INTRODUCTION

The Finance Commission of India is a constitutional body established under Article 280 of the Indian Constitution to define the financial relations between the central government and the individual state governments. Tasked with making recommendations on the distribution of tax revenues, it plays a crucial role in ensuring a balanced fiscal framework that supports equitable development across the country. The Sixteenth Finance Commission was constituted on 31.12.2023 with Shri Arvind Panagariya, former Vice-Chairman, NITI Aayog as its Chairman.

Terms of reference(ToR)

Duration and Commencement of Recommendations:The Sixteenth Finance Commission will provide recommendations covering a five-year period starting from April 1, 2026.The Union Cabinet has approved the Terms of Reference (ToR) for the Commission, setting a deadline of October 31, 2025, for the submission of its recommendations.

• Distribution of Tax Revenues:The Commission will recommend the formula for sharing the net proceeds of taxes between the Central government and the States.

• It will also propose methods for allocating shares of these proceeds among the States.

• Financial Support to Local Bodies:To supplement the resources of panchayats and local bodies, the Commission will suggest measures to augment the Consolidated Fund of a State based on recommendations from State Finance Commissions.

• Principles Governing Grants-in-Aid: The ToR include recommendations on principles that should guide grants-in-aid from the Consolidated Fund of India to the revenues of the States.

• The Commission will specify the amounts to be paid to the States as grants-in-aid to support their revenues.

• Review of Disaster Management Financing:The Commission may review existing financing arrangements for Disaster Management initiatives and propose suitable recommendations in this regard.

Issues

• Meeting the needs of Cities: Cities contribute around 66% of India's GDP and 90% of total government revenues. 

• Despite this, the economic scale is insufficient to meet rising needs, with the World Bank estimating a need for $840 billion for urban infrastructure in the next decade.

• Financial Devolution: Five commissions since the 11th Finance Commission have made efforts, but financial devolution to cities remains inadequate.

• The fiscal health of municipalities is poor, affecting both city productivity and quality of life.

• Low Intergovernmental Transfers (IGTs): IGTs to Urban Local Bodies (ULBs) in India are about 0.5% of GDP, significantly lower than the 2-5% typical of other developing nations (South Africa 2.6%, Mexico 1.6%, Philippines 2.5%, Brazil 5.1%).

• IGTs constitute about 40% of ULBs’ total revenue but face issues with predictability, earmarking for vulnerable groups, and horizontal equity.

• State Finance Commissions recommended only about 7% of States' own revenue to ULBs in 2018-19

• Impact of GST on ULBs' Revenue: GST introduction reduced ULBs' tax revenue (excluding property tax) from 23% in 2012-13 to 9% in 2017-18.

• Urbanisation: Rapid urbanisation without appropriate fiscal action adversely affects development.

• Challenges from Parallel Agencies:The 13th Finance Commission noted that parallel agencies emasculate local governments financially and operationally.

• Programs like MPLADS and MLALADS exacerbate this issue, distorting the federal structure.

• Updated Census Data: Reliance on 2011 data is inadequate; the absence of the 2021 Census necessitates capturing current urban demographics and migration trends.

Agenda of the 16th FC

• Need for Stable Support:Given the poor financial state of ULBs, stable intergovernmental transfers are crucial until their own revenues improve.

• The 16th FC must ensure that intergovernmental transfers to urban areas are at least doubled to meet the growing infrastructure needs.

• Recognition of Urban Growth: India has around 4,000 statutory towns, an equal number of Census towns, and approximately 23,000 effectively urban villages that must be included in fiscal devolution considerations.

• Migration to Tier-2 and Tier-3 Cities:Significant migration to smaller cities should be acknowledged and factored into resource allocation.

• Revisiting the 15th FC's Guiding Principles: Principles needing attention include:

• Enhancement of property tax collection in tandem with State's GST.

• Maintenance of accounts by local bodies.

• Allocation of resources for pollution mitigation.

• Focus on primary health care, solid waste management, and drinking water.

Urban Infrastructure Investment: Address warnings from the McKinsey Global Institute about inadequate urban infrastructure investment, leading to potential issues like water shortages and untreated sewage.

Short Takes

Member of Parliament Local Area Development Scheme (MPLADS): Launched in 1993, allows MPs to recommend developmental projects in their constituencies. Each MP is allocated funds annually to create durable community assets in areas like infrastructure, health, education, and sanitation, addressing local needs directly.

CONCLUSION

The 16th Finance Commission faces a critical task in realigning fiscal devolution to address the dynamic urban landscape of India. With outdated census data and an expanding urban population, it is imperative to update the framework to reflect current re

Tags:
Polity

Keywords:
16th Finance Commission Constitutional Bodies Federalism