Finance Commision

7/7/2014
Evernote shared notebook: economics India
Finance Commissions
Saturday, March 10 2012, 1:42 PM
Situation @ Independence
1.
2.
3.
4.
50% of Income tax was given to states.

62.5% of export duty collected from jute went to jute producing states.
Sarkar Committee in 1948 recommended states' share to go up to 60% but was rejected by JLN.
Deshmukh Committee in 1949 recommended grants to be given to jute producing states instead of share
in taxes.
1st Finance Commission (1951)

Recommendations
1. Income Tax: States' share to go up to 55% from 50%.
2. Allocation Among States: IT allocation should be done on basis of population (80% weight) and revenue
generated in the state (20% weight). For others, it stressed the need of doing it on basis of need of the
state.
3. Excise Duties: They were growing in importance. 40% of excise duty collected from some commodities
like tobacco, vegetables etc. allocated to states.
2nd Finance Commission (1956)
Recommendations
1. Income Tax: States' share to go up to 60% from 55%.
2. Allocation Among States: IT and Excise Duty allocation should be done on basis of population (90%
weight) and revenue generated in the state (10% weight).
3. Excise Duties: They were growing in importance. 25% of excise duty collected from additional
commodities allocated to states.
4. Railway Taxes: To be distributed according to route mileage in a state.
Limitations
1. Railway Taxes: Route mileage is inappropriate since it ignores the intensity of usage.
3rd Finance Commission (1961)
Recommendations
1. Income Tax: States' share to go up to 66.67% from 60%.
3. Excise Duties: They were growing in importance. 20% of excise duty collected from additional
commodities (now 35) allocated to states.
4. General: It also highlighted overlap of FC and PC specially in matters of special grants to states.
https://www.evernote.com/pub/crazyphoton/economicsindia/#st=p&n=2dfe0c1f-beef-4853-b138-6902d1f3868c
1/7
7/7/2014
4th Finance Commission (1965)

Recommendations
1. Income Tax: States' share to go up to 75% from 66.67%.
3. Excise Duties: They were growing in importance. 20% of excise duty collected from all
commodities allocated to states. On some commodities like tobacco, sugar, the allocation wold be 100%.
4. Grants: FC grants are unconditional as opposed to PC's conditional grants. 4th FC raised the grants
significantly.
5. General: Continuous collection of data needed by FC and state borrowings to be allowed.
Recommendations
1. Income Tax: States' share @ 75%.
commodities allocated to states. On some commodities like tobacco, sugar, the allocation wold be
100%.
Recommendations
1. Income Tax: States' share @ 80%.
commodities allocated to states. On some commodities like tobacco, sugar, the allocation wold be
100%.
4. It was asked, for the first time, to go in the debt position of states and their non-plan capital gap.
1. It was the first commission whose report was rejected as Art 281 nowhere mentions its recommendations
are binding on president.
12th Finance Commission
1. It initiated a debt relief facility scheme where states would be given debt relief subject to
enactment of fiscal responsibility legislations.
2. 11th and 12th finance commissions recommended States shares in net Central taxes at
29.5% and 30.5% but actual tax devolution was 26.5% and 26% of gross tax revenue in
respective tenures. So overall states used to get ~2.5% of GDP through share in taxes and
~3% through grants.
3. It assigned a weight of 25% to population, 50% to per capita income distance, 10% to area and 7.5%
2/7
7/7/2014
each to tax effort and fiscal discipline.
Q. Critically assess the key recommendations of the 12th finance commission. (2009, II, 20)
Recommendations
1. The share of states in the net proceeds of central taxes (excluding cesses) be increased to 32% from
30.5%.
2. Parameters for allocation are: Population (25% weight), Income distance from richest state replaced by
"Fiscal Capacity Distance" (47.5%), Fiscal Discipline (17.5%) and Geographical area (10%).
3. It recommended that cesses / surcharges should be either brought in the sharing domain or be done away
with.
4. The transfers through plan grants and CSS distort public finances and should be done away with in favor
of formula based grants.
5. It suggests revenue deficit to be eliminated by 2014-15, total public debt to be limited to 68% of GDP by
2014-15 (45% center and 23% states) and better disclosure on debt position.
TORs
1. Suggestions to amend the FRBMAs currently in force. Recommend incentives and
disincentives for states for observing the obligations laid down in the FRBMAs.
2. Recommendations on expenditure and its monitoring for maintenance of capital assets
3. Review the state of finances, deficit, and debt levels of the union and states and suggest
measures for maintaining a stable and sustainable fiscal environment
4. Implications of GST on centre and states.
5. Review the present arrangements as regards financing of Disaster Management.
Fiscal Federalism
Concept
1. It means assigning functions to different levels of government and assigning revenues to them as well to
3/7
7/7/2014
carry out such functions.

