Context: 

In November of this year, the Sixteenth Finance Commission is going to be set up to recommend the formula for sharing revenues between the Centre and the States for the five-year period beginning 2026-27.

Finance Commission: 

• Constitutional Provision: Article 280 in the Constitution Of India.
• Constituted By: The President shall, within two years from the commencement of Indian Constitution and thereafter at the expiration of every fifth year or at such earlier time as the President considers necessary, by order,  constitute a Finance Commission.
• Composition: It consists of a Chairman and four other members to be appointed by the President.

Duties of the Commission:

• It shall be the duty of the Commission to make recommendations to the President as to:
  • The distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them under this Chapter and the allocation between the States of the respective shares of such proceeds.
    • Vertical Devolution: It focuses on Union to state transfers.
    • Horizontal Distribution: It involves the allocation of resources between states based on a specific formula.
  • The principles which should govern the grants in aid (under Article 275 of the Indian Constitution) of the revenues of the States out of the Consolidated Fund of India.
  • Any other matter referred to the Commission by the President in the interests of sound finance. 
• The Commission shall determine their procedure and shall have such powers in the performance of their functions as Parliament may by law confer on them. 

Challenges for the Sixteenth Finance Commission:

• High Imbalances: 
  • High Centre’s large fiscal imbalances. 
    • In actual terms, the deficit was Rs 2,10,287 crore at end-May 2023, as per the data of the Controller General of Accounts (CGA).
  • The combined government debt-GDP ratio had also shot up close to 90% at the end of 2020-21 and many States show large fiscal imbalances too.
• Concern of High Non-shareable Cesses & Surcharges:
  • During 2020-21 to 2023-24 (BE), the effective share of States in the Centre’s gross tax revenues (GTR) averaged close to 31%, which was significantly lower than the previous years’ comparison. 
  • This was due to the inordinate increase in the share of cesses and surcharges. 
  • The need for the latest data to take actions and make recommendations accordingly. 
• Structuring of GST Tax: 
  • GST still needs restructuring to make it a good and simple tax.
• Criteria for Determining States’ Share:
  • The share of individual states in the Centre’s divisible pool of taxes is determined by a set of indicators, including population, per capita income, area, and incentive-related factors.
  • The Southern States took these factors as a step against them as they worked positively to reduce population while receiving negative share.
• The Impact of Covid-19 Pandemic:
  • The Covid-19 pandemic has caused unprecedented disruption and uncertainty in the economy and public finances.
• The Impact of Geopolitical Challenges: Like the Ukraine-Russia War, China-US Trade War and also for the Global Climate impacts.
  • They also led to the unprecedented disruption and uncertainty in the economy and public finances.

Way Forward:

• Need to Set up a Loan Council: 
  • The Twelfth Finance Commission also recommended setting up an independent Loan Council.
  • This independent body should oversee the loan magnitudes and profiles of the central and State governments. 
• Examination of Non-Merit subsidies in Detail: 
  • The Sixteenth Finance Commission should examine the subject of non-merit subsidies in detail. 
• Strict Maintenance of Fiscal Deficit within limits:
  • The Sixteenth Finance Commission should be strict about States maintaining fiscal deficit within limits. 
  • It should appreciate the States maintaining a fiscal deficit.
    • Example: By including fiscal performance as a criterion in horizontal distribution.
  • It should be strict with those states that exceed fiscal deficit limits.
    • Example: By suitably acting on the extent of borrowing allowed.
• Need For Re-examination of FRBM norms:
  • The target of Fiscal Responsibility and Budget Management (FRBM) norms for debt-GDP ratio for central and State governments of 40% and 20% need to be achieved. 
    • There is a need to re-examination of 2018 amendment to the Centre’s FRBM Act. This was also recommended by the Fifteenth Finance Commission.
    • The Sixteenth Finance Commission needs to focus on FRBM norms in a strict way. 
• Need to Work Upon the Equalization Principle:
  • The suggestion is made to use the equalization principle in the transfer of resources to individual states.
  • There is a need to pay attention to the needs of lower income states.
  • This principle aims to balance the needs, costs of providing services, and equity considerations using a limited number of criteria such as population, area, and distance, supplemented by suitable grants.
• Scrutiny on Cesses & Surcharges:
  • The heavy reliance on cesses and surcharges requires scrutiny by the Sixteenth Finance Commission, and it can freeze their shares to some base number.
• Need to Consider Upon the Changes in Criterias for Determining share of States:
  • There is a need to apply modifications in the criteria for determining States’ share in the Centre’s divisible pool of taxes.
• Restructuring of GST Tax: 
  • An issue of concern in recent years has been the poor performance of the Goods and Services Tax (GST) and the consequent decline in total divisible pool. But for this time, GST collections have maintained good buoyancy in the last two years and GST still needs restructuring to make it a good and simple tax.
• Share for Lower Income States:
  • These States are expected to provide a relatively larger share of ‘demographic dividend’ to India in future provided attention is paid to the educational and health needs of their populations.

News Source: The Hindu