Question – The Finance Commission, as a constitutional body, performs an important role in balancing fiscal federalism, although its recommendations are not binding in nature. Describe.

Question – The Finance Commission, as a constitutional body, performs an important role in balancing fiscal federalism, although its recommendations are not binding in nature. Describe. – 3 September 2021


The Finance Commission is a constitutional body which is the pivot of fiscal federalism, constituted under Article 280 of the Constitution. Its main responsibility is to evaluate the financial position of the Union and the states, recommend the distribution of taxes between them and to determine the principles for the distribution of these taxes among the states. The specialty of the Finance Commission is to strengthen the principle of cooperative federalism by conducting extensive and thorough consultations at all levels of the government. Its recommendations are also geared towards improving the quality of public expenditure and enhancing fiscal stability. The first Finance Commission was constituted in 1951 and so far fifteen Finance Commissions have been constituted. Each of them has faced unique challenges.

Need for finance commission

  • The center collects the majority of tax revenue, and contributes to the economy at large through the collection of certain taxes.
  • Knowing closely the local issues and needs, it is the responsibility of the states to take care of the public interest in their areas.
  • However, due to all these reasons, sometimes the expenditure of the state exceeds the revenue received by them.
  • Furthermore, due to wide regional disparities, some states are unable to take advantage of adequate resources more than others. To address these imbalances, the Finance Commission recommends setting limits on central funds to be shared with the states.

Functions and Responsibilities of Finance Commission:

  • To recommend to the President of India how to distribute the net proceeds of taxes between the Union and the States, and the allocation of such proceeds among the States.
  • Under Article 275, out of the Consolidated Fund, grants/assistance should be given to the states.
  • To recommend necessary steps for augmenting the Consolidated Fund of the State for supply of resources to Panchayats and Municipalities on the basis of the recommendations made by the State Finance Commission.
  • Any other specific direction given by the President with reference to the interest of sound finance of the country.
  • The commission submits its report to the President, which is laid by the President in both the Houses of Parliament.
  • An Explanation Memorandum is also kept along with the submitted recommendations, so that the action taken in respect of each recommendation can be known.
  • The recommendations made by the Finance Commission are of advisory nature, whether to accept it or not depends on the government.

Under the federal structure envisaged in the Constitution, most of the taxation powers are with the Center but, the bulk of the expenditure is done by the states. Such a federal structure requires the transfer of resources from the Center, which levies and collects taxes in the form of income tax and indirect taxes such as excise and customs duties, to the states. Therefore, proper allocation of resources among different states is necessary on the basis of state’s population, state’s fiscal position, state’s forest area, income disparity and area. By such proper allocation, the Finance Commission can prevent conflicts between the states and the Centre.

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