15th Finance Commission (FC) - Introduction, Background, Report & Concerns [UPSC Economics Notes]

To define financial relations between the Central government and state governments, there has been a need to constitute such a body like the Finance Commission of India. The Fifteenth Finance Commission was constituted on 27 November 2017 against the backdrop of the abolition of the Planning Commission and the introduction of the goods and services tax (GST), which has fundamentally redefined federal fiscal relations.

Latest Update – The 15th Finance Commission has released a report titled ‘Finance Commission in COVID Times’ on its official website – https://fincomindia.nic.in/.

Read about the 15th Finance Commission and a gist of its latest report in this article for IAS Exam preparation.

15th Finance Commission Report 2021-26:-Download PDF Here

15th Finance Commission Report 2020-21:-Download PDF Here

Table of Contents:

15th FCI Report 2021-26

The important points about the latest report of the 15th Finance Commission of India that was tabled on 1st February 2021 are listed down below:

1. Maintaining vertical devolution at 41 per cent:
   • The commission has suggested that while maintaining the vertical devolution at the same rate suggested in the report 2020-21; it would help in maintaining predictability and stabilizing the resources, especially during COVID times.
2. On GST:
   • GSTaccounts for 35 per cent of the gross tax revenue of the Union.
   • GSTaccounts for around 44 per cent of own tax revenue of the States.
3. On Gross Tax Revenue:
   • There is a drop of 1.7 percentage points in the gross tax revenue after excluding GST cess collection in comparison to 2016-17 figures. The impact of this drop could be seen in the tax devolution to states.
   • Gross Tax Revenue Assessment 2021-26: It is expected to be 135.2 lakh crore, out of which the divisible pool is estimated to be 103 lakh crore.
4. On Horizontal Devolution: The criteria and the weights assigned for horizontal devolution are:
   • Population – 15%
   • Area – 15%
   • Forest & Ecology – 10%
   • Income Distance – 45%
   • Tax and Fiscal Efforts – 2.5%
   • Demographic Performace – 12.5%
5. The commission has assigned a 12.5 per cent weight to the demographic performance criterion in the horizontal devolution. The commission has also re-introduced tax effort criterion to reward fiscal performance.
6. On Revenue Deficit Grants (RDG):
   • It has recommended total revenue deficit grants of around Rs 2.94 crore over the award period for seventeen States.
7. On Local Governments: Rs. 4,36,361 crore is the total grant given to the local governments for the period of 2021-26. Out of the total grant; Rs.450 crore is dedicated to the shared municipal services.
   • Grants to Rural Local Bodies – Total sum of Rs. 2,36,805 crore is a grant for the rural local bodies.
   • Grants to Urban Local Bodies – Rs.1,21,055 crore is the total grant for the urban local bodies.
   • Grants for Health to be Channelised through Local Governments – Rs. 70,051 crore stands for the Health grant to the local governments.
8. On Health:
   • The commission has suggested increasing the state expenditure on health by 8 percent by 2022.
   • The commission suggested prioritizing the creation of All India Health Services/All India Medical Services on the pattern of the UPSC Civil Services.
   • National Medical Council is suggested to develop small courses on wellness clinic, basic surgical procedures, anaesthesia, obstetrics and gynaecology, eye, ENT etc. for MBBS doctors.
   • AYUSH to be encouraged as an elective subject for medicine undergraduates.
   • The Allied and Healthcare Professions Bill should be passed at the earliest.
9. On Higher Education:
   • The XV finance commission has recommended two subtypes of higher education grants:
     • Promotion of online education – Rs. 5,078 crore is a total sum of grant for the promotion of online education.
     • Development of professional courses in regional languages: The commission’s recommendation is in line with the New Education Policy 2020. Rs. 1,065 crore has been allocated for the development of these courses from 2021-26.
       • Two colleges in each state should convert their learning material and pedagogy into the recognized regional language.
10. On Defence:
    • Recommendation to create a non-lapsable pool for the defence and internal security sector under the Public Accounts of India. (Read about the funds of the central government in the linked article.)
11. On Disaster Risk Management:
    • The fifteenth finance commission recommended maintaining the contribution of states to the State Disaster Risk Fund (SDRF) to be 25 per cent except by the NE States (10 per cent.) It has seen no changes since 13th Finance Commission recommended the same arrangement.
    • Creation of Mitigation Funds both at central and state levels.

15th Finance Commission Importance

The commission comes out with its reports highlighting reforms relating to the fiscal scenarios. The 15th FC has been set up in a time when huge reforms have been taken under the fiscal federalism.

