[Gist of Yojana March 2021] Finance Commission

Mains Paper 3: Economy
Prelims level: 15th Finance Commission
Mains level: Indian Economy, growth and development, infrastructure


• The Fifteenth Finance Commission (FC-XV) was constituted by the President under Article 280 of the Constitution on November 27, 2017. The title of the report ‘Finance Commission in Covid Times’, submitted to the President for the period 2021-26.

• The first Finance Commission was constituted on November 22, 1951 and was chaired by K.C. Niyogi.

• The Union government, in its action taken report on the commission’s report tabled in Parliament on February 1, 2021 accepted most of the recommendations.

Constitutional framework:

• The Finance Commission transfers are made under Articles 270, 275 and 280 of the Constitution, which provides a mechanism for sharing of taxes and revenues vertically between the Centre and states: and horizontally among all states.

• Fifteenth Finance Commission was additionally tasked with reviewing and commenting on the design of fiscal principles for various grants that are typically provided alongside revenue shares.

• It was also asked to consider performance-based incentives to support and motivate the efforts of State and/or local governments the “appropriate level of government” in a variety of policy areas.

• Another unique ToR given to it included recommending funding mechanism for defence and internal security.

Vertical Transfer: Approach and Logic

• The Constitution empowered both the Union and the States to raise revenues from different sources of taxation and also assigned responsibilities to incur expenditure through subjects in three lists-Union List, State List and Concurrent List in the Seventh Schedule.

• By Constitutional design, this distribution has assigned higher and more buoyant taxation and resource raising powers to the Union Government whereas higher responsibilities for incurring expenditure have been assigned to the States.

• The Fifteenth Finance Commission, in its final report, recommended this devolution to beat 41 per cent. This will maintain the predictability and stability of resources, especially during the pandemic.

• This vertical devolution is in line with the recommended share in our first report as well as with the devolution of the FC-X1V. As compared to FC-XIV, this Commission has only made the required adjustment of about 1 per cent due to the changed status of the erstwhile State of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir, as the resources for these Union territories will now be provided by the Union government.

• This level of vertical transfers will allow’ appropriate fiscal space for the Union as well to meet its demands as well as maintain an adequate level of unconditional resources to the States.

Horizontal Distribution:

• Horizontal devolution of taxes is mainly driven by considerations of need, equity and performance. However. balancing equity and efficiency is never an easy exercise.

• The diverse nature of this country with States at different levels of development and having complex characteristics related to their history, geography, economy and sociology impact their revenues and expenditures. Additional financial resources are certainly needed to help a state develop, but the ability to effectively use those resources is undoubtedly more crucial, and is a distinctive feature visible across States.

• Fifteenth Finance Commission has tried to harmonise the principles of expenditure needs, equity and performance in determining the criteria for horizontal sharing by broadly assigning appropriate weightages.


• After the distribution of the net proceeds of taxes, the second core function entrusted to the Finance Commission is to determine the principles which should govern grants-in-aid, assess the needs of States in relation to such norms developed and applied to both revenue effort and desirable levels of expenditure and thereafter recommend grants in specific sums.

The Commission has recommended five different categories of grants:

a. Revenue deficit grants,
b. Grants for local governments,
c. Grants for disaster management,
d. Sector-specific grants, and
e. State-specific grants.

Revenue Deficit Grants:

• It is evident that no formula-based horizontal devolution can meet the needs of each of the twenty-eight States whose cost disabilities and fiscal capabilities are so vastly different from each other. Therefore, the Commission has recommended an allocation of 1.92 per cent of the gross revenue receipts of the Union as revenue deficit grants to specific States. The revenue deficit grants aggregate to Rs. 2,94.514 crore, with gradual tapering off during the award period.

Local Government Grants:

• Urban local bodies have been categorised into two groups, based on population, and different norms have been used for flow of grants to each, based on their specific needs and aspirations. Basic grants are proposed only for cities/towns having a population of less than a million. For Million-Plus cities, 100 per cent of the grants are performance-linked through the Million-Plus Cities Challenge Fund (MCF).

Disaster Management Grants:

• While assessing disaster management grants, the Commission recommended Mitigation Funds to be set up at both the national and State levels, in line with the provisions of the Disaster Management Act.

• The Mitigation Fund should be used for those local level and community-based interventions which reduce risks and promote environment-friendly settlements and livelihood practices.

Other Sector-specific and State-specific Grants:

• Under the category of sector specific grants, the Commission has also recommended performance based grants and incentives for sectors like health, education, agriculture.
PMGSY roads, judiciary, statistics and aspirational districts and blocks.

• The Commission laid special focus on health sector while doing a detailed analysis of health expenditure and related facilities and infrastructure in various States. The health sector still faces critical challenges like low investment, sharp inter-State variations in the availability of health infrastructure and health outcomes and supply side problems of doctors, paramedics and inadequate number of healthcare centres.

Defence Fund:

• The extant strategic requirements for national defence in the global context, the Commission re-calibrated the relative shares of Union and States in gross revenue receipts by reducing its grants component by 1 per cent.

• This will enable the Union to set aside resources for the special funding mechanism that has been proposed in the report. It has also been recommended that the Union Government may constitute in the Public Account of India, a dedicated non-lapsable fund. Modernisation Fund for Defence and Internal Security (MFDIS).


• While making its recommendations, the Commission went through widespread stakeholder consultations including Union Government, State governments, local bodies, trade bodies, political parties and economists. It also took inputs from experts through its advisory council, international and national organisations, think-tanks, high-level group on health sector etc.

• As the Commission faced the unprecedented challenge of making projections and recommendations under the most uncertain circumstances, it consistently tried to balance the views of these stakeholders to achieve efficient, equitable, inclusive solutions in this extremely diverse country.

• The Commission believes that the distribution of resources between the Union and the States and for the third tier of government have been addressed in a manner which is fair, reasonable, rational and equitable. In this sense, it represents a continuation of the legacy of trust—the trust which it has inherited from its very inception in a tentative way in 1949 with an unbroken record.

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