share 32%, 42% and 41% of funds, respectively, from the divisible pool with States. It should be noted that the Centre may also aid States through additional grants for certain schemes that are jointly funded by the Centre and the States.
- The 16th Financial Commission is also expected to recommend ways to augment the revenues of local bodies such as panchayats and municipalities. It should be noted that, as of 2015, only about 3% of public spending in India happened at the local body level, as compared to other countries such as China where over half of public spending happened at the level of the local bodies.
What are the confrontations between the States and the Center?
- The Centre collects major taxes such as the income tax, the corporate tax, and the goods and services tax (GST) while the States primarily rely on taxes collected from the sale of goods such as liquor and fuels that are beyond the ambit of GST.
- The States, however, are responsible for the delivery of many services to citizens, including education, healthcare and the police. This has led to complaints that the Centre has reduced the power of the States to collect taxes and that it does not give enough funds to the States to match with the scale of their responsibilities.
- States argue that they should receive more funds than what is recommended by the Finance Commission as they have greater responsibilities to fulfil than the Centre.
- They also point out that the Centre does not even share the amount of funds recommended by the Finance Commissions, which they believe is already too low. For example, according to analysts, the Centre has devolved an average of only 38% of funds from the divisible pool to the States under the current Fifteenth Finance Commission as against the Commission’s actual recommendation of 41%.
- States have complaints about what portion of the Centre’s overall tax revenues should be considered as part of the divisible pool out of which the States are funded.
- More developed States such as Karnataka and Tamil Nadu have also complained that they receive less money from the Centre than what they contribute as taxes. Tamil Nadu, for example, received only 29 paise for each rupee that the State contributed to the Centre’s exchequer while Bihar gets more than ₹7 for each rupee it contributes.
In other words, it is argued that more developed States with better governance are being penalised by the Centre to help States with poor governance. Beyond some critics that the Finance Commission, whose members are appointed by the Centre, may not be fully independent and immune from political influence, as a constitutional body it needs to ensure the balanced approach between centre and states including local bodies.