• Replacement of Planning Commission with NITI Aayog
• Implementation of GST reforms
• Abolition of the planned and non-planned expenditure

• Article 270 – sharing of central taxes.
• Article 275 – grant in aid of revenues (grant-in-aid/statutory grants/non-plan grants are to be given to the States in need of assistance and the amount of grant-in-aid and the principles for judging the eligibility of states for these grants-in-aid are to be determined by the Finance Commission).
• Article 280 – provides the main responsibilities of the finance commission.
• The central government collects the majority of the taxes in the form of Income-tax, Corporate tax, Customs, Central GST, etc whereas it is the state which needs to provide a huge amount of services to the public hence it is natural for the states to fall into revenue imbalance/gap.
• Before 2000, only Income tax and union excise on certain duties were shared but the constitutional amendment in 2000 allowed all the central taxes to be shared with the states
• The government has amended the constitution twice – 80th CAA and 88th CAA in 2000 and 2003 respectively to change the scheme of distribution of taxes between the centre and the states.
• The tax sharing is done to correct the vertical and horizontal imbalances which arise due to constitutional assignment of tax powers and responsibilities of the expenditure.
• The tax sharing recommendations given by the FC does not form part of the consolidated fund of India.

• Since the 90’s it has also started to recommend the augmentation of revenues at the local government level.
• The usage of the population of 1971 for deciding on the horizontal devolution was made mandatory from the 7th FC, having said so it should be remembered that the 6th FC also used the 1971 population but wasn’t mandated to use it.
• 2011 data along with the 1971 population data was used by the 14th FC (if it had used only the 1971 population then the data would have margin years of 45 years to 50 years during the implementation from 2015 to 2020).

Why these transfers are important?

• The central taxes that are devolved are the untied funds and these can be used as per the discretion of the states.
• Apart from this, such revenues transferred have comprised of over 80% of the central transfers to the states.
• Apart from these funds, the centre allocates the grants to states and local bodies.
• If the 15th FC considers the population of 2011, then along with southern states, Punjab, WB, Assam, Maharashtra will also be on losing side.

• Constituted by the President in November 2017.
• It is headed by N K Singh.
• Deliberation period from the end of 2017 to the end of October 2019.
• The recommendations would be applicable for the period from 2021-2026.
• The recommendation involves:
  • The distribution of tax proceeds between the centre and states.
  • Principles governing grant in aid to the states.
  • Measures to be taken to augment the consolidated fund of states.
  • Review the impact of the 14th Finance Commission recommendations on the fiscal position of the centre.
  • Review the debt level of the centre and states, and recommend a roadmap.
  • Study the impact of GST on the economy.
  • Recommend performance-based incentives for states based on their efforts to control population, promote ease of doing business, and control expenditure on populist measures, among others.

2011 Population

• Before the 42nd CAA of 1976, deciding the distribution of the Lok Sabha seats was determined by the population in the last preceding census. The 1971 census showed a huge jump and then the family planning was introduced at the policy level (but remember that the family planning measures have been implemented in India since the 1950s but came to the forefront only during 1970s)
• According to the Constitution, there are four areas in which the population is used as a factor
  • Manner of Election of President – Article 55
  • Composition of the House of the People – Article 81
  • Composition of the Legislative Assemblies – Article 170
  • Reservation of seats for Scheduled Castes and Scheduled Tribes in the Legislative Assemblies of the States – Article 330
• Supporting Points for the usage of the 2011 population
  • The population of 1971 would have been 45-50 years old data which may not represent the present situation
  • The argument of the southern states that they have controlled the population growth is true but there is no proof that the northern states have supported the proliferation of the population through the policy measures
  • FC has to ensure that the poorer states have adequate resources to promote socio-economic development, critical infrastructure, balanced regional development, etc
  • The 1971 population does not take into consideration the issue of migration. Which is observed at a very large scale in today’s scenario
    • As per the census of 2011, stock of migrants is around 3.3 million per annum
    • As per economic survey 2016
      • The inter-state migration stood at around 5-6 million per annum (between 2001 and 2011)
      • The rate of change of growth in annual migration was about 2.4% from 1991 to 2001 and has almost doubled to 4.5% for the period 2001 to 2011
    • The FC allocation helps in providing economic and social services to the population. But taking the older population may not lead to the right amount of services to be provided by the states
    • The concept of demographic dividend will only lead to results if the population is given access to the right education, nutrition, skilling, etc and the larger states in terms of population will require this kind of assistance
  • Concerns/Worries regarding the usage of the 2011 population
    • The share of southern states out of India’s population has decreased by 4 percentage points (between 1971 to 2011) whereas the share of the northern state at the same time has increased
    • The per capita income of AP, Telangana, TN, and Karnataka is almost twice that of states such as Bihar, UP, MP, Rajasthan, etc
    • There is no denying that the rich states will have to help the poorer states but the developmental gap has not narrowed even after assisting for decades
    • The grand bargain done under GST has led to some rule-based distribution of revenues between the center and states and not dependent on the population of the states
    • Does the FC incentivize/reward backwardness?
  • Hierarchical to command and control relations – after the abolition of the Planning Commission the 15th FC becomes very important but the ToRs have been skewed in favour of the central government like the one which deals with the review of the enhanced allocation of funds because of 14th FC recommendations and its impact on the fiscal situation of the central government keeping in mind the imperatives of the national development programme

