Finance Commission of India - Finance Commissions, Their Terms of Reference and Recommendations

Finance Commissions, Their Terms of Reference and Recommendations

• First Finance Commission

The First Finance Commission was appointed by the President on November 20, 1951, which was chaired by Mr. K.C. Neogy. Other members of the commission included Mr. V.P. Menon, Mr. R. Kaushalendra Rao, Dr. BK Madan and Mr. M.U. Rangachari. After Mr. V.P. Menon’s resignation on February 18, 1952, Mr. V.L. Mehta was appointed as a member. The commission was asked to make recommendations regarding:

1. Allocations of income tax and Union Excise Duties and tax sharing.
2. Amounts payable as Grants- in-Aid to the States in need of Assistance under the ‘substantive portion of Clause 1 of Article275’.
3. Grants-in-Aid to certain States in lieu of their share of export duty on jute and jute products according to Article 273 # Continuation or adjustment of the terms of agreement with Part B States under Article 278 (1) or under Article 306.

Recommendations

• The share of States in the proceeds of income tax was to be 55 per cent.
• The First Commission recommended that shares of States in the Union excise duties be 40 per cent of the proceeds of the tax on three commodities, 25 per cent of the proceeds of the tax on eight commodities and 20 per cent of the proceeds of the tax on 35 commodities, respectively.
• As far as Horizontal Distribution is concerned, overwhelming weightage is given to Population (80%). Only residual weightage of 20% given to contribution.
• No recommendations regarding grants for meeting capital requirements of the state were made by the commission.
• The Commission provided Grants in- Aid (under Article 273) to only four states, namely, Assam Bihar, Orissa and West Bengal. However, Grants were provided to many states under Substantive Portion of Article 275 (1) and under the head of Primary education grants.

All recommendations made by the commission were accepted by the Union Government.

• Second Finance Commission

The Second Finance Commission was constituted by President Rajendra Prasad, on June 1, 1956. The Commission was chaired by Shri K. Santhanam and consisted of Shri Ujjal Singh, Shri L.S. Misra (Retired Chief Justice, Hyderabad), Shri M.V. Rangachari and Dr. B.N. Ganguli, as its other members.

The Commission was asked to make the following recommendations:

1. Grants-in-Aid to certain States, in need of assistance under Article 275, having regard to the requirements of Second Five Year Plan and the efforts made by those states to raise additional revenue.
2. Allocation of Estate Duty and Tax on Railway Passenger Fares proposed to be levied by the Railway Passenger Fares Bill, 1957, introduced in the Lok Sabha on 15 May 1957.
3. Grants-in-Aid to the States of Assam, Bihar, Orissa and West Bengal, to compensate for their share of the export duty on jute and jute products as per Article 273.
4. The principles which should govern the distribution under article 269 of the net proceeds of estate duty in respect of property other than agricultural land, levied by the Government of India in the States within which such duty is leviable.
5. Revisions, if any, of the rates of interest on loans made by the Centre to the States between August 15, 1947 to March 31, 1956 and their terms of repayment. The phenomenal growth of the Union loans to the States justified such adjustments.
6. Apportionments of the net proceeds of the additional Excise Duties proposed to be levied in view of States’ Sales Taxes on the mill made textiles, sugar and tobacco, and the amounts which should be assured to the States as the income now derived by them from the levy on these commodities and the States Sales Tax (which is to be replaced by the additional duty of excise).

With regard to the distribution of Income Tax, the Commission made the following recommendations:

• Despite the receding contribution by the Income Tax to the devolution of revenue to the States, the Commission recommended an increase in the per cent of the net proceeds to the States from 55 to 60, and the share of the Union Territories should be 1 per cent.
• It was recommended that the distribution of the share of Income tax among the States should be 10 per cent on the basis of collection and 90 per cent of the basis of population, thereby giving greater importance to population than it was earlier.

As far as the allocation to the States from the Union duties of excise on matches, tobacco, vegetable products, tea, coffee, sugar, paper and vegetable non-essential oils was concerned, the Commission considered that it should be 25 per cent.

