15th Finance Commission

15th Finance Commission

This article deals with ‘National Incomes.’ This article is part of our series on ‘Economics’ which is an important pillar of the GS-3. For more articles, you can click here.


Introduction

15th Finance Commission came up with two reports due to the sudden creation of the Union Territory of Jammu and Kashmir and Ladakh as more time was required to analyse the impact of these developments.

  • 1st Report: Recommendations from 1/April 2020 to 31/ March/2021
  • 2nd Report: Recommendations from 1/April/2021 to 31/March/2026

Composition of 15th Finance Commission

It consists of 5 members, including the Chairman (according to the provisions of the Indian Constitution)

NK Singh Chairman
Shantikanta Das (Member) RBI Governor
Dr. Anoop Singh (Member) Professor
Dr. Ashok Lahiri  (Member) Senior Executive of Bandhan Bank
Prof. Ramesh Chand (Member) Agriculture Economist

Terms of Reference of 15th Finance Commission

Terms of Reference for all Finance Commissions mentioned in the Indian Constitution are as follows.

  1. Distribution of the net proceeds of the divisible pool of taxes to be shared between Centre and states (Vertical Distribution), and the allocation between states (Horizontal Distribution) 
  2. Principles that should govern the grants-in-aid to the states by the Centre.
  3. Measures needed to augment the consolidated fund of a state to supplement the resources of Panchayats and municipalities. 
  4. Any other matter referred to it by the President in the interests of sound finance.
  5. Constitution also allows Finance Commission to make broader recommendations in the interests of sound finance. 

President referred the following additional matters. 

  1. For population, use data of Census of 2011 instead of Census of 1971.
  2. Keep New India 2022 vision in mind (i.e. Smart City, Swachh Bharat Scheme etc.).
  3. Keep Union’s Defence and Internal Security responsibilities in mind.
  4. Recommend whether Union should continue to give Revenue Deficit Grants or not along with the additional conditions that Union can impose on states while borrowing from external sources.
  5. Finance Commission should propose performance-based incentives (PBI) in areas such as
    • Steps taken by particular state towards expanding and deepening GST.
    • Steps taken to achieve population replacement rate.
    • Improvement in ease of doing business.
    • Sanitation
    • Reign in populist measures 
    • Promoting savings through the adoption of direct benefit transfers.
    • Promoting a digital economy.

States are apprehensive on the additional terms of references

Issue 1: Using 2011 census for population

  • 14th Finance Commission had used both Census of 1971 and 2011 for horizontal distribution of taxes among states. 17% weightage was given to the 1971 population, and 10% weightage was given to the 2011 population.
  • But 15th Finance Commission was ordered to use the Census data of 2011 only. Hence, the Southern States and states like Punjab who have reduced their fertility rate between 1971 to 2011, are bound to lose some share in favour of states like UP, Bihar, etc. who have performed worse in reducing their fertility rate. Therefore, Commission is punishing the states for performing better in the initiative started on the directions of the Union government to reduce population growth in the 1970s-80s.

Counter Argument: 12.5% weightage is also given to demographic performance to appreciate the work of states that have performed well to reduce the Total Fertility Rate in their states (shown below)


Issue 2: Issues with keeping New India-2022 vision in mind

  • States are apprehensive that this can reduce the percentage of devolved funds to states.
  • Along with that, another apprehension is that Local Governments will get more grants with tied objectives. Hence, their independence and the ability to start area-specific schemes will be curtailed.

Issue 3: Issues with keeping Union’s defence responsibilities in mind

  • This will also reduce the share of the state’s in the devolved funds as defence is the Union’s responsibility.
  • In the final report, the 15th Finance Commission has reduced the vertical distribution to 41% (i.e. 1% less than 14th Finance Commission), keeping Jammu and Kashmir’s security concerns in mind.

Issue 4: Debt and Grants

  • 15th Finance Commission will examine whether revenue deficit grants given to the states should be abolished.
  • Article 293: States can’t borrow without consent of the Union. Terms of Reference includes suggestion on additional conditions that Union could impose on the states when states borrow from external sources?  States fear that this will reduce their autonomy in raising loans from the market.

Issue 5: Issues with performance-based incentives

States are apprehensive about them because

  • Small states like Mizoram, Manipur etc., due to their geographical constraints, can’t deepen their GST tax net in the same way as can be done by states like Punjab, Haryana or Maharashtra. 
  • Northern states are apprehensive that due to higher Fertility rates, they will lose money.
  • The southern States have apprehensions that they will have to stop their populist schemes like Amma Canteens (Tamil Nadu).

Recommendations of 15th Finance Commission

1. Vertical Devolution

All the money collected by the Union government through direct and indirect taxes is shared by the Union government with the states on the formula suggested by the Finance Commission, which is to be constituted by the President every five years (under the provisions of Article 280 of Indian Constitution).

Such arrangement has been made because

  • Taxation powers of State governments are low. 
  • The Union government collects all the important direct taxes like Income and corporate taxes.

Previous Finance Commissions have suggested the following percentage of Union Government’s devisable taxes to be shared with states.

