Fifteenth Finance Commission – Interim Report & Recommendations

fifteenth finance commission upsc

The interim report of the Fifteenth Finance Commission was placed before the Parliament ahead of the General Budget (2020-21). The Commission will submit its report for an extended period of 2020-21 to 2025-26 by October.

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What is the Finance Commission?

  • Article 280 of the Indian Constitution provides for a finance commission Constituted by the President of India every fifth year or at such earlier time as he considers necessary.
  • It is a Quasi-Judicial body that acts as a balancing wheel of fiscal federalism in India.
  • The recommendations of the Finance Commissions are recommendatory in nature only as the implementation of the recommendations is not mandatory for the government of the day
  • Till now We have had 14 such commissions since 1951 and the current Finance Commission is working on a full report.
  • The Finance Commission is required to make recommendations to the President of India on the flowing matters
  1. Distribution of net proceeds of taxes that are to be shared between the Centre and the states, and the allocation between the states.
  2. The principles governing the grants-in-aid to the states by the Centre out of the consolidated fund of India.
  3. The measures which are needed to augment the consolidated fund of the states necessary for supplementing the resources of the panchayats and the municipalities in the state (on the basis of the recommendations made by the state finance commission)
  4. Any other matter referred by the President of India in order to maintain sound
  • The Presidential Terms of References (ToR) consist of matters above and any other matters as the President sets before the Finance Commission.

The Fifteenth finance commission (FFC)

  • The Fifteenth Finance Commission (FC-XV) was constituted by the President of India
    under Article 280 of the Constitution on 27 November 2017 under N.K. Singh as its chairman.
  • The FFC is important as it is
  1. The first Finance Commission after doing away with the Planning commission.
  2. Abolition of the distinction of the Plan and non-Plan expenditure.
  3. Introduction of the GST which has redefined the federal fiscal relations

Most probable and repeated topics of upsc prelims

What are its Terms of Reference (ToR) of the FFC?

  • Distribution of net proceeds of taxes to be shared by the Centre and the states, and the allocation of the states’ proceeds between the states.
  • The principles that should govern the grants-in-aid to the states by the Centre out of the consolidated fund of India.
  • The measures which are needed to augment the consolidated funds of the state’s necessary for supplementing the resources of the panchayats and the municipalities in the state (As per the recommendations of the state finance commission)
  • The Commission shall review the current status of the finances and recommend a fiscal consolidation roadmap for sound fiscal management.
  • While making its recommendations, the Commission shall regard following matters among others
  1. The resources of both i.e. Central Government and the State Governments
  2. The demand on the Central Government resources on account of different matters such as defence, internal security, climate change, administration of UTs without a legislature, and other expenditure and liabilities;
  3. The demand on the State Government resources on account of financing socioeconomic development and critical infrastructure, balanced regional development, etc
  4. The impact of substantially enhanced tax devolution to States by the 14th Finance Commission, along with the imperative of the national development programmes including New India – 2022
  5. The impact of the GST regime, payment of compensation for possible loss of revenues for 5 years, and abolition of different cesses, and other structural reforms programme, on the finances of Centre and States.
  • The Commission may consider measurable performance-based incentives for States in the following areas
  1. Efforts made in expansion and deepening of tax net under GST
  2. Efforts and Progress made towards replacement rate of population growth
  3. Achievements in implementation of flagship schemes of central government, disaster-resilient infrastructure, quality of expenditure, sustainable development goals
  4. Increasing capital expenditure, eliminating power sector losses, improving the quality of expenditure
  5. Progress made in increasing tax/non-tax revenues, promoting savings and digital economy
  6. Ease of doing business by bringing policy and regulatory changes and promotion of labour-intensive growth
  7. Provision of grants in aid to local bodies for basic services and implementation of the performance grant system
  8. Control in incurring expenditure on populist measures; and
  9. Bringing behavioural change to end open defecation, progress made in sanitation and solid waste management.
  • The Commission shall use the population data of 2011 while making its recommendations
  • Review of the arrangements on financing Disaster Management initiatives

What are the issues regarding the ToR?

