Role of the Finance Commission

Context

Recently the sixteenth Finance Commission headed by Arvind Panagariya has begun its work by inviting suggestions from the public on the mandate set for it by the Centre.

About

• The Finance Commission is a constitutional body constituted by the President of India under Article 280, that recommends how tax revenues collected by the Central government should be distributed between the Centre and various States in the country. 
• The Commission is reconstituted each five years and typically takes a couple of years to make its recommendations to the Centre.
• The Centre isn’t legally certain to enforce the recommendations made by the Finance Commission. 

Tax Devolution 

• The Finance Commission decides what proportion of the Centre’s net tax revenue is going to the States overall (vertical devolution) and the way this percentage for the States is shipped between various States (horizontal devolution). 
• The horizontal devolution of funds between States is commonly decided based on a system created by the Commission that takes under consideration a State’s population, fertility level, income level, geography, etc. 
• The vertical devolution of budget, however, isn’t always based on this kind of goal formula. 
• The Centre also aids States through more offers for positive schemes which are jointly funded by the Centre and the States.

Friction between the Centre and States

• The Centre and the States have been at loggerheads over the problem of sharing tax sales.
• The Centre collects most important taxes such as the income tax, the company tax, and the Goods and Services tax (GST) while the States mostly rely upon taxes gathered from the sale of goods which includes liquor and fuels which are beyond the ambit of GST. 
• This has caused complaints that the Centre has reduced the strength of the States to accumulate taxes and that it does not give sufficient budget to the States to fit with the size of their obligations.

What are the disagreements?

• Demand for more funds: States argue they ought to receive more budget than advocated by the Finance Commission. States have more obligations, such as training, healthcare, and policing services.
• Disparities between States: Developed States like Karnataka and Tamil Nadu sense they receive less money from the Centre than they make a contribution in taxes.
  • Tamil Nadu receives only 29 paise for each rupee contributed, while Bihar receives more than ₹7 for every rupee contributed.
  • In other phrases, it’s far argued that more advanced States with better governance are being penalized by using the Centre to assist States with bad governance. 
• Divisible Pool Concerns: Cesses and surcharges, which aren’t shared with the States, can constitute up to 28% of the Centre’s tax sales, leading to revenue losses for States.
• Shortfall in Devolution: The Fifteenth Finance Commission endorsed 41% of the divisible pool to the States. However the Centre has devolved a mean of only 38% of funds from the divisible pool to the States.
• Criticism of the Finance Commission: Critics believe the Finance Commission may not be absolutely unbiased due to the Centre’s function in appointing its members, leading to enhanced political impact.

Way Ahead

• In reaction to evolving financial and social dynamics, the Finance Commission desires to stay proactive and responsive. This entails addressing challenges stemming from GST implementation, the Covid-19 Pandemic, Climate Change, and Digital Transformation.
• Also the issues must be accommodated so that they do not experience penalization for development and better governance in their state.