15th Finance Commission

Presently, the 15th Finance Commission has recommended that for the financial year 2020-21, Union should share 41% of devisable taxes with the states.

15th Finance  Commission

Why 15th Finance Commission reduced the percentage of taxes to be devolved?

15th Finance Commission headed by NK Singh believed that, because of the creation of new Union Territories of Jammu and Kashmir and Ladakh, Union’s responsibilities have increased.


2. Horizontal Devolution

  • Horizontal devolution means how to distribute the devolved taxes horizontally between the individual States.
  • 15th Finance Commission considered the following criteria to divide the devolved taxes between the states.
    • 45% weightage to Income distance (states with lesser per capita GSDP (Gross State Domestic Product), i.e. poorer states will get more share)
    • 15% weightage to the area (states with more area will get more share)
    • 15% weightage to the population as per 2011 census (more population means more share)
    • 12.5% weightage to demographic performance (states that have reduced Total Fertility Rate will get more share)
    • 10% weightage to forest and ecology (states with more area under forest will get more share)
    • 2.5% weightage to tax efforts (States who have improved their per capita (State) tax collection in the last three years will get more share).
  • After doing calculations based on the above formula, the final list is as follows
Rank State %age
1 UP 17.93%
2 Bihar 10.06%
3 MP 7.89%
—- —– —–
6 Rajasthan 5.979%
—– —– —–
16 Kerala 1.943%
17 Punjab 1.788%
—- —- —-
26 Mizoram 0.51%
27 Sikkim 0.39%
28 (last) Goa 0.39%
Note Any Union Territory 0%

3. Grants from Union to States

Apart from the tax devolution, Finance Commission also suggest Union to give some grants to the states. These grants are as follows:-

3.1 Grants to Local Bodies

  • Union Government should give ₹4.36Lcr  for 2021-26 to local bodies.

3.2 Post devolution Revenue Deficit Grant

Some states like Andhra Pradesh and Punjab, which have revenue deficits even after devolved taxes from the Union, will get this grant to cover that deficit. Union government will give ₹ 2.94 lakh crore to such states in the form of Revenue Deficit Grants.

There are 14 such states eligible for this: Assam, Himachal Pradesh, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, Uttarakhand, Andhra, Kerala, Punjab, Tamil Nadu, West Bengal.

civilspedia.com

3.3 Special Grants

  • If any state receives less money than earlier getting under 14th Finance Commission, it will be compensated through Special Grants.
  • Under the 15th Finance Commission, there are three such states, i.e. Telangana, Karnataka and Mizoram. 

3.4 Disaster Management Grants

Under Disaster Management Act 2005, four funds have been created (two at the union level and two at the state level, respectively). 15th Finance Commissions recommendations have been explained in the infographic given below.

Disaster Management Grant

3.5 Sector-Specific Grants

  • 15th Finance Commission has recommended special grants for seven sectors mentioned in its Terms of Reference, i.e. health, pre-primary education, judiciary, rural connectivity, railways, statistics and housing. 
  • For example, 
    1. Health Sector has been given 1.06 lakh crore for upgrading the PHCs, building new hospitals, training doctors and healthcare workers. 
    2. State-specific grants of ₹ 49599 cr have been allocated for developing tourism, historical monuments, infrastructure, water etc.
    3. ₹ 2.38 lakh crore has been given to the Union for Defense and Internal Security Fund.
    4. ₹45,000 crores have been allocated for the implementation of agricultural reforms.
    5. ₹27,000 crores have been allocated to maintain Pradhan Mantri Gram Sadak Yojana (PMGSY) roads.
    6. ₹10,000 crores have been allocated for the judiciary to set up infrastructure to settle the property cases pending for five years or more, civil cases of marginalized people, POSCO cases (child sex abuse) & heinous crimes. 
    7. ₹6,000 crores have been allocated for developing online learning and translating medical engineering courses in regional languages.

3.6 Performance-based Incentives

  • Finance Commission will also propose performance-based incentives (PBI) in areas such as
    1. Efforts made by the states in expansion and deepening of the tax net under GST.
    2. Efforts and progress made in moving towards replacement rate of population growth.
    3. Improvement in ease of doing business.
    4. Sanitation 
    5. Reign in populist measures.
    6. Promoting savings through adoption of direct benefit transfers.
    7. Boosting a digital economy; etc.
  • If States perform well in the above areas, they will get more money in grants.
  • 15th Finance Commission hasn’t decided the amount yet.

4. Other Recommendations by Finance Commission

  • Government should reform the direct tax system to increase tax collection.
  • Government should review the outcomes of all Government schemes and abolish non-essential schemes.
  • Government should follow FRBM Act in letter and spirit. It should avoid off-budget borrowings through para-statal entities.
  • Union and State Government should together spend 2.5% of their GDP on Healthcare sector by 2025.
  • Form All India Medical and Health Service as 4th All India Service and IAS, IPS and IFS.
  • Some States have requested special category status. But Finance Commission has refrained from commenting on this matter as it wasn’t part of their Terms of Reference.

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