The 15th Finance Commission: Transforming Fiscal Federalism in India

1. Introduction: The Lynchpin of Indian Fiscal Federalism

The Finance Commission of India is a unique constitutional body, pivotal to the functioning of fiscal federalism in the country. Established under Article 280 of the Constitution, its primary role is to recommend the distribution of financial resources between the Union and the States. This mechanism is crucial in a quasi-federal country like India, where the Centre has greater revenue-raising powers, while the States bear a disproportionately larger share of developmental and welfare expenditure. The Finance Commission, therefore, acts as an institutional arbiter, ensuring a fair and equitable distribution of resources to correct both vertical and horizontal fiscal imbalances.

The Fifteenth Finance Commission (15th FC), chaired by Shri N.K. Singh, was constituted in November 2017. Its recommendations, covering the period 2021-26, have been formulated in the backdrop of significant economic and political shifts. These include the abolition of the Planning Commission, the introduction of the Goods and Services Tax (GST), the COVID-19 pandemic's unprecedented economic shock, and the changed status of Jammu & Kashmir. Consequently, the 15th FC's report, titled "Finance Commission in COVID Times", is not merely a set of fiscal recommendations but a roadmap for navigating the complexities of Centre-State financial relations in a new era.

This comprehensive set of notes will delve into the historical context, constitutional mandate, key recommendations, and the transformative impact of the 15th Finance Commission on India's fiscal architecture.

2. Historical and Constitutional Background

The genesis of the Finance Commission lies in the need to create a stable and predictable framework for inter-governmental fiscal transfers.

Constituent Assembly Debates and Pre-Constitutional Legacy

The Government of India Act, 1935, first introduced a federal-style distribution of financial resources. However, the system was skewed in favour of the Centre. The framers of the Indian Constitution, while opting for a strong Centre, were acutely aware of the need for financially viable states. Dr. B.R. Ambedkar envisioned the Finance Commission as a robust, impartial body that would periodically redefine Centre-State financial relations based on evolving needs.

Constitutional Mandate: Articles 280 & 281

The role and functions of the Finance Commission are enshrined in the Constitution:

• Article 280: The Finance Commission

  • Clause (1) mandates the President to constitute a Finance Commission every fifth year, or earlier. It shall consist of a Chairman and four other members.
  • Clause (2) empowers Parliament to determine the qualifications and selection process of the members.
  • Clause (3) outlines the core duties of the Commission. It shall make recommendations to the President on:
    • The distribution of the net proceeds of taxes between the Union and the States (Vertical Devolution) and the allocation of these shares among the States themselves (Horizontal Devolution).
    • The principles that should govern the grants-in-aid to the States out of the Consolidated Fund of India (under Article 275).
    • Measures needed to augment a State's Consolidated Fund to supplement the resources of Panchayats and Municipalities (based on the recommendations of the State Finance Commission).
    • Any other matter referred to it by the President in the interests of sound finance.

• Article 281: Recommendations of the Finance Commission

  • This article requires the President to lay the report of the Finance Commission, along with an explanatory memorandum of the action taken on its recommendations, before each House of Parliament.

It is crucial to note that the recommendations of the Finance Commission are advisory in nature and not binding on the government. However, they are generally accepted by the Union Government, lending them a high degree of sanctity.

3. The 15th Finance Commission: Key Provisions & Recommendations

The 15th FC's recommendations were presented in two reports: an interim report for 2020-21 and a final report for the period 2021-26.

A. Vertical Devolution: Share of States in Central Taxes

This refers to the percentage of the divisible pool of central taxes that is to be shared with the states.

• Recommendation: The 15th FC recommended that the share of states in the central divisible pool be 41% for the 2021-26 period.
• Rationale for the 1% Reduction: This is a reduction from the 42% share recommended by the 14th Finance Commission. The 1% adjustment is to provide for the newly formed Union Territories of Jammu & Kashmir and Ladakh from the Centre's resources. This ensures that the erstwhile state's aggregate resources are not diminished.

Key Takeaway: Despite the nominal reduction, the 15th FC has maintained the spirit of high devolution established by its predecessor, reaffirming the principle of cooperative federalism.

