Charting the Path for Sixteenth Finance Commission

GS Paper II Indian Polity and Governance

Context:

The Union government is planning to set up the 16th Finance Commission during the fiscal year 2023-24.

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The commission’s main task is to suggest the ratio in which taxes should be divided between the Centre and states for the five-year period starting from April 1, 2026.
The members of the commission and its Terms of Reference (ToR) are currently being determined.

About Finance Commission(FC):

It is a constitutional body that provides recommendations on Centre-state financial relations.
It is established every five years under Article 280 of the Constitution.

Their recommendations cover three main aspects:

Vertical Devolution (Union to state transfers): FCs suggest the share of states in the divisible pool of central taxes.
- The share of taxes is determined by a set of indicators that includes population, per capita income, area, and incentive-related factors such as forest cover and demographic change.
Horizontal Distribution ((between states): Allocation of resources among states based on a formula considering their fiscal needs, capacities, and performance.
Grants-in-aid: It also recommend additional transfers to specific states or sectors requiring assistance or reform. For instance, the 13th FC provided grants for justice delivery and the statistical system.