Introduction
Recently, the Indian government has accepted the 15th Finance Commission’s proposal to keep the States’ share in the divisible pool of taxes at 41% for the five years commencing from 2021-22. The Commission’s Report was presented before Parliament.
About the 15th Finance Commission
Established by the President of India in November 2017 under Article 280 of the Constitution, the Finance Commission, led by NK Singh, is a constitutional body that decides on the methods and formula for tax distribution between the Centre and states, as well as among the states themselves based on the current provisions and demands. The recommendations of the 15th Finance Commission will apply for five years, from 2021-22 to 2025-26.
Key Points
The Commission has recommended that vertical devolution, or the distribution of Union Taxes to the States, be kept at 41%, the same as its interim report for 2020-21. It matches the 42% allocation suggested by the 14th Finance Commission, with a 1% reduction due to the transformation of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir.
For horizontal devolution, ensuring the allocation among States, the Commission proposed considering multiple factors: demographic performance (12.5%), income (45%), population and area (15% each), forest and ecology (10%), and tax and fiscal efforts (2.5%).
Revenue Deficit Grants to States
The Commission suggested post-devolution revenue deficit grants approximating Rs. 3 trillion over the five years leading to FY26. The number of states breaching revenue targets will drop from 17 in FY22 to 6 in FY26.
Performance-Based Incentives and Grants to States
The Commission’s recommendations for these grants involve four main areas: the social sector, rural economy, governance and administrative reforms, and performance-based incentives for the power sector. The focus is on health and education within the social sector, and on farming and maintenance of rural roads within the rural economy.
Fiscal Space for Centre
The total transfers by the 15th Finance Commission constitute about 34% of the Union’s estimated Gross Revenue Receipts, leaving ample fiscal space to meet the Centre’s resource requirements and spending commitments.
Grants to Local Governments
In addition to funding municipal services and local government bodies, the Commission included performance-based grant recommendations for incubating new cities and distributing health grants to local governments.
Criticism
The Commission’s approach has drawn criticism for potentially undermining independent decision-making and cooperative fiscal federalism. Critics argue that imposing conditions on a state’s borrowing ability could deter state spending on development projects. Furthermore, the Union government doesn’t appear to be held responsible for its fiscal caution, which weakens the joint liability shared by the Union and States.
Horizontal Devolution Criteria Explained
There are six criteria taken into account for horizontal devolution. Population represents the expenditure needs of a state to provide services to its residents. Area is considered as the greater area a state has, the larger expenditure it requires. Forest and Ecology gives states with denser forests more shares. Income Distance awards states with lower per capita income a higher share to maintain equity. Demographic Performance favors states with controlled population growth. Tax Effort rewards states with efficient tax collection systems.