2. Centre must provide goods and services which are consumed by people of nation at large like railways,
defence. States must provide those which are consumed within the state and are unique to the needs of the
state.
3. But with time, the distinction between local and national consumption is blurring as economy becomes
more and more linked. A factory located in Nagaland may cater to markets in Bengal uses roads for such
operations.
4. Between grants in aid and tax devolution, grants in aid are considered better because they are targeted.
But tax devolution is more rule based, hence certain. Grants may be arbitrary specially when the FC is
appointed by centre.
States Fiscal Statistics
1. Revenue receipts of states: 12.4% of GDP. Borrowings: 3.2% of GDP. Devolvement of central taxes:
2.6% of GDP (this has come down from 3% since 2004-05).
2. State expenditures: 15.5%. Fiscal deficit: 2.2%. Revenue surplus: 0.2%.
Disadvantages
1. It can impede national level trade as different states impose different taxes on goods and services. Permits
may be needed for commercial vehicles to travel across states leading to stoppages, corruption, wastage.
2. The body which decides allocation in India is FC which is appointed by Centre and reports to it. So it
may be biased.
Indian Case
1. The revenue receipts of states are 12.4% of GDP while expenditures are 15.5% of GDP.
2. Traditionally finances were divided between centre and states. But with 73rd and 74th CA, local self
governing bodies too get a share in the pie. Now the Finance Commission decides on distribution of
revenues between centre and states. It also suggests measures to augment the resources of local bodies. It
allocates based on cost disability, fiscal efficiency and needs of the states. These can be mutually
conflicting as a state can be penalized for being able to collect more revenues like Maharastra was done
and revenues may be allocated to UP and Bihar. For the NE states except Assam, all budgetary deficits
are provided for by the centre.
3. Cost Disability: Nagaland has sparse population which is little and spread over a large area. The terrain is
hilly so roads are difficult. Gujarat on the other hand is industrialized and has a concentrated population.
So collecting taxes in Gujarat is easier than in Nagaland. So backward hilly states like Nagaland suffer
from cost disability and must be compensated.
4. Fiscal Efficiency: Some states are efficient in fiscal matters and must be rewarded. But inefficiency may be
a result of government's inefficiency or peculiarities of the state. So many states which are agri-dependent
have very low tax base and hence fiscally inefficient compared to industrialized states. Different finance
commissions have been confused so far on the criteria to determine these allocations. Some emphasize
needs, some emphasize efficiency. So far no common policy has been evolved. Thus states have no
incentive to keep their deficits in check.
5. Siloization of the economy: As different states impose different taxes on movement of goods and services
thereby impeding trade and leading to corruption. Hence the need of GST.
6. Central Hegemony: Center's collection is ~ 9x that of states' in direct taxes. Center's collection is ~ 1.2x
4/7
7/7/2014
that of states' in indirect taxes. That is why states want more allocations. Over the years states' share has
increased.
7. In India, the transfer of funds from centre to states takes place via FC (1/3) and PC and central
government allocations in various schemes. There is a lot of discretion in these.
Q. Critically examine the fiscal federal system as it operates in India presently. What improvements would you
suggest? (2010, II, 30)
Center-State Relations
(a) Issues
1. Lack of coordination: States don't allocated matching funds to CSS.
2. Market alignment of central lending: Earlier centre used to lend to states for 25-30 years on account of
central plan assistance, now they are given a share of market borrowing @ market tenures (~10 years)
and market costs. Similarly form the National Small Savings Fund the states have to borrow @ market
rates only (~9.5%).
3. Cesses & surcharges: Cesses and surcharges are not to be shared with state so center has
been increasingly collecting its revenue from cesses and surcharges. 11th and 12th finance
commissions recommended States shares in net Central taxes at 29.5% and 30.5%
but actual tax devolution was 26.5% and 26% of gross tax revenue in respective tenures.
