The constitution of the Finance Commission (FC) is governed by Article 280 of the Constitution. It
spells out the manner and modality for the management of the finances of the Union and the States as
well as the principles for governing the divisible resources.

• The fifteenth Finance Commission (FC-XV) was constituted on November 27, 2017. It submitted
its report, titled ‘Finance Commission in Covid Times’,to the President for the period 2021-26.
• The Finance Commission transfers are made under Articles 270, 275 and 280 of the Constitution,
which provides a mechanism for sharing of taxes and revenues vertically between the Centre and
states; and horizontally among all states.
• FC-XV was additionally tasked with reviewing the design of fiscal principles for various grants that
are typically provided alongside revenue shares. It was also asked to consider performance-based
incentives to support and motivate the efforts of State and/or local governments.
• Another unique mandate given to it included recommending funding mechanism for defence and
internal security.
• Challenges faced by commission: The difference-in opinion on the use of the population census of
2011, Non-lapsable defence fund, Use of certain parameters for performance incentives.
Recommendation of FC-XV
A. Vertical Transfer
• The constitution has assigned higher and more buoyant taxation and resource raising powers to the
Union Government whereas higher responsibilities for incurring expenditure have been assigned to
the States. For example, in 2018-19, the Union Government raised 62.7 per cent of the aggregate
resources raised by both the Union and States, whereas the States spent 62.4 per cent of the
aggregate expenditure of the Union and the States.
• This imbalance between revenues and expenditure responsibilities forms the basis of a fair vertical
devolution. FC-XV recommended this devolution to beat 41 per cent.
• As compared to FC-XIV, this Commission has only made the required adjustment of about 1 per cent
due to the changed status of the J&K into the new UT of Ladakh and J&K, as the resources for these
Union territories will now be provided by the Union government.
B. Horizontal distribution
• Horizontal devolution of taxes is mainly driven by considerations
of need, equity and performance. However, balancing equity and
efficiency is never an easy exercise.
• FC-XV has given the criterion for horizontal distributionof
taxes which is shown in the side table.
• Population, area and forest & ecology represents the need-based
principle, while income distance criterion represents an equity-
based principle. Tax and fiscal efforts and demographic
performancehave been used as a performance criterion.

Which Census Year to be Used?
• All FCs since sixth one, used the population data of the 1971
Census.FC-XV was mandated to use the population data of the
most recent Census.

A sudden use of the latest Census data will be unfair to States which have performed well on the
national objective of demographic management. Hence, use of demographic performance as a
criterion has addressed these issues.
• FC recommended relatively higher per capita tax devolution to States with lower per capita
income. This clarifies that the overall allocation to States as recommended by the Commission is
C. Grants-in-aid
• The second core function of the FC is to determine the principles which should govern grants-in-
aid. The Commission has recommended five different categories of grants: Revenue deficit grants;
Grants for local governments; Grants for disaster management; Sector-specific grants, and State-
specific grants.
• FC-XV recommended grants aggregating to Rs. 10,33,062 crore, which is 19.65 per cent of total
recommended transfers to States.
Rationale behind Grant-in-aids
• The revenue deficit grants will allow states time to adjust to changes in the pattern of tax devolution
recommended by FCs based on the evolving patterns of their assessed needs, ability and
• Besides, grants-in-aid are more directly targeted and equalises the standards of basic social services
to some extent. Some of these grants have been linked with performance-based criteria that seek to
promote some sectors in furtherance of national goals.
• Also, attaching performance criteria to fiscal transfers may enhance transparency, accountability,
provide feedback on improving policy formulation and implementation and lead to better monitoring
of expenditures.
Revenue Deficit Grants
• No formula-based horizontal devolution can meet the needs of each of the twenty- eight States so
vastly different from each other. Therefore, the Commission has recommended an allocation of 1.92
per cent of the gross revenue receipts of the Union as revenue deficit grants to specific States.
Local Government Grants
• The total size of the grant to local governments recommended by the Commission is Rs. 4,36,361
crore for the period 2021-26. A sum of Rs. 2,36,805 crore is earmarked for rural local bodies, Rs.
1,21,055 crore for urban local bodies and Rs. 70,051 crore for health grants through local
• Urban local bodies have been categorised into two groupsbased on population. Basic grants
are proposed only for cities/towns having a population of less than a million. For Million-Plus cities,
100 per cent of the grants are performance-linked through the Million-Plus Cities Challenge Fund.
• For rural local bodies, the FC-XV allocations cover all the three panchayati tiers—village, block and
district—as well as the Excluded Areas exempted from the purview of Part IX and Part IX-A of the
• The rural-urban distribution gradually increases in favour of the urban local bodies from 67:33 in
2021- 22 to 65:35 by 2025-26.
• The grants to local bodies, both rural and urban (less than a million category), contain a mix of basic,
tied as well as performance grants such as sanitation, solid waste management and ease of breathing
in the metro cities.

Disaster Management Grants
• The Commission recommended Mitigation Funds to be set up at both the national and State levels,
in line with the provisions of the Disaster Management Act.
Other Sector-specific and State-specific Grants
• The Commission has also recommendedperformance-based grants and incentives for sectors like
health, education, agriculture, PMGSY roads, judiciary, statistics and aspirational districts and
• The Commission laid special focus on health sector. It recommended total grants-in-aid support to
the health sector over the five-year award period aggregating to Rs.1,06,606 crore which is 10.3 per
cent of the total grants-in-aid recommended by the Commission.
Defence Fund
• It has been recommended that the Union Government may constitute in the Public Account of India,
a dedicated non-lapsable fund, Modernisation Fund for Defence and Internal Security (MFDIS).
The total indicative size of the proposed MFDIS over the period 2021-26 is Rs. 2,38,354 crore. This
recommendation has been accepted by the government.
• This would make a significant difference in addressing the issue of adequacy of capital expenditure
both for defence and internal security.
• In the formula given by the Finance Commission, whereas Rs. 40,000 crore per annum would be
available for defence, Rs. 10,000 crore per annum would be available for home ministry to upgrade
paramilitary forces. Finally, Rs. 1,000 crore per annum has been recommended as Jawan Welfare
Fund given the enormous sacrifices of India’s armed and paramilitary forces.
• Notwithstanding challenging times, the Commission believes that the distribution of resources
between the Union and the States and for the third tier of government have been addressed in a
manner which is fair, reasonable, rational and equitable.
“Never let the future disturb you. You will meet it, if you have to, with the same weapons of reason which
today arm you against the present”- Marcus Aurelius

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