The reduction of funds going to states may not necessarily mean a bad thing as the central government is more important in terms of industrial growth, inter-generational concerns, environmental concerns, etc as in such cases the centre is suited better compared to the states to take care of the issues.

Abolition of revenue deficit grants

If the revenue deficit grants are to be phased out then the government should bring some other mechanism in its place. One way would be to provide the grants on the case by case basis.

15th Finance Commission & the debate of ‘North Vs South’ – 2020 Report

• The southern states are not alone in the reduction of population share. Apart from the four southern states, there are many more states whose population share has reduced between 1971 to 2011 (these are Assam, Goa, Himachal Pradesh, Odisha, Punjab, and West Bengal.
• There are some western states (such as Gujarat, Maharashtra) and northern states (such as Punjab, Haryana, etc) which have received lesser than what they have paid to the central government
• Maharashtra, Gujarat, Haryana, and TN receive lesser than Rs.30 (taxes devolved and other transfers) for every Rs.100 they contribute to the central exchequer. In contrast Bihar, UP received more than Rs.200 and around Rs.150 respectively for every Rs.100 they contributed to the central exchequer
• Looking at the above point the devolution may seem to be very progressive but when per capita income is compared with per capita transfers received the story changes. Under this, the southern states are getting better devolution compared to northern states such as UP, Bihar
• Compared to large developing democracies India’s devolution looks much more regressive. In the case of India, the bottom 25% of the states received 22% of the transfers it was 30% and 36% in the case of South Africa and Brazil respectively
• The states such as UP appear to be dependent on the central transfers primarily because of their population. Certain parts of UP are richer than some of the regions in other states

BIMARU Vs the Southern states – Then and Now (1971 and 2011)

BIMARU stands as an acronym for states – Bihar, Madhya Pradesh, Rajasthan & Uttar Pradesh.

Population

• In 1971, the BIMARU states had 57% more population than the southern states and today it twice that of southern states.
• The total population of four southern states is lower than the combined population of UP and Rajasthan.
• The northern states’ share of the population has increased from 38.7% (1971) to 42.4% (2011) whereas that of southern states has fallen from 24.7% to 20.7%.

Total Fertility Rates (TFR)

• TFR for India was 5.5 in 1971 and has been brought down to 2.3 by 2013.
• The southern states’ TFR ranged between 3.9 for TN to 4.6 in AP in 1971, which was way below the national average. By 2013 it has been brought down to the range of 1.7 to 1.9.
• The northern states’ TFR in 1971 was over 6 and by 2013 has been brought down to the range of 1.9 to 3.4.

Size of the Economy

• At 1980-81 prices the size of the BIMARU states was 32% larger than the combined size of the southern states.
• By 2016-17, the economic size of the southern states is 15% more than the northern states.

PCI

• The per capita income of southern states is much higher than that of northern states (the lowest PCI in a southern state is of Rs.95566 which is more than the PCI of Rajasthan Rs.72072-highest amongst the northern states).

Contributions to direct taxes

• Southern states contributed 23.5% whereas northern states’ contribution was just 9.7% (Karnataka contributed 10.1%)

15th Finance Commission – Conclusion

• Giving a lower weightage to 2011 population
• Including the population of 1971 also
• Providing incentives to the states which have better performance in the population control reforms
• It is premature to jump to a conclusion regarding the shares of the southern states as the finance commission is yet to come out with the weightages to various parameters to determine the horizontal formula
• Equalization approach as in Australia and Canada wherein the financial resources are allocated to ensure that services are provided in each of the states at comparable levels provided the states make comparable efforts in raising the revenues. In the case of India, the FCs follow a gap-filling approach dependent on the historical trends of expenditure and revenues.

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