4.
5. Reducing GBS for state plans: The gross budgetary support from centre allocated to state plans has been
declining progressively and is now only 23%. Total central assistance to states is ~ 5% of GDP (out of this
~3% is the share from revenues). As a result the size of state plan to central plan has come down from
66:33 to 40:60 now.
5/7
7/7/2014
Recommendations
a) Resource Sharing
1. The monetary limit on tax on professions should be revised.
2. Surcharge on income tax should not be levied by the Union Government except for a specific
purpose and for a strictly limited period.
b) Expenditure Reforms
1. A comprehensive paper on subsidies covering both the Union and the State Governments be
prepared by the Planning Commission every year.
2. The number of Centrally Sponsored Schemes (CSS) should be kept to the minimum. The need for the
Union Government initiating pilot projects even in regard to subjects in the States is recognized. But these
should be formulated in prior consultation with the States. Once a programme has passed the pilot stage
and has been accepted as desirable for implementation on a larger scale, it should appropriately form part
of the State Plan. State Governments should be fully involved in determining the contents and coverage of
the CSS so that local variations are taken care of.
c) Finance Commission and Planning Commission
1. The present division of responsibilities between the Finance Commission and the Planning
Commission may continue but they must be made synchronous.
2. Information gathered by the Finance Commission should be published within six months of the
publication of the report.
3. It will be a healthy practice if the observations and suggestions made by the Finance
Commission on matters other than the ToR are also considered by the Government and placed in the
parliament.
4. In its permanent ToRs should be the CSS and the burden on states therein.
5. State finance commissions should be made synchronous with the central finance commission. The allocations to
PRIs should be made through states only and not via bypassing them.
6/7
7/7/2014
Fiscal Imbalances
Concept
1. It is the mismatch between revenue raising capacity and expenditure needs. This is impossible to measure.
A crude measure is based on actual revenues and expenditures. I = 1 - R/E. R = revenues of a state grants in aid. E = total expenditure of a state. This tells the importance of grants in aid. In India, it was
0.51 in 1991
2. Vertical fiscal imbalance is between centre and states whereas horizontal are among different states. These
are inter-related as centre can encroach upon revenue raising capacities of states as well as change the
allocation of revenues among them.
3. Larger the horizontal imbalances, greater the need of central intervention and redistribution of revenues.
Impact of Economic Reforms
1. Reduced emphasis on central planning will place more burden on states and thus their expenditure will go
up. At the same time, central government needs will reduce and it may give up more revenues. But at the
balance, imbalance is likely to go up.
2. WTO membership and globalization has increased trade. The lowering of customs duties as a part of
WTO obligations has also increased compliance. Hence central revenues have gone up which may be
shared with the states.
3. Reforms have also increased regional disparities due to deregulation and foreign investment. So revenue
raising capacities of a few states are likely to go up and increase horizontal imbalance.
Local Self Government Bodies
1. In order to determine allocation among LSG bodies, FC considers 3 things - (a) Population, (b)
Geographical area, (c) Index of deprivation.
2. Index of Deprivation: It consists of proportion of SC / ST population and status of utilization of the
previous funds.
7/7

Finance Commision

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Finance Commision

Uploaded by

Copyright:

Available Formats

7/7/2014

Evernote shared notebook: economics India

50% of Income tax was given to states.

1st Finance Commission (1951)

Evernote shared notebook: economics India

4th Finance Commission (1965)

Evernote shared notebook: economics India

each to tax effort and fiscal discipline.

Evernote shared notebook: economics India

carry out such functions.

Evernote shared notebook: economics India

Evernote shared notebook: economics India

Evernote shared notebook: economics India

You might also like