| Role of Finance Commission (Article 280) • Its role is to distribute taxes among States and recommend grants for specific purposes. • As per 15th Finance Commission India has a larger VFI than most federations, exacerbated during COVID-19 crises. • The 14th and 15th Finance Commissions recommended only 42% and 41% share to states in tax devolution. • Many States demand that the 16th Finance Commission raise the tax devolution share to 50%, citing the exclusion of cesses and surcharges from net proceeds. |
- The financial relationship between the Union and States in India is asymmetrical, with States incurring 61% of revenue expenditure but collecting only 38% of revenue receipts, leading to a Vertical Fiscal Imbalance (VFI).
- States depend heavily on transfers from the Union government, as expenditure decentralization exceeds their revenue-raising abilities.
- VFI occurs when the Union collects most taxes, while States handle expenditures.
- The Finance Commission addresses VFI by recommending the distribution of Union-collected taxes to States
- Beyond this, the Union government allocates funds through centrally sponsored and sector schemes, which often include conditions.
- However, the only unconditional transfer from union to state is through tax devolution from net proceeds.
- To calculate VFI, a ratio is used comparing Own Revenue Receipts (ORR) plus tax devolution against Own Revenue Expenditure (ORE).
- If the ratio is less than 1, it indicates a deficit, reflecting VFI after-tax devolution.
- Analysis suggests a 49% devolution is necessary to eliminate VFI, ensuring States have more untied resources and better respond to local needs.
- This would enhance fiscal federalism and improve the efficiency of expenditures.
Dig Deeper: Read about the Terms of Reference of the 16th Finance Commission.
