Critically Examine the Role of Finance Commission in the Centre-State Financial Relations

India is a federal country. In a federal system, powers and responsibilities are divided between the central government and the state governments. Some powers are with the Centre, some with the states, and some are shared. But when it comes to money and financial resources, the Centre has more powers than the states. This creates a situation where states depend on the Centre for funds to carry out their responsibilities. To solve this issue and to maintain balance, the Finance Commission was created under Article 280 of the Indian Constitution. The Finance Commission is a constitutional body. Its main duty is to recommend how taxes collected by the Centre should be shared with the states. It also looks into issues of grants, loans, and financial stability. Over the years, the Finance Commission has played a crucial role in shaping Centre-State financial relations. But at the same time, its role has been debated and criticized.the role of the Finance Commission, examine its importance, and critically evaluate its impact on Centre-State financial relations.

Background of Finance Commission

When the Constitution was written, the makers knew that states would need financial support from the Centre because many sources of revenue were kept with the Centre, while states had larger responsibilities like health, education, and law and order. To make sure that financial distribution is fair, the Constitution provided for a Finance Commission.

• Article 280: It says that the President shall constitute a Finance Commission every five years.
• The Finance Commission consists of a Chairman and four other members.
• It gives recommendations on the distribution of taxes and grants between Centre and states.

So, the Finance Commission acts as a balancing wheel in the financial structure of India.

Functions of the Finance Commission

The main functions of the Finance Commission are:

1.Tax distribution: Recommending how net proceeds of taxes should be divided between the Centre and the states (vertical devolution) and among the states themselves (horizontal devolution).

2.Grants-in-aid: Recommending grants to states in need of assistance from the Consolidated Fund of India.

3.Strengthening Panchayats and Municipalities: After the 73rd and 74th Amendments, the Finance Commission also recommends funds for local bodies.

4.Reviewing financial position: Examining the financial situation of the Centre and the states and suggesting ways to improve it.

5.Any other matter: The President can refer additional issues to the Finance Commission for advice.

Importance of the Finance Commission in Centre-State Relations

1. Ensures Fairness in Sharing of Resources

The Finance Commission ensures that states get a fair share of central taxes. Without it, the Centre might keep most of the revenue with itself, leaving states financially weak.

2. Reduces Regional Imbalances

Some states are economically strong while others are weak. The Finance Commission recommends more funds to weaker states so that they can provide basic services to their people.

3. Encourages Fiscal Discipline

The Finance Commission asks states to control unnecessary expenditure and improve their revenue collection. This brings discipline in state finances.

4. Strengthens Cooperative Federalism

By regularly reviewing and recommending transfers, the Finance Commission acts as a bridge between the Centre and the states. It promotes cooperative federalism.

5. Provides for Local Governance

After 1992, Finance Commissions also recommend funds for Panchayats and Municipalities. This gives strength to grassroots democracy.

Recommendations of Some Important Finance Commissions

• 10th Finance Commission (1995–2000): First to recommend that states should get a share of the proceeds of all central taxes, not just certain taxes.
• 12th Finance Commission (2005–2010): Gave importance to debt relief for states.
• 14th Finance Commission (2015–2020): Increased the share of states in central taxes from 32% to 42%. This was a big step for strengthening fiscal federalism.
• 15th Finance Commission (2021–2026): Recommended 41% share for states (reduced because Jammu & Kashmir was made a Union Territory). Also gave performance-based grants for health, education, and agricultural reforms.

Critical Examination of Finance Commission’s Role

While the Finance Commission has done important work, there are many criticisms:

1. Limited Scope

The Finance Commission only deals with tax-sharing and grants. But Centre-State financial relations also involve issues like planning, centrally sponsored schemes, and GST compensation, which are not fully handled by the Finance Commission.

2. Increasing Dependence on Centre

Even though states get a share of central taxes, they are still heavily dependent on the Centre for funds through centrally sponsored schemes. This reduces financial autonomy of states.

3. Vertical Imbalance

The Centre controls most of the revenue sources, while the states handle more expenditure responsibilities. This creates a vertical imbalance. The Finance Commission’s role is limited in correcting this.

4. Political Influence

Though the Finance Commission is a constitutional body, its recommendations depend on acceptance by the Union government. Sometimes, political considerations affect the implementation.

5. Conflict with Planning Commission / NITI Aayog

Earlier, the Planning Commission (now replaced by NITI Aayog) also gave funds to states. This created overlap and confusion. States often complained that the Finance Commission was not enough to address their developmental needs.

6. Short-Term Focus

The Finance Commission is set up every five years and makes recommendations only for that period. It does not provide a permanent solution for long-term financial issues.

7. Distribution Formula Issues

The formula for dividing taxes among states (horizontal distribution) has been controversial. For example, giving more weight to population sometimes penalizes states that have successfully controlled population growth. Similarly, richer states argue that they get less benefit.

Suggestions for Improvement

1.Wider Scope: The Finance Commission should look beyond tax-sharing and grants. It should also consider issues of fiscal management, GST-related concerns, and performance of centrally sponsored schemes.

2.Greater Autonomy: Recommendations of the Finance Commission should be binding on the Centre to reduce political influence.

3.Permanent Finance Commission: Instead of creating a new body every five years, a permanent Finance Commission can continuously review Centre-State finances.

4.Better Coordination with NITI Aayog: There should be clear roles for Finance Commission and NITI Aayog so that states get funds in a transparent and efficient manner.

5.Balanced Formula: The formula for horizontal distribution should balance equity (helping poor states) and efficiency (rewarding states that perform well).

6.Encouraging State Revenue Efforts: States should be rewarded for improving their tax collection and reducing fiscal deficits.

7.Local Body Empowerment: The Finance Commission should ensure stronger transfers to Panchayats and Municipalities for real grassroots development.

The Finance Commission is a cornerstone of India’s federal financial system. It has played a very important role in distributing financial resources and promoting cooperative federalism. It has also helped weaker states by reducing regional imbalances. At the same time, its scope and powers are limited. States remain dependent on the Centre, and political influence often affects financial transfers.

For a healthy federal system, India needs a stronger and more independent Finance Commission with a wider scope. If properly empowered, it can act as a true balancing wheel of Centre-State financial relations. In the future, reforms in the Finance Commission can ensure fairness, stability, and efficiency in India’s fiscal federalism.