B. Horizontal Devolution: Criteria for Inter-se Distribution among States

This is perhaps the most debated aspect, as it determines how the 41% share is distributed among the states. The 15th FC introduced significant changes to the criteria and weightages.

📊 Table 1: Comparative Analysis of Horizontal Devolution Criteria (14th vs 15th FC)

This shift in criteria, especially the introduction of 'Demographic Performance' and 'Tax Effort', signifies a move towards a more performance-oriented and balanced framework.

C. Grants-in-Aid and Other Recommendations

Beyond tax devolution, the 15th FC made crucial recommendations on grants:

1. Revenue Deficit Grants: Recommended post-devolution Revenue Deficit Grants of nearly ₹3 trillion to 17 states over the five-year period to cover gaps in their revenue accounts.
2. Grants to Local Bodies: A total of ₹4.36 lakh crore was recommended for local bodies (Rural and Urban), a significant increase from the 14th FC's allocation. These grants are linked to performance conditions like publishing audited accounts and notifying minimum property tax rates. A key condition is that states must constitute State Finance Commissions and act on their recommendations by March 2024 to continue receiving these grants.
3. Sector-Specific Grants: The commission recommended grants for eight sectors:
   • Health
   • School Education
   • Higher Education
   • Agriculture Reforms
   • Maintenance of PMGSY Roads
   • Judiciary
   • Statistics
   • Aspirational Districts and Blocks
4. Disaster Risk Management: Recommended grants for both national and state-level disaster response funds, with a focus on mitigation over relief.
5. Fiscal Consolidation Roadmap:
   • Centre: Recommended bringing the fiscal deficit down to 4% of GDP by 2025-26.
   • States: Recommended a fiscal deficit limit of 4% of GSDP in 2021-22, 3.5% in 2022-23, and 3% for 2023-26.
   • It also recommended the formation of a high-powered inter-governmental group to review the Fiscal Responsibility and Budget Management (FRBM) Act.
6. Defence and Internal Security Funding: A significant and controversial Term of Reference was to examine the need for a separate, non-lapsable fund for defence and internal security. The commission recommended constituting a Modernisation Fund for Defence and Internal Security (MFDIS).

4. Institutional Framework & Functions

The Finance Commission does not operate in a vacuum. Its work is defined by its Terms of Reference (ToR) and its quasi-judicial character.

Terms of Reference (ToR) of the 15th FC: The Guiding Framework

The ToR for the 15th FC were wider and more complex than for previous commissions. Key unique aspects included:

• Use of 2011 Population Data: This was a significant point of contention, as southern states felt it would penalize them for successful population control policies.
• Reviewing the FRBM: To recommend a new fiscal consolidation roadmap in light of the changing economic landscape.
• Performance-based Incentives: To recommend incentives for states based on their performance in areas like GST implementation, digital economy, and ease of doing business.
• Funding for Defence and Internal Security: A novel and contentious ToR that critics argued could impinge on the divisible pool of taxes meant for states.

Composition and Quasi-Judicial Nature

As per the Finance Commission (Miscellaneous Provisions) Act, 1951, the Chairman is a person with experience in public affairs, and the four members are chosen from among:

1. High Court judges or those qualified to be one.
2. Persons with special knowledge of government finances and accounts.
3. Individuals with wide experience in financial matters and administration.
4. Experts with special knowledge of economics.

The Commission has the powers of a civil court, which lends it a quasi-judicial character. It can summon witnesses and call for public records, ensuring a thorough and evidence-based inquiry.

🏛️ 15th Finance Commission Composition

• Chairman: N.K. Singh
• Full-time Members: Ajay Narayan Jha, Anoop Singh, Ashok Lahiri
• Part-time Member: Ramesh Chand

5. Judicial Interpretations and Landmark Cases

While the Finance Commission's work is primarily economic and political, the judiciary has played a crucial role in shaping the broader principles of fiscal federalism.