The table below summarizes what each State was to expect in each of the five years starting from April 1, 1957 under the Second Finance Commission’s recommendations:

States	Share of Taxes	Grants under Article 273	Grants under Article 275	TOTAL
Andhra Pradesh	8.50	-	4.00	12.50
Assam	2.75	0.45	4.05	7.25
Bihar	10.00	0.43	3.80	14.23
Bombay	14.75	-	-	14.75
Kerala	3.75	-	1.75	5.50
Madhya Pradesh	7.00	-	3.00	10.00
Madras	8.25	-	-	8.25
Mysore	5.50	-	6.00	11.50
Orissa	4.00	0.09	3.35	7.44
Punjab	4.25	-	2.25	6.50
Rajasthan	4.25	-	2.50	6.75

• The Third Finance Commission

The Third Finance Commission was appointed in the year 1960, for the period 1960-64, by the President and was chaired by Shri A.K. Chanda and the its members were :- Shri Govinda Menon, Shri Dwijendra Nath Roy, Prof. M.V. Mathur, Shri G.R. Kamat, Member Secretary. The Commission was asked to make recommendations to the President with regard to the following:- 1) On account of Tax Sharing between the Centre and the State and allocation of Income Tax and Central Excise Duties 2) Under Article 275, Grants-in-Aid to States in need of assistance, other than the sums specified in the provisos to Clause of article 275 a) With regard to the requirements of third five-year plan b) Secondly, with regard to the efforts to be made by those states to raise additional revenue amount 3) Allocation of duties, namely, additional excise duty and estate duty 4) The manner of distribution ofAd hoc Grantsin-lieu of tax on Railway Passenger Fares With regard to the TOR the following were the recommendations made by the FC:- The Finance Commission recommended the formulation of an independent commission to assess the tax potential of each state, to review its tax structure and to recommend rates under different heads of the levies of the state list :- Income Tax With regard to the divisible pool of income tax among the states the FC adopted the criterion of the first FC that 80% be distributed on the basis of population and 20% on the basis of collection. The recommended percentage share of the states in divisible pool of the Income Tax: Maharashtra - 13.41, Bihar - 9.33, Punjab - 4.49, Uttar Pradesh - 14.12, Kerala - 3.55 Union Excise Duty With regard to the distribution of the proceeds of UED the FC decided to cover all commodities on the existing list. It recommended that 20% of the net proceeds of UED on all commodities on which such duties were collected and the yield of which exceeded Rs. 50 lakhs in1960-61 should be allocated to the state. The share of each state in the distribution of UED was determined by the Commission on the basis of population and it rejected consumption as the basis of distribution due to two major reasons a) Reliable data on consumption wasn’t available b) As it would have given advantage to the more urbanised and financially stronger states. Percentage share of the 20% of proceeds of the UED for certain major states were:- Maharashtra - 5.73, Bihar - 11.56, Punjab - 6.71, Uttar Pradesh - 10.68, Kerala - 5.46 Additional Duties of Excise The GOI in consultation with the state governments, decided that an AED be levied on mill-made textiles, sugar, tobacco, rayon among others and the net proceeds of which should be distributed among them subject to then income derived by each state being assured to it. The Commission rejected this contention as the rates of sales taxes had been revised by them since then. The commission distributed the guaranteed amount of Rs. 32.54 crores among the States and the remaining amount was distributed, first, on the basis of the percentage increase in the collection of sales tax in each state since 1957- 58 when AED were imposed and then on the basis of the population. The Act imposing a tax on the railway passenger fares was repealed after the Third Finance Commission had been constituted. Hence, the commission was asked to make recommendations on the principle on which the ad hoc grant should be distributed among the states. The commission adopted the principle of compensation based on which the grants should be distributed.