  • While the ToR of the 14th Finance Commission used the 1971 census data, The FFC is to use the 2011 data. It is argued that it may act as penalizing term for the Southern states who have done commendably on the Population control.
  • The performance-based incentives are vague as
  1. All the states cannot do the same in the area of the deepening of the GST regime.
  2. The definition of populist measures is not clear as there can be different needs of different states. Also, the states have been indulging in populist measures for long such as giving free TVs, laptops, etc.
  3. There is a potential of favoritism in deciding which one is a populist measure.
  4. The condition of behavioral change to end open defecation is alleged to be an imposition from the central Government as the Swachh Bharat Campaign is its pet project.
  • The ToR asks the commission to examine the impacts of 42% devolution to the states by the 14th Finance commission. There were fears of FFC reducing the percentage Which, interestingly it did recently (41% i.e. 1% deduction that approximately equal to Jammu and Kashmir’s share which was recently made UT)
  • The FFC has been asked to examine whether revenue deficit grants given to states should be discontinued.

Even as the work of the Commission was in a fairly advanced stage, designed towards submitting the report by the stipulated date, there were new developments.

  • The enactment of the Jammu and Kashmir Reorganization Act, 2019.
  • The Global Situation such as slowdown, the USA-China trade war, volatile geopolitical situation.
  • India itself is going through a slowdown with major global organizations lowering the growth estimates for the current year.
  • Weak revenue collections and the shortfall in expected and actual GST collection figures.
  • The major structural reforms over the last five years such as New Monetary policy framework, demonetization, a new corporate tax order, plans of privatization of the PSUs

What are the salient features of the FFC Interim report?

The interim report for 2020-21 was presented before the parliament.  The FFC report assures on the following aspects

  • The ToR enjoining FFC to use the population data of 2011 created apprehensions
    that in the process those States that have achieved greater progress in reducing population growth since 1971 would be adversely affected. The FFC has attempted to allay the fears by introducing a new criterion of total fertility rate (TFR) as a measure of demographic performance.
  • The Commission has received a large number of proposals for State-specific grants.
    However, given the financial constraints in 2020-21, we propose to make appropriate recommendations on such grants in our final report.
  • As the recommendations of this report are only for one year, The FFC has refrained from giving any State-specific grants but has provided a roadmap for sector-specific grants and performance-based incentives that it expects to address in greater detail in the final report.
  • The FFC has taken into consideration of the states about a greater impetus on the environment and climate change and continued the 14th FC approach.

What are the recommendations?

Devolution of taxes to states:

The share of states in the centre’s taxes is recommended to be decreased from 42% to 41% for 2020-21. The 1% decrease is to provide for the newly formed union territories of Jammu and Kashmir, and Ladakh from the resources of the central government.  The comparison of the criteria for the horizontal devolution is as given in the table

Criteria 14th FC

2015-20

15th FC

2020-21

Income Distance 50.0 45.0
Population (1971) 17.5
Population (2011) 10.0 15.0
Area 15.0 15.0
Forest Cover 7.5
Forest and Ecology 10.0
Demographic Performance 12.5
Tax Effort 2.5
Total 100 100

Grant in Aids:

The following grants will be provided for the year 2020-21. The interim report also contains a framework for some grants for the full report

  1. Revenue deficit grants– for 14 states
  2. Special grants

The states of Karnataka, Mizoram, Telangana will get these because of the decline in the sum of devolution and revenue deficit grants in 2020-21

  1. Sector-specific grants

The sector-specific grant of Rs. 7375 crores is given for Nutrition. The sector-specific grants for the following sectors will be provided in the Final report.

      1. Nutrition
      2. Health
      3. Pre-primary education
      4. Judiciary
      5. Rural connectivity
      6. Railways
      7. Police training
      8. Housing

4. Performance-based grants

Guidelines for the performance-based grants include

  1. Development of aspirational districts and blocks
  2. Power sector reforms
  3. Enhancing trade including exports
  4. Incentives for education
  5. Promotion of domestic and international tourism.