• S.R. Bommai v. Union of India (1994): While not directly about finance, this case cemented the principle that federalism is a part of the 'basic structure' of the Constitution. A robust fiscal framework is an indispensable component of this structure.
• State of West Bengal v. Kesoram Industries Ltd. (2004): The court deliberated on the distinction between a 'tax' and a 'royalty', clarifying the taxation powers of the Centre and states concerning minerals. This has significant implications for states' own revenue sources.
• Union of India vs. M/s Mohit Minerals Pvt. Ltd. (2022): The Supreme Court held that the recommendations of the GST Council are not binding on the Union and State legislatures. This judgment reinforced the idea of "cooperative and uncooperative federalism," where dialogue and persuasion are key, not coercion. It underscores the legislative autonomy of states in the fiscal domain.
• Mineral Area Development Authority vs. M/s Steel Authority of India (2024): In a landmark 8:1 majority judgment, the Supreme Court upheld the power of states to tax mineral rights and mineral-bearing lands. The court emphasized that diluting the taxation powers of states would adversely affect their ability to deliver welfare. This ruling is a significant victory for fiscal autonomy and strengthens the financial position of mineral-rich states.

These judgments collectively affirm that fiscal federalism is not just an economic arrangement but a constitutional creed. They protect the fiscal autonomy of states from legislative or executive overreach.

6. Contemporary Relevance, Debates & Criticisms

The recommendations of the 15th FC have sparked intense debate and have far-reaching implications.

Positive Implications:

• Balancing Equity and Efficiency: The introduction of 'Demographic Performance' and 'Tax Effort' as criteria is a laudable attempt to balance the needs of populous, poorer states with rewarding the performance of fiscally prudent ones.
• Empowering Local Governments: The substantial increase in grants and the imposition of strict conditionalities for their release can catalyze fiscal decentralization and improve governance at the grassroots level.
• Focus on Key Sectors: Earmarking grants for critical sectors like health and education addresses developmental gaps and aligns fiscal policy with national priorities.
• Pragmatic Fiscal Roadmap: The fiscal deficit targets provided are realistic, considering the economic impact of the pandemic.

Criticisms and Concerns:

• Centralisation Concerns: Critics argue that increased conditionality on grants and the ToR on defence funding represent a trend towards recentralization, undermining state autonomy.
• The Population Debate: The use of the 2011 census data, despite the introduction of the 'Demographic Performance' criterion, continues to be a point of contention for states that have successfully managed their population growth.
• Shrinking Divisible Pool: States have consistently raised concerns about the shrinking size of the divisible pool due to the increasing resort by the Centre to cesses and surcharges, which are not shareable. The 15th FC noted this but couldn't offer a binding solution.
• Untied vs. Tied Funds: The shift towards more sector-specific and performance-linked grants reduces the quantum of 'untied' funds available to states, limiting their fiscal flexibility to spend according to their unique local needs.

Diagram 1: The Flow of Fiscal Transfers Recommended by the Finance Commission

graph TD
    A[Consolidated Fund of India] -->|Net Proceeds of Central Taxes| B{Divisible Pool};
    B -->|Vertical Devolution (41%)| C[Aggregate Share of States];
    C -->|Horizontal Devolution Criteria| D{Distribution Among States};
    D --> E[State A];
    D --> F[State B];
    D --> G[State 'n'];
    A -->|Grants-in-Aid (Art. 275)| H{Grants};
    H --> I[Revenue Deficit Grants];
    H --> J[Sector-Specific Grants];
    H --> K[Grants for Local Bodies];
    H --> L[Disaster Management Grants];
    I --> G;
    J --> F;
    K --> E;

• Explanation: This flowchart illustrates the two main channels of resource transfer recommended by the Finance Commission. The first is the devolution of taxes from the divisible pool, which is distributed vertically (Centre to states) and then horizontally (among states). The second channel consists of various grants-in-aid, which are more targeted and often conditional.

7. Comparative Perspective: 14th vs. 15th Finance Commission

A comparative look at the two most recent commissions highlights the evolving nature of Indian fiscal federalism.

8. Conclusion & Summary

The 15th Finance Commission has navigated a complex and challenging landscape to deliver a report that is both pragmatic and forward-looking. It has performed a delicate balancing act—between the Centre and states, between equity and efficiency, and between rewarding performance and addressing needs.