• The Fourth Finance Commission of India

The Fourth Finance Commission was constituted on May 18, 1964, under the chairmanship of Dr. P.V. Rajamannar. Other members of the Commission included

Shri Mohan Lal Gautam Shri D.G. Karve Prof. Bhabatosh Datta Shri P.C. Mathew, Member Secretary.

The Commission suggested in its report that there should be greater co-ordination between the Centre and the States in common financial interests for which it recommended the establishment of a permanent organization in the Ministry of Finance

Recommendations

Tax sharing and allocation of Income-tax and Union Excise Duties.

Grants-in –aid to States in need of assistance, having regard to:

The revenue resources of States for Five Years ending with 1970-71 on the basis of the levels of taxation likely to be reached at the end of 1965-66; Creation of a fund out of Estate Duty proceeds over a specified limit, for repayment of State’s debt to the centre; and Scope for economy with efficiency in States’ administrative expenditure.

The changes to be made in the principles governing the distribution amongst the States of the grant to be made available to the States in lieu of taxes on railway fares;

To study the combined incidence of Sales Tax and Union Excise Duties on the production, consumption or export of products, the duties on which are shareable with the State.

The changes to be made in the principles governing the distribution of the net proceeds in any financial year of the additional excise duties levied on commodities, namely, cotton fabrics, silk fabrics, woolen fabrics, sugar and tobacco- in replacement in the States’ tax formerly levied by the state governments.

• The Fifth Finance Commission of India

The Fifth Finance Commission was constituted by the President of India on March 15, 1968. The Terms of Reference of the Fifth Finance Commission were wider than those of the earlier ones. Apart from the matters referred to in the earlier Commissions, this Commission was required to:

Examine the desirability or otherwise of maintaining the existing arrangements in regard to additional excise duties levied in lieu of Sales Tax and the scope for extension of such arrangements to other items

To inquire into the unauthorized overdrafts of the States and recommend the procedure for avoiding such overdrafts

Examine the scope for raising revenue from taxes and duties mentioned in Article 269, the scope for States in raising additional revenue from their sources as well their scope for better fiscal management and economy in expenditure, and make a comprehensive study of the States’ expenditure on various subjects

Grants-in-aid recommended under Article 275 (1) are to be for purposes ‘other than the requirements of the Five Year Plan’, and while making its recommendations, the Commission was called upon to have regard to “the resources of the Central Government and the demands thereon” on account of expenditure on civil administration, defence, debt servicing, etc.

The Commission was asked for the first time to indicate the basis of its findings and make available relevant information. Since then these were made clear in the Terms of Reference of every successive Finance Commission

• The Sixth Finance Commission of India

The Sixth Finance Commission was incorporated in the year 1973 consisting of Shri K. Brahmananda Reddi as the chairman and the following four other Members, namely:-

Shri Justice Syed Sadat Abal Masud

Dr. B.S. Minhas

Dr. I.S. Gulati

Shri G. Ramachandran, Member Secretary

Recommendations

The States demanded the inclusion of corporation tax into the divisible income tax and 1005 allocation of the net proceeds to them. The commission expressed that such inclusion was constitutionally forbidden but it can be reviewed by National Development Council

States share was increase from 75% to 80% due to the decrease in the divisible pool as the arrears of the advance tax collection had been cleared

In view of the increasing integration of the national economy and for eliminating the regional imbalances the contribution factor was kept at 10% in the distribution of share amongst the states. The distribution inter se the states should be on the basis of fixed percentages

Out of the net proceeds of the income tax, 1.79% should be allocated to the Union Territories

• The Seventh Finance Commission of India

Introduction The Seventh Finance Commission was incorporated in the year 1978 consisting of Shri J.M. Shelat as the chairman and the following four other Members, namely:-

Dr. Raj Krishna Dr. C.H. Hanumantha Rao Shri H.N. Ray Shri V.B. Eswaran, Member Secretary

Recommendations

The share of the states in the net proceeds should be raised to 85% excepting the share of the Union Territories which would be 2.19% of net proceeds

The inter se distribution between the states should include 10% contribution factor and rest 90% would be on basis of population. The 10% allotment would be based on the State-wise net assessments

