15th Finance Commission Recommendations Notes for UPSC

The 15th Finance Commission was formed under the provisions of Article 280 to recommend the devolution of a share of net proceeds of central taxes to the states.

N. K. Singh chaired the 15th Finance Commission. The Commission was required to submit its report by October 2019, but the deadline was missed, and therefore, it submitted two reports based on the terms of reference provided by the government:

  1.  The first report was an interim report tabled in Parliament in February 2020, which consisted of recommendations for the financial year 2020-21.  
  2. The final report was tabled in Parliament on February 1, 2021, with recommendations for the 2021-26 periods.

Key recommendations in the 2021-26 Report:

Share of states in central taxes

States’ share in the central taxes for the period 2021-26 is recommended to be 41%, which is the same as that for 2020-21. 

  • This is less than the 42% share suggested by the 14th FC (2015-20). 
  • The adjustment of 1% is to provide for the newly created UTs of J&K and Ladakh from the resources of the Centre.

Criteria for Horizontal devolution

The following table shows the criteria used by the Finance Commission to determine each state’s share in central taxes and their respective weight assigned:

Criteria 14th FC 2015-20 15th FC 2020-21 15th FC 2021-26
Income Distance 50 45 45
Area 15 15 15
Population (1971) 17.5
Population (2011) 10 15 15
Demographic Performance 12.5 12.5
Forest Cover 7.5
Forest and Ecology 10 10
Tax and Fiscal efforts 2.5 2.5
Total 100 100 100
  1. Income distance:
    • The gap between a state’s income and that of the state with the highest income is known as income distance. 
    • To preserve parity across the states, a state with lower per capita income will receive a higher share.
    • The income of a state is calculated as the average per capita GSDP (Gross State Domestic Period) during the three years between 2016-17 and 2018-19. 
  2. Population:
    • According to the terms of reference, the Commission was required to use the population data of the 2011 Census (instead of 1971) for its recommendations. Therefore, the larger the population, the higher the devolution of taxes to the concerned state will be.
    • Context: the 14th Finance Commission used both the 1971 Census data and the 2011 Census data for the first time. Before it, only 1971 data was being used.
  3. Demographic performance:
    • The demographic performance criterion has been used for the first time to reward states’ efforts to control their population. States scoring a lower fertility ratio will be scored higher and given a greater share, and vice versa.
    • Context: the use of 2011 population census data could penalise the states for better management of demographics. Southern states, which have controlled their population growth over the years, would remain at a disadvantage. Thus, demographic performance has been introduced as a new criterion.
  4. Forest and ecology: This criterion is determined by calculating the proportion of the dense forest in each state in proportion to the total dense forest of all the states.
  5. Tax and fiscal efforts:
    • States with higher tax collection efficiency are rewarded under this criterion. 
    • It is calculated as the ratio of the average per capita state GDP and the average per capita own tax revenue during the three years between 2016-17 and 2018-19.
  6. Area:
    • A larger area means additional administrative costs on account of increased expenditure.
    • Therefore, larger states are provided more devolution of taxes to support the administrative governance of a large state.

Grants Recommended by 15th Finance Commission

Over the period 2021-26, the following grants will be provided from the Centre’s resources.

  1. Revenue deficit grants for some states to eliminate revenue deficit
  2. Sector-specific grants: for health, education, agricultural reforms, judiciary, aspirational districts, etc.
  3. State-specific grants: for social needs, administrative governance and infrastructure, water and sanitation, preservation of culture and historical monuments, and tourism.
  4. Grants given to local bodies:
  5. A portion of grants is performance-linked. The grants shall be made to all three tiers of Panchayat- village, block, and district.
  6. The distribution of grants to local bodies (other than health grants) among states will be based on population and area, with 90% and 10% weightage, respectively. 
  7. If a state does not establish a State Finance Commission by March 2024 and implement its recommendations, no grants will be given to local bodies of that state.
  8. Disaster risk management:  The existing cost-sharing pattern between the Centre and states is retained for disaster management funds, i.e., (i) 90:10 for north-eastern states and the Himalayan states and (ii) 75:25 for all other states. 

Fiscal roadmap of 15th Finance Commission

  1. Fiscal deficit and debt levels: 
  2. The Commission advised that the Centre should reduce the fiscal deficit to 4% of GDP by 2025-26.  
  3. For states, it advised the fiscal deficit limit (as % of GSDP) of:
  4. 4% in 2021-22,
  5. 3.5% in 2022-23, and
  6. 3% during 2023-26
  7. If a state is unable to completely utilise the sanctioned borrowing limit as mentioned above during the first four years (2021-25), it can avail the unused borrowing amount (calculated in rupees) in later years (within the 2021-26 period).
  8. Performance linked Extra annual borrowings:

Extra annual borrowing worth 0.5% of the GSDP will be permitted to states during the first four years (2021-25) if they implement the following reforms in the power sector

  • Reduction in operational losses,
  • Reduction in revenue gap,
  • Reduction in cash subsidy payment by adopting direct benefit transfer and
  • Reduction in tariff subsidy as a percentage of the revenue.
  • Reduction in total liabilities: It was observed that if the Centre and States implement the recommended path for fiscal deficit, then it will result in a reduction of total liabilities of:
  • The liability of the Centre will decline from 62.9% of Gross Domestic Product (GDP) in 2020-21 to 56.6% in 2025-26
  • The liability of states collectively will decline from 33.1% of GDP in 2020-21 to 32.5% by 2025-26. 
  • Composition of the inter-governmental group – It proposed the creation of a high-powered inter-governmental group to:
  • Evaluate the Fiscal Responsibility and Budget Management Act (FRBM),
  • Advise a new FRBM framework for the Centre as well as states and oversee its implementation.
  • Revenue mobilisation: Strengthening income and asset-based taxation.
  • GST: The rate structure should be simplified by merging the rates of 12% and 18%. States should make efforts to expand the GST base and ensure compliance.   
  • Financial management practices: 
  • An independent Fiscal Council (with only advisory role) should be established with powers to verify records from the Centre as well as states. 
  • Adoption of standard-based accounting and financial reporting
  • The Centre and states should not resort to off-budget financing or other non-transparent means of financing for any expenditure.

Other recommendations of Fifteenth Finance Commission

  1. Health: Increase spending on health to more than 8% of the state’s budget by 2022. 
  2. Funding of internal security and defence and: A dedicated non-lapsable fund – Modernisation Fund for Defence and Internal Security (MFDIS) will be created to reduce the difference between budgetary requirements and the allocated budget for defence and internal security. 
  3. Centrally-sponsored schemes (CSS): Policies/schemes under CSS lower than a minimum budget should be removed or halted to divert funds for more significant schemes that have utility in current times. The idea is to phase out small-budgeted CSS schemes that have outlived their utility or have insignificant outlay.

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