Its recommendations mark a significant evolution in Indian fiscal federalism. While it builds upon the high devolution legacy of the 14th FC, it introduces a strong emphasis on performance, outcomes, and fiscal prudence. The focus on local bodies, health, and education aligns fiscal policy with pressing developmental challenges. However, concerns regarding the centralizing tendency through conditional grants and the issue of cesses and surcharges remain pertinent.

Ultimately, the 15th FC report is a testament to the resilience and adaptability of India's federal structure. Its recommendations will shape the economic trajectory of the Union and the States for years to come, making it a critical document for understanding the future of Indian governance.

9. Practice Questions & Answers

✅ Multiple-Choice Questions (MCQs)

1. The 15th Finance Commission recommended a vertical devolution of what percentage of the divisible pool of taxes to the states for the period 2021-26? a) 42% b) 41% c) 32% d) 40%

   Answer: (b) 41%

   • Explanation: The 15th FC recommended 41%, a 1% reduction from the 14th FC's 42%, to account for the new Union Territories of J&K and Ladakh.

2. Which of the following criteria was newly introduced by the 15th Finance Commission for horizontal devolution? a) Population (2011) b) Income Distance c) Demographic Performance d) Area

   Answer: (c) Demographic Performance

   • Explanation: The 'Demographic Performance' criterion was introduced to reward states for their efforts in population control, using the Total Fertility Ratio as an indicator. 'Tax Effort' was also a new addition.

3. Under which Article of the Constitution is the Finance Commission constituted? a) Article 275 b) Article 280 c) Article 281 d) Article 263

   Answer: (b) Article 280

   • Explanation: Article 280 mandates the President of India to constitute a Finance Commission at the expiration of every fifth year or at such earlier time as he considers necessary.

4. The recommendations of the Finance Commission are: a) Binding on the Government of India. b) Advisory in nature. c) Binding only if approved by the Supreme Court. d) Binding on the states but not the Centre.

   Answer: (b) Advisory in nature.

   • Explanation: The Constitution does not make the recommendations of the Finance Commission binding on the government. However, they are treated with great weight and are generally accepted.

🔍 Scenario-Based Question

Scenario: A state 'X', which has successfully implemented population control measures over the last few decades, argues that the 15th Finance Commission's recommendations penalize it for its good performance. How would you analyze this claim?

Answer: This claim has two sides and reflects a central debate surrounding the 15th FC's recommendations:

• Argument for the Claim: The primary basis for State 'X's' argument is the use of the 2011 population data with a significant weightage of 15%. This naturally favors more populous states. State 'X' would have benefited more if the 1971 population data (used by previous commissions) had been retained, as that would have rewarded its early success in population control.
• Counter-argument: The 15th FC was aware of this potential grievance. To balance this, it introduced a new criterion called 'Demographic Performance' with a 12.5% weightage. This criterion is specifically designed to reward states like 'X' that have a lower Total Fertility Ratio. Therefore, while State 'X' might lose out on the population criterion, it gains significantly from the demographic performance criterion.

Conclusion: The claim is partially valid in principle but is substantially mitigated by the commission's innovative balancing mechanism. The net impact on State 'X' would depend on the combined effect of its share from both the population and demographic performance criteria. The debate highlights the commission's attempt to reconcile the principles of 'need' (represented by population) and 'efficiency/performance'.

🔄 Match-the-Following Exercise

Answer: 1-C, 2-A, 3-D, 4-B.

Recommended Books

You can explore these highly recommended resources for a deeper understanding.

• Indian Polity (English) by M Laxmikanth for UPSC CSE 2025 | 7th edition (latest) | Civil Services Exam - Prelims, Mains and Interview | State PSCs exams/ PCS exams - by M Laxmikanth
• Oswaal NCERT One For All Book for UPSC & State PSCs | Indian Polity Classes 6-12 - by Oswaal Editorial Board
• Bharat Ki Rajvyavastha (भारत की राजव्यवस्था) - M Laxmikanth for UPSC CSE