• The Eighth Finance Commission of India

The Eighth Finance Commission was constituted by the President of India, on April 28, 1984 under the chairmanship of Shri Y.B. Chavan. The commission also consisted of the following members

Shri Justice Sabya Sachi Mukherjee Dr. C.H. Hanumantha Rao Shri G.C. Baveja Shri A.R. Shirali Shri Justice T.P.S. Chawla Shri N.V. Krishnan, Secretary

It was asked to make recommendations on

The distribution of net proceeds of taxes between the union and the states which are to be or may be divided between them under chapter 1 of Part XII of the constitution and allocation between the states of the respective shares of the same The principles which govern the grants in aid of the revenues of the states out of the Consolidated Fund of India and the amount to be paid to the needy States which seeks assistance by way of grants in aid of their revenues under Article 275 of the constitution for purposes other than those specified in the provisions to clause (i) of that article

The commission is to examine the possibility for increasing revenue from the taxes and duties mentioned in article 269 of the constitution but which are not levied at present. It will probe into the scope for enhancing revenue from the duties mentioned in the article 268. Making an assessment of the non plan capital gap of the states on a uniform and comparable basis for the 5 years ending with 1988-89 also comes under its agenda. It will review the policy and arrangement in regards to the financing of relief expenditure by the States affected by natural calamities and make appropriate suggestions. The commission shall make its report by October 31, 1986 on each of the matters aforesaid

The major objective of the Eighth Finance Commission was to reduce interstate disparities through their scheme of devolution

Recommendations

Sharing of Income Tax – To retain the share of the States in the proceeds of the income tax at 85% level. Withdrawal of surcharge on income tax from the financial year 1985-86 is also recommended Union Excise Duties – Recommended its increase from 40% to 45%. It made a beginning by using one unified formula to distribute the net yield from Union Excise Duties and 90% share of the income tax Additional Excise Duties – The distribution from the net yield from additional duties of the excise was made 50% on the basis of the share of each state in the average state domestic products of all the states for the years from 1976-77 to 1978-79 and 50% on the basis of the population figures as given in 1971 census Grants in Lieu of tax on railway passenger fair – It has boldly defended the case of the state government in regard to their claim on the tax on railway fair. The compensatory grant which replaced the tax was increased to Rs. 95 crores Grants in Aid – They have been made more flexible. The commission has provided for an annual growth of 5% in respect of the amount of grants payable in nature of the forecast period commencing from 1984 to 1985. The recommendation to write off a substantial portion of loan amounting to Rs. 2285.39 crores is an appropriate step towards strengthening the state finances

• The Ninth Finance Commission of India

The Ninth Finance Commission was set up in June 1987 under the chairmanship of Mr. N.K.P Salve along with the following members

Shri Justice Abdus Sattar Qureshi Dr. Raja J. Chelliah Shri Lal Thanhawla Shri Mahesh Prasad Shri S. Venkitaramanan Shri Venkitaramanan Shri R. Keishing Shri K.V.R. Nair

Terms of References

The commission has been asked to adopt a normative approach in assessing the receipts and the expenditures on the revenue account not only of the states but also of the centre with due regard to the special problems of each state and the special requirement of the centre. Generating surpluses on revenue account of both the states and centre for capital investment should also be considered. Changes in the principles that govern the distribution between the union and the states and also the states inter se of the net proceeds of central taxes are to be made

The commission will also make recommendations regarding the principles which should govern the grants in aid of the revenue of the state out of the Consolidated Fund of India. It is to assess the debt position of the states as on March 31, 1989 and suggest corrective measures. In regard to the financing of the relief expenditure by the states affected by natural calamities the commission is to examine the feasibility of establishing a National Insurance Fund to which the state governments may contribute a percentage of their revenue receipts. The government’s decision to accept all the major recommendations of this commission which would bring substantial benefits to the state during the eighth five-year plan period (especially in relation to debt relief) shows the upper hand enjoyed by this body

