Why in the News?

Recently, Tamil Nadu hosted the Sixteenth State Finance Commission, highlighting the need for fair resource allocation to performing states and addressing fiscal imbalances between the Union and states.

What are the primary challenges faced by State Finance Commissions?

• Vertical Fiscal Imbalance: There is a significant disparity in revenue-raising capabilities between the Union and state governments. The Union holds greater powers to generate revenue, while states bear most of the expenditure responsibilities. This imbalance has led to insufficient funds for states to meet developmental needs.
• Inequitable Resource Distribution: Despite efforts to achieve equitable redistribution through vertical and horizontal devolution, actual outcomes often fall short of expectations.
  • For instance, the Fifteenth Finance Commission’s effective devolution was only 33.16% of the Union’s gross tax revenue, despite a declared share of 41%.
• Inadequate Devolution: The increasing reliance on cess and surcharges by the Union government has further constrained the financial resources available to states. This trend undermines the intended fiscal autonomy that states require to implement local schemes effectively.
• Demographic and Urbanization Challenges: Progressive states like Tamil Nadu face unique challenges related to ageing populations and rapid urbanisation, which strain their fiscal capacities while necessitating increased investment in infrastructure and services.

How can compliance with constitutional mandates be improved?

• Strengthening Legal Frameworks: Ensuring that SFCs operate within a robust legal framework that mandates transparency and accountability can enhance compliance with constitutional directives. This includes clearer guidelines on resource allocation and devolution processes.
• Public Disclosure: Mandating public disclosure of financial data and project details in accessible formats can foster greater transparency and allow for citizen engagement in governance, thereby ensuring that SFCs adhere more closely to their constitutional roles.
• Participatory Budgeting: Encouraging participatory budgeting practices can help align state financial decisions with local needs, ensuring that resources are allocated in a manner that reflects constitutional mandates for equitable development across regions.

What reforms are necessary to enhance the effectiveness of SFCs?

• Revising Devolution Principles: A reassessment of the principles governing vertical and horizontal devolution is essential to create a fairer distribution system that recognizes both the needs of less-developed states and the contributions of high-performing states like Tamil Nadu.
• Augmenting State Resources: Increasing the share of gross central taxes allocated to states from 41% to at least 50% could provide states with greater fiscal autonomy, allowing them to fund locally relevant initiatives effectively.
• Focus on Growth Incentives: Developing a progressive resource allocation methodology that rewards high-performing states can stimulate economic growth while ensuring that less-developed states also receive adequate support for their development needs.
• Addressing Urbanization Needs: Specific reforms aimed at addressing urbanization challenges—such as earmarking funds for infrastructure development—will be crucial for progressive states experiencing rapid urban growth.

Conclusion: State Finance Commissions must address fiscal imbalances, enhance devolution principles, and prioritise growth incentives to empower states. This is vital for achieving Sustainable Development Goals (SDGs) through equitable and inclusive development.

Mains PYQ:

Q Discuss the recommendations of the 13th Finance Commission which have been a departure from the previous commissions for strengthening the local government finances. (UPSC IAS/2013)

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