GS-3, Indian Economy, Uncategorized

15th Finance Commission’s interim report

Context

  • The report of the 15th Finance Commission headed by N K Singh was tabled in Parliament.

The Finance Commission and its purpose

  • The Finance Commission is a body set up under Article 280 of the Constitution, primarily to recommend measures and methods on how revenues, which the government earns through various taxes, need to be distributed between the Centre and the states.
    • The First Finance Commission was constituted in 1951 headed by KC Neogy.
  • With this, the framers of the Constitution were seeking to address the vertical imbalance between the taxation powers and expenditure and responsibilities of the federal government and the states, and the horizontal imbalance, or inequality, between states that were at different stages of development.
  • Ensuring inclusiveness is, therefore, a key mandate of the Finance Commission. That means assigning weights to things like population, the fiscal distance between the top-ranked states and the others, etc.

Who appoints the Finance Commission and what are the qualifications for Members?

  • The Finance Commission, which is headed by a Chairman and has four other members, is appointed by the President under Article 280 of the Constitution.
  • As per the provisions contained in the Finance Commission [Miscellaneous Provisions] Act, 1951 and the Finance Commission (Salaries & Allowances) Rules, 1951, the chairman of the Commission is selected from among persons who have had experience in public affairs.
  • The Finance Commission Rules, 1951, lay down the criteria for being members of the constitutional body: those having special knowledge of finance and accounts of government with wide knowledge and experience in financial matters and in administration, or with special knowledge of economics, and those who have been qualified to be appointed as a judge of a High Court.

Interim Report of 15th FC

  • The interim report of the 15th Finance Commission has largely preserved the devolution of its predecessor.
  • As part of an effort to balance the principles of fiscal needs, equity and performance, as well as the need to ensure stability and predictability in transfers, the criteria for the horizontal sharing of taxes among States have been rearranged.
    • A crucial new parameter, demographic performance, has been added to the mix.
  • Having been mandated to adopt the population data from the 2011 Census, the commission has incorporated the additional criterion to ensure that States that have done well on demographic management are not unfairly disadvantaged.
    • And since the norm also indirectly evaluates performance on the human capital outcomes of education and health, it has been assigned a weight of 12.5%.
    • This should address the concerns voiced by several States over the switch to the 2011 Census from the 1971 data.

Changes introduced by 15th FC

  • The 15th Finance Commission has recommended reducing states share by 1% from Centre’s divisible pool to 41% in 2020-21 as against 42%
    • The one percentage point cut has come on account of the re-organisation of the erstwhile State of Jammu & Kashmir.
    • While the former State’s estimated share based on the parameters for horizontal devolution would have been about 0.85%, the commission has cited the security and other special needs of the two territories to enhance their aggregate share to 1%, which would be met by the Centre.

In its report, the FC has tweaked the criteria and weights under which funds are allocated to States.

  • Population of a State: 15 per cent weight (down from 17.5 per cent allocated by the 14th Finance Commission) has been assigned.
  • Weight for demographic performance: It has been increased to 12.5 per cent (as against 10 per cent allocated by the 14th Finance Commission).
  • Income Distance (difference of a state’s per capita income from that of the state with the highest per capita income)It has reduced the weight for income distance from 50% to 45%.
  • “Tax Effect”: The 15th FC report has introduced a new criteria, the “tax effect”, for states, with 2.5% weightage.

Local Bodies

The commission’s effort to improve the granularity in devolution to local bodies has generated some interesting results.

  • Urban local bodies, especially municipalities in cities with populations of more than one million, are set to get a larger share of the pie.

Other Recommendations

  • The Commission also suggested that the country needs an overarching fiscal framework for Centre as well as states, on the lines of the FRBM Act, which would lay down accounting, budgeting and auditing standards to be followed at all levels of the government.
  • The Commission has also been critical of the Union and State governments’ tendency to finance spending through off-budget borrowings and via parastatals.
  • It has done well to ask that such extra-budgetary liabilities be clearly earmarked and eliminated in a time-bound manner.

Formula used by 14th FC

Formula used by 14th FC

The formula had five elements:

  • Population as of 1971 with a weight of 17.5%;
  • Demographic Change reflecting population shifts between 1971 and 2011 with a weight of 10%;
  • Fiscal Capacity measured by the income distance method with a weight of 50%; and
  • Area with a weight of 15%;
  • Forest cover with a weight of 7.5%.

Thank you!

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