Recommendations

Income Tax – 85% of the divisible pool of the income tax to be assigned to the state and out of the net distributable proceeds a sum equal to 1.437% should be deemed to represent the proceeds attributable to the union territories. Relief Funds – The Existing arrangements to be replaced by a new order under which the states will have greater autonomy and accountability. A calamity relief fund to be constituted for each state to which contribution is to be made in the ratio 75:25 (centre: state) Debt Relief – The commission recommended that the RBI may work out a formula for amortization of the states’ market borrowings. From 1990 to 1991 the direct central loans for states’ plans should have a maturity period of 20 years with 50% of the loans enjoying a grace period of 5 years. The loans given to the federating states for drought relief during 1986-89 as outstanding on March 31, 1989 are to be waivered. The state plan loans advance to the states during the 1984-89 period and outstanding on March 31, 1990 should be consolidated, rescheduled to 15 years in the case of all the states.

• The Tenth Finance Commission of India

The Tenth Finance Commission was incorporated in the year 1995 consisting of Shri Krishna Chandra Pant as the Chairman and the following four other Members, namely

Dr. Debi Prosad Pal, Member of Parliament, Member Shri B.P.R. Vithal, Member Dr. C. Rangarajan, Member Shri M.C. Gupta, Member Secretary

Recommendations

The share of the Union Territories would not be determined on the grounds used for state share but it would be decided on the basis of population solely. The percentage would be 0.927% for the years 1995-2000. The proceeds from the ‘penalties’ and ‘interest recovered’ under the miscellaneous receipts should be included in to the divisible income tax pool as recommended by Ninth commission with effect from 1 April 1995. The share of the net proceeds would be 77.5% for five years. The commission dropped the collection factor as the criterion for distribution The distribution of the net proceeds among states would be as follows:-

§ 20% on the basis of population of 1971

§ 60% on basis of distance of per capita income

§ 5% on basis of area adjusted

§ 5% on basis of infrastructure index

§ 10% on basis of tax effort

• The Eleventh Finance Commission of India

The Eleventh Finance Commission was appointed by the President on July 3, 1998 for the period 2000-05.It was chaired by : Prof. A.M. Khusro and its members were Shri N.C Jain, Shri J.C Jetly, Dr. Amaresh Bagchi, Shri T.N. Srivastava The Commission was asked to make recommendations to the President with regard to the following:- (a) With regard to Chapter I of Part XII of the Constitution, the distribution between the Centre and the States of the net proceeds of taxes and the allocation between the States of the shares of these proceeds (b) The principles governing the grants-in-aid of the revenues of the States out of the Consolidated Fund of India and with regard to article 275- the sums to be paid to the States which are in need of assistance by way of grants-in-aid of their revenues for purposes other than those specified in the provisos to clause (1) of that article; (c) With regard to the recommendations made by the Finance Commission of the State;the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State (d) Suggestions for a restructuring of the public finances so as to restore budgetary balance and maintain macro-economic stability. With regard to the TOR the following were the recommendations made by the FC:- a)the total share of the States in the net proceeds of central taxes and duties would be 29.5 per cent for the next five years b)With regard to the revenue deficit grants to States, a lump-sum amount of Rs. 11,000 crore in the Central Budget 2000-01. c) Grants - For the five years commencing from April 1, 2000, Rs.4,972.63crore be given forup gradation of standards of administration and specific grants to certain States for special problems. - For the five years commencing from April 1, 2000,Rs.10,000 crore for local bodies, to be directed for maintenance of civic services Rs.1600 crore per annum is for rural local bodies and Rs.400 crore per annum is for urban local bodies. d)With reference to the Grants-in-Aid under Article 275 (1) of the Constitution, which amounts to a total of Rs.35359 crore for the period 2000-2005 to be provided to such States (15 States) which will have deficit non-plan revenue account even after the devolution of central tax revenues, equal to the amount of deficits assessed during the period 2000-2005. e) With regard to the Calamity Relief Funds in States with an aggregate size of Rs.11007.59 croreduring 2000-05. - The tax devolution from the Centre to the State should not exceed 37.5 per cent of total Centre’s revenues this should be inclusive of the Central taxes/duties to States and grants-in-aid to States. The FC recommended that each State be given a share as specified the net proceeds of all shareable union taxes and duties except the expenditure tax and service tax. Data for percentage share for certain states is Bihar-14.597, Maharashtra-4.632, Kerala-3.057, Uttar Pradesh-19.798, Punjab-1.147

