The Union government is gearing up to constitute the Sixteenth Finance Commission in November this year to recommend the formula for sharing revenues between the Centre and the States for the five-year period beginning 2026-27.

What is the Finance Commission?

• The Finance Commission (FC) was established by the President of India in 1951 under Article 280 of the Indian Constitution.
• It was formed to define the financial relations between the central government of India and the individual state governments.
• The Finance Commission (Miscellaneous Provisions) Act, 1951 additionally defines the terms of qualification, appointment and disqualification, the term, eligibility and powers of the Finance Commission.
• As per the Constitution, the FC is appointed every five years and consists of a chairman and four other members.
• Since the institution of the First FC, stark changes in the macroeconomic situation of the Indian economy have led to major changes in the FC’s recommendations over the years.

Constitutional Provisions

Several provisions to bridge the fiscal gap between the Centre and the States were already enshrined in the Constitution of India, including Article 268, which facilitates levy of duties by the Centre but equips the States to collect and retain the same.

Article 280 of the Indian Constitution defines the scope of the commission:

1. Who will constitute: The President will constitute a finance commission within two years from the commencement of the Constitution and thereafter at the end of every fifth year or earlier, as the deemed necessary by him/her, which shall include a chairman and four other members.
2. Qualifications: Parliament may by law determine the requisite qualifications for appointment as members of the commission and the procedure of selection.
3. Terms of references: The commission is constituted to make recommendations to the president about the distribution of the net proceeds of taxes between the Union and States and also the allocation of the same among the States themselves. It is also under the ambit of the finance commission to define the financial relations between the Union and the States. They also deal with the devolution of unplanned revenue resources.

Important functions

• Devolution of taxes: Distribution of net proceeds of taxes between Center and the States, to be divided as per their respective contributions to the taxes.
• Grants-in-aid: Determine factors governing Grants-in-Aid to the states and the magnitude of the same.
• Augment states fund: To make recommendations to the president as to the measures needed to augment the Fund of a State to supplement the resources of the panchayats and municipalities in the state on the basis of the recommendations made by the finance committee of the state.
• Any financial function: Any other matter related to it by the president in the interest of sound finance.

Members of the Finance Commission

• The Finance Commission (Miscellaneous Provisions) Act, 1951 was passed to give a structured format to the finance commission and to bring it to par with world standards.
• It laid down rules for the qualification and disqualification of members of the commission, and for their appointment, term, eligibility and powers.
• The Chairman of a finance commission is selected from people with experience of public affairs. The other four members are selected from people who:

1. Are, or have been, or are qualified, as judges of a high court,
2. Have knowledge of government finances or accounts, or
3. Have had experience in administration and financial expertise; or
4. Have special knowledge of economics

Key challenges ahead for 16^th FC

• Overlap with GST Council: A key new challenge for the 16th FC would be the co-existence of another permanent constitutional body, the GST Council.
• Conflict of interest: The GST Council’s decisions on tax rate changes could alter the revenue calculations made by the Commission for sharing fiscal resources.
• Feasibility of recommendations: Centre usually takes the Commission’s recommendations on States’ share of tax devolution and the trajectory for fiscal targets into account, and ignores most other suggestions.

Major outstanding recommendations

• Creating a Fiscal Council: The 15th FC has suggested creating a Fiscal Council where Centre and States collectively work out India’s macro-fiscal management challenges, but the government has signalled there is no need for it, he pointed out.
• Creating a non-lapsable fund for internal security: The centre accepted to set up a non-lapsable fund for internal security and defense ‘in principle’, its implementation still has to be worked out.

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