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Paper – 2
Chapter: 6 (State Government and Administration)

FINANCE COMMISSION

The Indian Finance Commission is a unique constitutional body, which has
survived fifty years. We do not find similar Constitutional institutions even in
older federations like the USA, Canada and Australia.

In any federation, the distribution of governmental functions, which involve
expenditure obligations, and sources of revenue, which ensure the capacity to
raise revenues, are distributed on the basis of different set of principles.
This leads to two types of imbalances between the expenditure requirements of
the national and state governments and the capacity to raise revenue to meet
these requirements. One imbalance is called vertical federal fiscal imbalance,
which indicates the deficit faced by the States vis-a-vis the surplus
experienced by the national government, and another is horizontal federal fiscal
imbalance, which indicates the relative financial imbalance between their own
revenues and expenditures among the states themselves.

Work of Finance Commission

The most important part of the Finance Commissions’ work is the methodology of
the Commission is

  1. To determine the quantum of divisible pool of the taxes,

  2. The quantum of grants and

  3. Other financial reliefs.

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The terms of reference are broadly indicated under Article 280 itself. Even
then, under provision any other matter’, the Central Government stipulates a
number of guidelines and even conditions in order to specify the scope of the
Finance Commission’s work which has led to the Commission confining its
recommendations to the non-plan revenue account of the state government
finances. In fact, there is no consistency in the scope of the Finance
Commission, though there is some continuity in regard to the terms of the
references of the Commission.

Conflict between Finance and Planning Commission

There has been serious debate in the country regarding the role of the Finance
Commission vis-a-vis the Planning Commission. Finance Commission is a
Constitutional body whereas the Planning Commission is a statutory institution.
Over a period of time, the working of both the institutions led to friction
among them due to lack of clear-cut guidelines demarcating their areas of work.
Scrutiny of plan expenditure and transfer of capital to the states have been
left to the; Planning Commission. This has led to a number of practical
problems. The relative role of the Planning Commission and Finance Commission
have come to be demarche in the terms of reference of the Finance Commission.

The Finance Commission assesses the non-plan requirements of the State
Governments and recommends a share in the net yield from two Central and Grants
in-aid. The divisible sum of Central taxes is distributed interest among the
states based on independent criteria. This lead to a situation where many states
experience non­plan revenue surplus after receiving the devolution and that
surplus is supposed to be used by them for plan purpose. But that is not the job
of the Finance Commission. It is left to the planning Commission to take it into
account while assessing the states resources for sate plans. The Planning
Commission finds it very difficult to till the shortfall in the sates financial
resources for plan purpose because of the limited budgetary support provided by
the Central Government for the total public sector plan. Consequently, the plan
expenditure becomes a casualty.

The various Finance Commissions have generally adhered to the criteria, for
grants-in-aid to the States, that this popularly come to be known as the Gadgil
formula (after the name of former Deputy Chairman of the Planning Commission),
that takes into account in variable proportions the population of the State,
developmental performance, budgetary deficit etc.

The Ninth Finance Commission in its first Report for 1989-90 recommended a
modified Gadgil whereby income tax and union excise duties may be distributed
among States in accordance with this ratio: (1) 20% on the basis of population,
(2) 50% on the basis of distance of the pre-capita income of a State from the
highest per­capita-income State multiplied by its population; (3) 12.5% on the
basis of a State’s per capita income multiplied by its population; and (4) 12.5%
on the proportion of poor people in the State to the total poor population
nationally. However, in the formula for Central assistance to the State
recommended by the Planning Commission and approved by the NDC in December 1991
population continues to be given more weightage, alongside, of course, some
other criteria: population (60%), per capita (25%) and performance (7.5%).
Moreover, of the 25% weightage given to per capita income was made to conform to
the -deviation method’ such that higher the allocation of Central assistance,
lower the per capita income of a State than the national average. In the meeting
of the Inter-State Council which was held in Delhi in July 1997, it was decided
that 29% share in Central taxes be given to the States as suggested by the tenth
Finance Commission. As per the Commission’s recommendation, this arrangement
should be suitably provided for in the Constitution and reviewed once in fifteen
years. The Commission also recommended-that the Centre should continue to have
the power to levy surcharges for the purposes of the Union and these should be
excluded from the sharing arrangements with the States.

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