What is the role of finance commissions?

Finance commissions are independent constitutional bodies with a key role to play in the division of the Centre's net tax proceeds between the Union and state governments, keeping in mind the fiscal needs of the states. All Central taxes other than those levied by the Centre but are collected and appropriated by the states or are assigned to states, as well as specific surcharges and cess levied by the Centre, form a part of this divisible pool of tax revenue. 

The finance commissions decide the extent of the Centre's revenue to be shared with the states as well as the formula for apportioning it among states. It ensures that such revenue-sharing is based on an independent external assessment of various factors, including the needs of the states and their fiscal performance.

What was the controversy over the mandate of finance commissions in the past?

Revenue sharing among states is a controversial subject given that there is always a fund crunch and the welfare needs vary. Besides, in a vastly diverse country, the parameters have to accommodate the interests of all the states, which are on different development trajectories. 

This leads to complaints from some states, especially those in southern India, that they get a smaller share, especially considering their contribution of taxes.

In the case of the 15th Finance Commission, one of the key terms of reference was to use the population data of the 2011 census. This prompted Karnataka and Tamil Nadu to express their concerns that it would lead to reduced allocations to them as they had been successful in their population stabilization initiatives. The commission under N.K. Singh eventually gave weight to both population as well as 'population performance' for an equitable allocation. 

In the case of the 14th Finance Commission, the government had suggested use of 1971 census data in general with the option to take into account subsequent demographic changes. The terms of reference of the 15th Finance Commission was also seen as prescriptive, but in the case of the 16th Finance Commission, the Central government chose to keep it short and direct.

What does the Centre want of the commission under Panagariya?

In addition to deciding on what share of the Centre's tax receipts should be devolved to states and how it is to be apportioned among them, the 16th Finance Commission has been asked to suggest ways to augment the states' respective consolidated funds to supplement the resources of local bodies such as panchayats and municipalities. The commission has been asked to also establish the principles for grants-in-aid of revenues of the states from the Centre.

What are the broader issues the new commission is expected to address?

A key issue that Panagariya is expected to address is the sustainability of debt at Central and state levels. The general government debt including that of both the Centre and states stood at 81% of GDP in 2022-23, as per information available from the finance ministry. 

The IMF recently said that in one extreme possibility, the debt-to-GDP ratio could be 100% under adverse shocks, by 2027-28, while also making projections for other countries. The finance ministry is of the view the Centre is on track to achieve its stated target of fiscal deficit below 4.5% of GDP by 2025-26, and that the general government debt will decline substantially in the medium to long term. 

The 16th Finance Commission is expected to look into this trajectory, various revenue trends at the Central and state levels, and expenditure obligations during its award period (FY27-FY31) to make recommendations. 

Another key area that the commission is expected to look into is expenditure reforms at the state level. The Central government has followed fiscal prudence without compromising on welfare needs during the pandemic, and the commission is likely to focus on the efficiency of expenditure at the state level.

What is there in the finance commission recommendations for the common man?

This is a vital area of the Finance Commission's recommendations. On the one hand, states with low per capita income tend to get a higher devolution of funds so that those states can deliver public goods at levels comparable to that in other states. On the other hand, 'tax and fiscal effort', or the states' effectiveness in raising resources compared to their potential, gets weight in the commission's award to states. 

This is expected to incentivise the fiscal performance of the states, including tax collections with greater devolution of funds to the states for various needs, benefiting their citizens. 

The 15th Finance Commission had recommended GST rate rationalisation as a medium-term goal, which the GST Council had taken up but could not make much progress due to high inflation and the need to support