Economics Prelims cum Mains

Fund fight: Why population became a sticking point for Centre and states

Details :

The news:

  • Some southern states have been protesting over the 15th Finance Commission’s terms of reference (ToR).


Finance Commission:

Need of the Finance Commission (FC):

  • In India’s federal structure, taxation powers and obligations for various services — like law and order, health, education — are unequally shared between the Centre and the states.
  • A fair distribution of tax revenues is necessary also so that public services are equally available to all people whether they live in the poorer or richer states.
  • Hence, the Constitution mandates (under Article 280) the setting up of a Finance Commission (FC) every five years to recommend how revenues from central taxes should be shared between the Centre and the states.
  • The FC deals only with revenue collected through taxes by the Centre (that is, corporation and income tax, customs and excise duties and, now, GST). These make up about two-thirds of central receipts.


Is the FC unique to India?

  • No, some other federal systems such as Australia and Canada also resolve the vertical (between federal & provincial governments) and horizontal (between states) imbalances through similar mechanisms.


Composition of FC:

  • The FC is appointed by the President under Article 280 of the Constitution.
  • It has five members, including a chairperson.
  • India has had 14 such commissions, the first one in 1951.


Duty of Commission to make recommendations to:

  • Vertical and horizontal distribution: The distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them and the allocation between the States of the respective shares of such proceeds.
  • Grant-in-aid: The principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India, and the sums to be paid to the States by way of grants-in-aid of their revenues, under Article 275 of the Constitution.
  • Local bodies funds: The measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State.
  • Any other matter referred to the commission by President.


Recommendation of FC:

  • As per Article 281, recommendations of Commission shall be laid before each House of Parliament.
  • Although its recommendations are not binding, in recent years, the Centre has gone beyond the FC mandate and has been transferring money equivalent to about half of its tax revenues to states.
  • Recommendations on distribution of Union taxes and duties and grants-in-aid are implemented by a Presidential order; others like sharing of petroleum profit, debt relief are implemented by executive orders.
  • The broad principle of various FCs has been to take the different needs and capacities of states into account. The precise formula varies from one FC to the next.


14th Finance Commission:

  • The formula used by the 14th FC took into consideration population, demographic changes, area, a state’s per capita income, and its share of forest cover.
  • These factors were assigned different weights and each state’s share was computed on that basis.
    • Population: Although the base year for population was taken as 1971 (more population meaning higher share), the FC also gave some weight to population changes in the ensuing four decades.
    • Forest cover: A larger area and higher forest cover also implied a higher share.
    • Income distance: A measure of how far the state’s per capita GSDP is from the top states. It implied that states with more poor people will get a higher than proportionate share of central taxes.
  • Local bodies: Apart from the states’ share, the FC also determined how much of central funds will be shared with panchayats and urban local bodies.
  • Other grants: The FC also mandated grants for certain states based on the level of fiscal stress they faced.

15th Finance Commission and controversy with it:

  • In 2017, President constituted the 15th FC, which will make recommendations for the five years commencing on April 1, 2020.
  • The biggest controversy is linked to the change in the population base year. Its terms of reference (ToR) state that the 15th FC is supposed to calculate the population weight entirely according to Census 2011.
  • This, it is feared, will mean that the shares of states more successful in controlling their population will decrease, while those who couldn’t control their population will get a larger share.
  • As a result, southern states could lose the most, while some in the north would gain.

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