The Finance Commission is a constitutional body formed by the President of India to give suggestions on centre-state financial relations. The 15th Finance Commission is required to submit two reports.
Criteria for devolution (2020-21)
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Income distance is the distance of the state’s income from the state with the highest income. The income of a state has been computed as average per capita GSDP during the three-year period between 2015-16 and 2017-18.
This criterion has been arrived at by calculating the share of dense forest of each state in the aggregate dense forest of all the states.
This criterion has been used to reward states with higher tax collection efficiency. It has been computed as the ratio of the average per capita own tax revenue and the average per capita state GDP during the three-year period between 2014-15 and 2016-17.
The 15th Finance Commission used the following criteria while determining the share of states:
For 2020-21, the Commission has recommended a total devolution of Rs 8,55,176 crore to the states, which is 41% of the divisible pool of taxes. This is 1% lower than the percentage recommended by the 14th Finance Commission.
Devolution of taxes to states: The share of states in the centre’s taxes is recommended to be decreased from 42% during the 2015-20 period to 41% for 2020-21.
The 1% decrease is to provide for the newly formed union territories of Jammu and Kashmir, and Ladakh from the resources of the central government.
Uttar Pradesh and Bihar have received the largest devolutions for 2020-21, receiving Rs 1,53,342 crore, and Rs 86,039 crore respectively.
Karnataka and Kerala saw the largest decreases in the share of the divisible pool with a decrease of 0.49% and 0.25% respectively.
Various grants recommended by the 15th Finance Commission
The Terms of Reference of the Finance Commission require it to recommend grants-in-aid to the States.
These grants include:
Sector-specific grants for the following sectors will be provided in the final report:
The grant amount will be provided in the final report.
For 2020-21, State Disaster Risk Management Funds have been allocated Rs 28,983 crore, out of which the share of the union is Rs 22,184 crore. The National Disaster Risk Management Funds has been allocated Rs 12,390 crore.
Recommendations on Fiscal Roadmap
Fiscal deficit and debt levels: The Commission noted that recommending a credible fiscal and debt trajectory roadmap remains problematic due to uncertainty around the economy. It recommended that both central and state governments should focus on debt consolidation and comply with the fiscal deficit and debt levels as per their respective Fiscal Responsibility and Budget Management (FRBM) Acts.
Off-budget borrowings: The Commission observed that financing capital expenditure through off-budget borrowings detracts from compliance with the FRBM Act. It recommended that both the central and state governments should make full disclosure of extra-budgetary borrowings. The outstanding extra-budgetary liabilities should be clearly identified and eliminated in a time-bound manner.
Statutory framework for public financial management: The Commission recommended forming an expert group to draft legislation to provide for a statutory framework for sound public financial management system. It observed that an overarching legal fiscal framework is required which will provide for budgeting, accounting, and audit standards to be followed at all levels of government.
Tax capacity: In 2018-19, the tax revenue of state governments and central government together stood at around 17.5% of GDP. The Commission noted that tax revenue is far below the estimated tax capacity of the country. Further, India’s tax capacity has largely remained unchanged since the early 1990s.In contrast, tax revenue has been rising in other emerging markets.
The Commission recommended:
GST implementation: The Commission highlighted some challenges with the implementation of the Goods and Services Tax (GST). These include:
The Commission observed that the continuing dependence of states on compensation from the central government (21 states out of 29 states in 2018-19) for making up for the shortfall in revenue is a concern. It suggested that the structural implications of GST for low consumption states need to be considered.
Financing of security-related expenditure: The ToR of the Commission required it to examine whether a separate funding mechanism for defence and internal security should be set up and if so, how it can be operationalised. In this regard, the Commission intends to constitute an expert group comprising representatives of the Ministries of Defence, Home Affairs, and Finance.
The Commission noted that the Ministry of Defence proposed following measures for this purpose:
The expert group is expected to examine these proposals or alternative funding mechanisms.