• The Twelfth Finance Commission of India

Introduction

The Twelfth Finance Commission was appointed on 1 November 2002 to make recommendations on the distribution of net proceeds of sharable taxes between union and states. The commission was headed by veteran economist of India, C. Rangarajan. The commission submitted its report on 30 November 2004 and covered the period from 2005 to 2010.

Major Recommendations of 12th Finance Commission

(a) Macro-economic stability

The total Fiscal Deficit for Centre & states to be reduced to 3% of GDP and The total tax-gdp ratio of both centre& states to be increased to 17.6% of gdp in 2009-10. The revenue deficit for the centre& states combined to be reduced to 0% by 2008.

(b) Distribution of Union Tax

The total share of states in the total sharable central taxes to be fixed at 30.5% and the share of states will come down to 29.5% if the states levy sales tax on sugar, textiles & tobacco.

(c) Grants to local bodies

The total grant that will have to given to the states for panchayati raj institutions and local urban bodies for the period of 2005-09 will be Rs 20000 crores& Rs 5000 crores respectively.

(d) Calamity Relief Fund

The calamity relief fund scheme will continue as it was in the previous plans with central & states contributing in the ratio of 75: 25. The size of fund will be Rs 21333 crore for the period of 2005-10.

(e) Grant in aids to the states

For the period of 2005-10, the total non-plan revenue deficit grant of Rs 56856 crores is recommended to 15 states and the total grant of Rs 10172 is recommended for 8 educationally backward states.A grant of Rs 15000 crores is recommended for building roads & bridges which is in addition to the normal expenditure of the states while the grants that is recommended to the states for maintenance of public buildings, forests, heritage conversation and specific needs of states is Rs 500 crore, Rs 100 crore, Rs 625 crore & Rs 7100 crore.

Terms of Reference

The commission shall make recommendations on the following matters:

(1) The distribution of net proceed of taxes between union and states which are to be divided under chapter 1 part 12 of the constitution.

(2) The policies required to increase the consolidated fund of states on the basis of recommendation made by the finance commission of states to supplement the resources of municipalities and panchayats in the state.

In making the recommendation, the commission shall have its regard, among other considerations to :

(1) The resources of the union government and state government for five years starting from 1 April 2005 on the basis of the total tax and non-tax that it will likely to receive by the end of 2003-04.

(2) The demand of the resources by the central government, in particular the need of expenditure on civil administration, internal security, defence, debt servicing and other committed expenditure and liabilities.

• Major Recommendations of 13th Finance Commission

1. The share of states in the net proceeds of the shareable Central taxes should be 32%.This is 1.5% higher than the recommendation of 12th Finance Commission.
2. Revenue deficit to be progressively reduced and eliminated, followed by revenue surplus by 2013-14.
3. Fiscal deficit to be reduced to 3% of the GDP by 2014-15.
4. A target of 68% of GDP for the combined debt of centre and states.
5. The Medium Term Fiscal Plan(MTFP)should be reformed and made the statement of commitment rather than a statement of intent.
6. FRBM Act need to be amended to mention the nature of shocks which shall require targets relaxation.
7. Both centre and states should conclude 'Grand Bargain' to implement the model Goods and Services Act(GST).To incentivise the states, the commission recommended a sanction of the grant of Rs 50000 crore.
8. Initiatives to reduce the number of Central Sponsored Schemes(CSS)and to restore the predominance of formula based plan grants.
9. States need to address the problem of losses in the power sector in time bound manner.