The Finance Commission and the State Finance Commission
Financial relations between the Union and the states are the backbone of Indian federalism, and two institutions make those relations work: the Finance Commission of India at the national level and the State Finance Commission in every state. The Union Finance Commission decides how central tax revenue is shared with the states, while the State Finance Commission decides how state revenue is shared with panchayats and municipalities. Both are constitutional bodies, and both are examined frequently in competitive tests.
The Finance Commission of India
The Finance Commission is established under Article 280 of the Constitution. It is a constitutional but non-permanent body. The President of India constitutes a Finance Commission every fifth year or earlier if necessary. It consists of a Chairman and four other members. The Chairman is appointed by the President and is a person having experience in public affairs, while the other members are chosen from among persons with qualifications in finance, administration, economics and the accounts of government. The qualifications and the manner of appointment are laid down in the Finance Commission (Miscellaneous Provisions) Act, 1951. The first Finance Commission was constituted in 1951 under the chairmanship of K.C. Neogy. The 15th Finance Commission, chaired by N.K. Singh, made recommendations for the period 2021-26.
Functions of the Finance Commission
- To recommend the distribution of the net proceeds of taxes between the Union and the states, and the allocation of the states' share among the individual states.
- To recommend the principles governing grants-in-aid to the states out of the Consolidated Fund of India.
- To recommend measures to augment the resources of panchayats and municipalities on the basis of the recommendations of the State Finance Commissions.
- To consider any other matter referred to it by the President in the interests of sound finance.
The recommendations of the Finance Commission are advisory in nature and are not legally binding on the government, but by convention they are accepted, and the President lays them before Parliament along with an Action Taken Report. The Commission's recommendations cover a period of five years, called a finance commission cycle. The 14th Finance Commission had recommended a 42 per cent share of the divisible pool for the states, and after the reorganisation of Jammu and Kashmir the 15th Finance Commission fixed the states' share at 41 per cent.
The State Finance Commission
The State Finance Commission is created by the 73rd and 74th Constitutional Amendment Acts. Article 243-I provides for a State Finance Commission for panchayats, and Article 243-Y provides for a similar commission for municipalities. The Governor of the state constitutes the State Finance Commission every fifth year. Its composition is determined by the state legislature. Its main function is to review the financial position of panchayats and municipalities and to recommend:
- the distribution between the state and the local bodies of the net proceeds of taxes, duties, tolls and fees leviable by the state;
- the assignment to local bodies of taxes and fees that may be collected and appropriated by them;
- the grants-in-aid to local bodies from the Consolidated Fund of the state; and
- measures to improve the financial position of panchayats and municipalities.
The Governor places the recommendations of the State Finance Commission before the State Legislature along with an Action Taken Report. Thus the State Finance Commission performs at the state level the same kind of function that the Union Finance Commission performs at the national level, but its focus is local self-government.
Difference between the Union Finance Commission and the State Finance Commission
- Constitutional basis: the Union Finance Commission is under Article 280; the State Finance Commission is under Articles 243-I and 243-Y.
- Appointing authority: the Union Finance Commission is constituted by the President; the State Finance Commission by the Governor.
- Scope: the Union Finance Commission distributes resources between the Union and the states; the State Finance Commission distributes resources between the state and local bodies.
- Composition: the Union Finance Commission has a Chairman and four members; the composition of the State Finance Commission is decided by the state legislature.
Related Financial Provisions
Several other articles and institutions complete the financial architecture. Article 266 creates the Consolidated Fund and the Public Account, Article 267 creates the Contingency Fund, and Article 275 provides for grants-in-aid to the states, especially for the welfare of Scheduled Tribes and Scheduled Areas. Article 279A provides for the GST Council, which recommends rates and the sharing of GST revenue. The GST compensation mechanism was created to compensate states for revenue loss after the introduction of the Goods and Services Tax. In Assam, the state receives its share of central taxes as recommended by the Union Finance Commission and shares resources with its panchayats and municipal bodies on the advice of the Assam State Finance Commission.
Significance for Competitive Examinations
The Finance Commission is a high-value topic in APSC, ADRE, Assam Police, Gauhati High Court, SSC and Railway exams. Questions are asked on the article that establishes the Union Finance Commission, the article for the State Finance Commission, the appointing authorities, the composition, the tenure and period of the commissions, the recommendations of the latest Finance Commission, the meaning of devolution and grants-in-aid, and the difference between the two commissions. Because the topic links the Constitution with public finance and fiscal federalism, it appears in both general studies and current affairs sections.
How to Prepare This Topic
- Memorise Article 280 for the Union Finance Commission and Articles 243-I and 243-Y for the State Finance Commission.
- Remember that the Union Finance Commission is appointed by the President and the State Finance Commission by the Governor.
- Learn the composition: a Chairman and four members for the Union Finance Commission.
- Note the milestones: first Finance Commission 1951 (K.C. Neogy) and the 15th Finance Commission (N.K. Singh, 2021-26).
- Understand the terms devolution, grants-in-aid and GST compensation.
- Practise the questions on this page and revise the FAQ answers.
Common Exam Traps
- The Finance Commission is under Article 280, while the State Finance Commission is under Article 243-I and 243-Y.
- The Union Finance Commission is appointed by the President, not the Prime Minister or Parliament.
- The Commission's recommendations are advisory, not binding, although they are normally accepted.
- The first Finance Commission was set up in 1951, not 1950.
- The State Finance Commission deals with panchayats and municipalities, not with the division of taxes between the Union and the states.
Frequently Asked Questions
Under which article is the Finance Commission of India established?
The Finance Commission of India is established under Article 280 of the Constitution. The President constitutes a Finance Commission every fifth year or earlier, and it consists of a Chairman and four other members. It recommends the distribution of taxes between the Union and the states and the principles governing grants-in-aid to the states.
What is the composition and tenure of the Finance Commission?
The Finance Commission consists of a Chairman and four other members appointed by the President. The Chairman is a person with experience in public affairs, and the other members are drawn from persons with qualifications in finance, administration, economics and government accounts. The Commission is constituted every five years or earlier, and its recommendations cover a period of five years.
What is the State Finance Commission and what does it do?
The State Finance Commission is created under Article 243-I for panchayats and Article 243-Y for municipalities. It is constituted by the Governor every five years. It reviews the financial position of panchayats and municipalities and recommends the distribution of taxes between the state and local bodies, the assignment of taxes, grants-in-aid from the state's Consolidated Fund and measures to improve local finances.
What is the difference between the Finance Commission and the State Finance Commission?
The Finance Commission under Article 280 is constituted by the President and distributes tax revenue between the Union and the states. The State Finance Commission under Articles 243-I and 243-Y is constituted by the Governor and distributes resources between the state and its panchayats and municipalities. The Union Finance Commission has a Chairman and four members, while the composition of the State Finance Commission is decided by the state legislature.
Which was the latest Finance Commission and what period did it cover?
The 15th Finance Commission, chaired by N.K. Singh, made recommendations for the period 2021-26. It fixed the states' share of the divisible pool at 41 per cent after the reorganisation of Jammu and Kashmir. The 14th Finance Commission had earlier recommended a 42 per cent share for the states.