Answer

The Finance Commission, a constitutional body under Article 280, ensures equitable fiscal distribution between the Union and States. Amid growing fiscal imbalances and increasing state demands, its role is critical. The upcoming Sixteenth Finance Commission must navigate challenges like revenue shortfalls and expenditure needs, fostering equitable and efficient resource allocation to strengthen cooperative federalism.

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Fiscal Challenges Between the Union and States in India

• Imbalanced Fiscal Autonomy: States depend heavily on the Union for fiscal resources but lack sufficient autonomy in utilizing funds.
  For example: The levying of cesses and surcharges by the Union reduces the effective share of States, as seen in the Fifteenth Finance Commission’s devolution, which amounted to only 33.16% of the gross tax revenue.
• Disparity in Revenue Generation and Expenditure Needs: Progressive States generate significant revenue but are often allocated fewer funds due to horizontal devolution formulas.
  For example: Tamil Nadu, despite being a high-performing State, faces challenges in receiving resources proportionate to its contribution to GDP.
• Increased Financial Burden on States: States face mounting expenditures for centrally sponsored schemes (CSS) while receiving inadequate devolution to meet counterpart funding.
  For example: The increased counterpart funding requirements for programs like PMAY strain State finances.
• Impact of Urbanization and Aging Populations: Progressive States encounter additional fiscal challenges due to rapid urbanization and aging demographics, leading to increased infrastructure and social service costs.
  For example: Tamil Nadu’s urban population is projected to reach 57.30% by 2031, far above the national average.
• Centralization of Taxation Powers: The GST regime has centralized indirect tax collection, limiting States’ ability to generate revenue independently.
  For example: States lost their power to levy taxes on goods and services like VAT and octroi, leading to greater dependence on GST compensation.

Role of the Finance Commission in Addressing Fiscal Challenges

• Equitable Resource Distribution: The Finance Commission ensures vertical and horizontal devolution to address fiscal imbalances.
  For example: The Fifteenth Finance Commission allocated 41% of the divisible pool to States under vertical devolution.
• Ensuring Predictability and Stability: It provides a stable framework for resource sharing between the Union and States for five years.
  For instance: The periodic recommendations help States plan their fiscal policies effectively.
• Incentivizing Performance: By incorporating performance-based criteria, the Commission can encourage States to enhance governance and fiscal prudence.
  For example: The Fifteenth Finance Commission introduced performance incentives for water management and population control.
• Addressing Regional Disparities: The Commission balances resources to support less-developed States while ensuring high-performing States have the means to grow.
  For example: Special grants for northeastern and hilly States address regional disadvantages.
• Encouraging Fiscal Discipline: It promotes responsible fiscal management by linking funds to compliance with targets like fiscal deficit limits.
• Adapting to Emerging Challenges: The Finance Commission evolves its approach to address contemporary issues like urbanization, aging populations, and climate change.
  For example: The Sixteenth Finance Commission can propose funds for urban infrastructure development in Tamil Nadu, addressing urbanization needs.

Balancing Equity and Efficiency in Resource Allocation

• Increased Vertical Devolution: Raising the States’ share of central taxes to 50% would enhance fiscal autonomy while addressing developmental needs.
  For example: A higher share would help states like Kerala to better manage urbanization and support its aging population.
• Differentiated Horizontal Devolution: Allocating resources based on a mix of need and performance to balance equity with efficiency.
  For example: High-performing States could receive incentives for maintaining growth, while less-developed States get funds to bridge gaps.
• Special Funds for Demographic Challenges: Earmarking resources for States facing challenges like aging populations or rapid urbanization.
• Flexible Use of Centrally Sponsored Scheme Funds: Allowing States greater discretion in tailoring CSS to their specific needs to maximize efficiency.
  For example: States could modify PMAY guidelines to address unique urban housing challenges.
• Focus on National Economic Growth: Encouraging policies that enlarge the national economic pie, ensuring equitable benefits for all States.
  For instance: Supporting high-growth States while ensuring less-developed regions catch up can drive overall economic progress.

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The Sixteenth Finance Commission holds the potential to redefine fiscal federalism by prioritizing transparency, sustainability, and inclusivity in resource allocation. By leveraging data-driven policies, incentivizing fiscal discipline, and addressing regional disparities, it can ensure a harmonious balance between equity and efficiency, promoting resilient Union-State relations and empowering India’s economic growth in an evolving global landscape.

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