Everything You Need To Know About State Finance Commission

State Finance Commission- UPSC Notes

State Finance Commission

State Finance Commission aims to maintain fiscal federalism between state Government and Local bodies. The State Finance Commission is constituted based on the Constitutional requirement in Article-243 (I) and 243 (Y).

For the success of the local government, besides functional devolution, fiscal devolution was felt necessary to maintain the fiscal independence of this institution. Without fiscal independence, Local bodies like Panchayati Raj institutions and municipalities will not be able to work efficiently. In this aspect, the State Finance Commission plays a vital role in sub-state decentralization.

Everything You Need To Know About State Finance Commission

Composition and Appointment of State Finance Commission

Appointment of the State Finance Commission:

According to Article -243 (I), the Governor of the State constitutes the Finance Commission at the expiration of every 5 Years. However, there is no fixed term of its working, and it ceases to exist as soon as it submits its report. The experience of most states indicates that a State Finance Commission generally works for a period of one year to one and a half years.

Composition of the State Finance Commission:

As per 243(I)(2), the Legislature of a State may provide for the composition of the Commission through a law. However, there is no uniformity in the composition. It varies from State to State. It consists of a Chairman and a few members.

Qualification of the Chairman/Members of State Finance Commission:

  • Some of the states have clearly specified the qualifications/conditions for the appointment of the Chairman and members, while in other states, there is no such specification.
  • Before appointing a person as a Chairman or Member of the State Finance Commission, the Governor has to satisfy herself/himself that the person to be appointed has no financial or any other interest as it is likely to affect prejudicially her/his functions as Chairman or Member of the state Finance Commission.

Terms of Service

  • Term of members: Every member of the State Finance Commission holds office for such period as may be specified in the order of the Governor appointing her/him. It shall be eligible for reappointment.
  • Salaries of members: Chairman and Members of the State Finance Commission shall be paid fees or salaries and such allowances as the State Government may prescribe from time to time.
  • Condition of the service: The Governor may specify whether the Chairman and Members of the Finance Commission may render whole-time or part-time service to the State Finance Commission.

Power and Function of State Finance Commission

State Finance Commission shall study and review the financial position of the rural and urban local bodies, namely village panchayats, panchayat union councils, district panchayats, municipalities and municipal corporations. It makes recommendations to the Governor in the following matters:

The principles that should govern: –

    • the distribution between the state and local bodies of net proceeds of the duties and taxes levied and collected by the State;
    • the determination of taxes, tolls, duties, and fees, which may be assigned to or appropriated by the local bodies; and
    • the grants-in-aid to the local bodies (Panchayat and Urban Local Bodies) from the Consolidated Fund of the State.
  • The measures needed to improve the fiscal position of both panchayats and municipalities.
  • Any other matter referred to the Finance Commission(FC) by the Governor in the interest of the sound financial position of the local bodies.

In some states, notification can carry some more details regarding the functions and duties assigned to the State Finance Commission.State Finance Commission: Appointment, Qualification, Tenure, Removal, Re-Appointment, Salary Of Members , Power, And Function

Issues with the State Finance Commission

  • Non-Appointment of the State Finance Commission: More than 30 years have passed since the decentralization. According to the Standing Committee on Panchayati Raj report, all the states should have constituted the Sixth Finance Commission, which operates over the years 2021-22 to 2026-27. However, so far, only nine states have constituted the 6th SFC, of which only two are active.
  • Issues in the Appointment: The state finance Commission is constituted by the Governor based on the recommendations of the State Government. This may increase the possibility of the political affiliation of the State Finance Commission as without broad-based discussion, the State government can use its discretion to appoint political persons.
  • Issue of the infrastructure: Non-availability of office space and basic facilities like computers, office furniture, etc., affects the functioning of the SFCs.
  • Delays in report submission: The average time to submit their reports for the first three generations of SFCs is 27 months. However, the average time taken by the 4th and 5th generation SFCs of states has been higher at about 33 months.
  • Inadequate staff: There is a lack of adequate technical staff to measure and collect the ground data regarding the local bodies; thus, it affects the quality of the reports submitted to the Governor.
  • Lack of expertise: As the majority of the members are bureaucrats and politicians, there is a lack of expertise in the State Finance Commission
  • Hampers the process of decentralization: It affects the functioning of even the Union Finance Commission as they rely on the data given by the State Finance Commission, and in the absence of reports by the State Finance Commission, Union Finance Commissions rely on their assessment.
  • The recommendation is not binding: The recommendations made by the State Finance Commission are of an advisory nature; therefore, they are not binding upon the government.
  • Less divisible fund available to the SFCs: There is less available fund to the State Finance Commission to be given to the local bodies.

Everything You Need To Know About State Finance Commission

Way Forward

  1. Regular Constitution of the State Finance Commission: There is a need for political will to constitute the State Finance Commission timely. There is a need to synchronize the formation of the State Finance Commissions with the Central Finance Commission.
  2. Prescribe the qualification: The 2nd ARC recommended that each State should prescribe the qualifications of persons to be appointed as Members of the State Finance Commission through an Act.
  3. Objective and transparent norms for devolution: The State Finance Commission should evolve objective norms for the devolution of funds to the local bodies. The norms should consist of various parameters like area-wise indices for backwardness. State Finance Commissions can link the devolution of funds to the quality of civic amenities that the citizens would prefer. This could then form the basis of an impact evaluation.
  4. Improve the quality of the report: The quality of the report can be increased with the following measures:
  • Improve the Questionnaire used by many SFCs for the collection of the data to increase the quality of the report.
  • State Finance Commissions should evolve principles for the analysis of the finances of local bodies.
  • Digitizing the data with proper classification and accounting for comparison of the local level data.
  • It needs to improve the efficiency of the data collection so that it can make concrete recommendations.
  1. Mechanism for the implementation of the recommendations: It is necessary that a mechanism be put in place that reviews the implementation of all the recommendations of the SFCs. Devolution of funds could also be made conditional to local bodies when recommendations of the SFCs are implemented.
  2. Action Taken Report: The Action Taken Reports (ATRs) on the recommendations of the State Finance Commissions must be placed in the concerned State Legislature within six months of submission.
  3. Capacity building of the State Finance Commission to have a research wing for independent data collection and research.


Without the proper functioning of the State Finance Commission, the sub-decentralization of urban and rural local governments will not be completed. In this aspect, it is very crucial to adopt the multipronged approach with regularity in the constitution of SFCs by the State governments, timely submission of reports by the respective SFCs, acceptance of recommendations of SFCs by the state governments and timely tabling of action taken reports in the legislature by state governments.

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