About
The Finance Commission (FC) is a constitutional body established under Article 280 of the Constitution of India. It is constituted by the President of India every five years (or earlier if required) to recommend the distribution of financial resources between the Union and the States, thereby strengthening cooperative fiscal federalism. It is a quasi-judicial body. It is not a permanent body.
Composition of the Finance Commission
The Finance Commission consists of one Chairman and four other members, making a total of five members. All members are appointed by the President of India under Article 280 of the Constitution. The composition and service conditions of the Commission are governed by the Finance Commission (Miscellaneous Provisions) Act, 1951.
The Finance Commission is a constitutional body consisting of a chairman and four other members, all appointed by the President of India under Article 280(1) of the Constitution.
The Chairman and members are eligible for reappointment.
Qualifications
The Chairman should be a person having experience in public affairs.
The four other members should possess any of the following qualifications:
· Judge of a High Court or qualified to become one.
· Special knowledge of Government finance and accounts.
· Wide experience in financial matters and administration.
· Special knowledge of economics.
Functions of Finance Commission
Constitutional Functions
1. Recommend distribution of net tax proceeds between Centre and States (Vertical Devolution).
2. Recommend allocation of States’ share among different States (Horizontal Devolution).
3. Recommend principles governing Grants-in-Aid under Article 275.
4. Suggest measures to augment State Consolidated Funds for:
5. Panchayats
6. Municipalities
Recommend on any other matter referred by the President in the interest of sound public finance.
Types of Devolution
A. Vertical Devolution
· Vertical Devolution refers to the distribution of the divisible pool of Central taxes between the Union (Centre) and the States. It determines how much of the total tax revenue collected by the Centre should be transferred to all States collectively.
The Finance Commission recommends this percentage by considering factors such as the expenditure of responsibilities of the Centre and the States, revenue needs, fiscal sustainability, and the objective of cooperative federalism.
Example
The 14th Finance Commission increased the States’ share from 32% to 42% of the divisible pool.
The 15th Finance Commission recommended 41% due to the creation of the Union Territory of Jammu & Kashmir.
The 16th Finance Commission has retained the 41% share for the States.
B. Horizontal Devolution
Horizontal Devolution refers to the distribution of the States’ share of Central taxes among the individual States. Once the total amount to be transferred to States is decided through vertical devolution, horizontal devolution determines how much each State receives.
The Finance Commission uses objective criteria to ensure fairness and balanced regional development. These criteria generally include:
Income Distance – Helps poorer States receive a larger share.
Population – Considers the population size of each State.
Area – Larger States require more resources for administration and infrastructure.
Forest & Ecology – Rewards States that conserve forests and protect the environment.
· Demographic Performance – Encourages States that have successfully controlled population growth.
Tax Effort/Fiscal Performance (or GDP Contribution in the 16th FC) – Rewards States for better fiscal management and economic performance.
Note: Vertical devolution determines the share of Central taxes between the Union and the States, whereas horizontal devolution determines the distribution of the States’ share among individual States.
Tenure
Constituted every five years or earlier if necessary.
Members hold office for the period specified by the President.
Members are eligible for reappointment.
Usually takes around 2 years to submit its report.
Functions of Finance Commission
Constitutional Functions
1. Recommend distribution of net tax proceeds between Centre and States (Vertical Devolution).
2. Recommend allocation of States’ share among different States (Horizontal Devolution).
3. Recommend principles governing Grants-in-Aid under Article 275.
4. Suggest measures to augment State Consolidated Funds for:
a. Panchayats
b. Municipalities
5. Recommend on any other matter referred by the President in the interest of sound public finance.
Comparison: 14th vs 15th vs 16th Finance Commission
| Feature | 14th FC | 15th FC | 16th FC |
| Chairman | Y. V. Reddy | N. K. Singh | Arvind Panagariya |
| Award Period | 2015–2020 | 2020–2026 | 2026–2031 |
| States’ Share in Central Taxes | 42% | 41% | 41% |
| Population Base | 1971 & 2011 | 2011 | 2011 |
| Income Distance | 50% | 45% | 42.5% |
| Population Weight | 17.5% | 15% | 17.5% |
| Area | 15% | 15% | 15% |
| Forest/Ecology | 7.5% | 10% | 10% |
| Demographic Performance | — | 12.5% | 10% |
| Tax Effort | — | 2.5% | Replaced by GDP Contribution |
| New Criterion | — | Tax Effort | GDP Contribution (2.5%) |
| Revenue Deficit Grants | Yes | Yes | Discontinued |
| Disaster Funding | SDRF reforms | Strengthened | Outcome & monitoring based |
The First Finance Commission was established in 1951 under the chairmanship of K. C. Neogy. It submitted its report in 1952, and its recommendations were applicable for the period 1952–1957.
Constitutional provisions
| Article | Provision | Brief Explanation |
| Article 268 | Duties levied by the Union but collected and retained by the States | Certain duties, such as stamp duties, are imposed by the Union Government but collected and appropriated by the States, becoming part of their revenue. |
| Article 269 | Taxes levied and collected by the Union but assigned to the States | Taxes on inter-State trade and commerce are collected by the Union Government and subsequently assigned to the States as prescribed by law. |
| Article 270 | Distribution of taxes between the Union and the States | Provides for the sharing of the divisible pool of Central taxes between the Union and the States based on the recommendations of the Finance Commission. It forms the foundation of tax devolution in India. |
| Article 271 | Surcharge on certain Union taxes and duties | Parliament may impose surcharges on specified Central taxes and duties. The proceeds from these surcharges belong exclusively to the Union Government and are not included in the divisible pool. |
| Article 275 | Grants-in-aid to States | Authorizes Parliament to provide grants-in-aid to States requiring financial assistance. The Finance Commission recommends the principles for distributing these grants. |
| Article 280 | Constitution of the Finance Commission | Mandates the President of India to constitute a Finance Commission every five years (or earlier if necessary) to recommend the distribution of financial resources between the Union and the States. |
| Article 281 | Submission of the Finance Commission’s report | Requires the President to place the Finance Commission’s report before both Houses of Parliament, along with an explanatory memorandum detailing the action taken on its recommendations. |