The grant amount will be provided in the final report of the FFC.

  1. Grants to local bodies

The total grants for local bodies are at Rs 90000 crores with the share of rural and urban bodies to be 67.5% and 32.5% respectively. The grant will be divided between states based on population and area in the ratio 90:10. Also, the grants will be made available to all the three tiers of the Panchayat.

  1. Disaster Risk management

The commission recommends Setting up of National and state-level Disaster management Funds for the promotion of local-level mitigation activities

Recommendations on the fiscal roadmap:

  1. Fiscal deficit and debt levels

It recommended that both central and state governments should comply with the fiscal deficit and debt levels as per their respective Fiscal Responsibility and Budget Management (FRBM) Acts. It did so while noting that the roadmap remains problematic due to uncertain economic conditions.

2. Off-Budget borrowings

The FFC recommended that the central and state governments should disclose fully the extra-budgetary borrowings.  The extra-budgetary liabilities should be clearly identified and eliminated in a time-bound manner.

3. Statutory framework for public financial management

The FFC recommended that an expert group should be formed to draft legislation to provide for a statutory framework for a sound public financial management system.

4. GST implementation

The FFC highlighted some challenges with the implementation of the GST regime. These include

  1. a large shortfall in collections as compared to the original forecast
  2. high volatility in collections
  3. glitches in invoice and input tax matching
  4. delay in refunds

It also suggested that the structural implications of GST for low consumption states need to be considered.

5. Financing Security related expenditure

The commission intends to constitute an expert group to examine the proposals of the defence ministry proposals and alternative funding mechanisms for internal security and defence.

Evaluation of the Interim report

  • With the inclusion of the criteria of the demographic performance in the horizontal devolution formula, it has sought to address the fear of southern states who alleged potential loss due to the 2011 census criteria inclusion in the ToR.
  • It has reduced the vertical devolution by 1% due to the Reorganization of the State of J&K. The past FCs had not reduced the vertical devolution. We must wait to see if it remains so in the final report.
  • Though the FFC has proposed 74000 crores as revenue deficit grants for the states but the budget allocated was only 30,000 crores.
  • The Finance Ministry has not accepted the Special grants and nutritional grant recommendations.
  • For the horizontal distribution, the commission arrived at the need-based formula with the income distance formula continuing to hold the highest weightage.
  • The Interim report highlighted that the government must abide by the definitions of both debt and Fiscal deficit as contained in the FRBM Act.
  • As it said that it will address the issue of extra-budgetary liabilities, it held that these should be clearly identified and eliminated in a time-bound manner.
  • The Commission acknowledged that the GST regime is still work in progress and there is a scope of improvement.

Way Forward

  • As it is an interim report with the full report is to be submitted by October 2020, it needs to be seen what more is in the offering.
  • As it is an interim report, it had its limitations while discussing a variety of topics in depth.
  • The question over revenue deficit grants still looms large. It needs to be seen what changes are made as the states cannot borrow without the Union’s consent.
  • The plunge the economy may take due to the COVID-19 crisis is still unknown as we are still in the middle of a lockdown. It is hoped that the FFC which is monitoring the situation would take positive steps on account of the crisis.
  • The demographic performance criteria have tried to allay the fears of the southern states. It needs to be seen if it features in the final report too.
  • The GST collection will take a huge plunge on account of the Corona Crisis. FFC will possibly take that into account.
  • As there are concerns about the nature of Fiscal Federalism after the introduction of the GST regime, it must look into the issue and provide a sound roadmap.
  • It is suggested that the fiancé commission must focus on removing basic public good imbalances.
  • Also, there is a demand for a permanent secretariat for the finance commission.

Practice Question for Mains

The Interim report of the FFC has tried to allay the major fears regarding the devolution of the finances. Examine (250 words)

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