FINANCE COMMISSION

Finance Commission of India is established by President of India as per Article 280 of the
constitution. The first finance commission was established in 1951. The Constitutional
requirement for setting up a Finance Commission in India was an original idea, not borrowed
from anywhere. That is why it is called the original contribution. Finance Commission also
serves a constitutional body for the purpose of allocation of certain resources of revenue
between the Union and the State Governments. It was established under Article 280 of the
Indian Constitution by the President of India. It was formed to define the financial relations
between the centre and the state.

Finance Commission of India was formulated with the purpose of allocation of resources
between the Union and the States. It is constituted by the President and all appointments to
the commission are made by him as well. Finance Commission of India was formed in the year
1951 under Article 280 of the Constitution of India. The Commission was structured according
to the world standards. The objective of forming the Finance Commission was to allocate
resources of the revenue between the Union and the State Governments in India adequately.

Article 280 reads: President should, within two years of commencement of the Constitution
and thereafter on expiry of every 5th year, or at such intervals as he/ she thinks necessary,
would constitute a Finance Commission.

Appointment: Formation of Finance Commission of India

The detailed set up and of the Finance Commission has been provided in Article 280 of the
Constitution of India. The Article states:

• The President shall, within two years from the commencement of this Constitution and
thereafter and at the expiration of every fifth year or at such time earlier time as the President
considers necessary, by order constitute a Finance Commission which shall consist of a
Chairman and four other members to be appointed by the President.

• Parliament may by law determine the qualification which shall be requisite for appointment
as members of the Commission and the manner in which they shall be selected.

• It shall be the duty of the Commission to make recommendations to the President as to the
distribution of the net proceeds of taxes which are to be, or may be divided between them
under this chapter and the allocation between the States of the respective shares of such
proceeds. It is also the duty of the Finance Commission to define the financial relations
between the Union and the State and it also caters to the purpose of devolution of non-plan
revenue resources.
Composition of Finance Commission of India
A Finance Commission would consist of a Chairman and 4 other members who are all will be
appointed by the President. The Finance Commission of India has a Chairman along with four
other members and a Secretary. The Chairman is the person who heads the Commission and
presides over its activities. The Indian Parliament is authorised to determine by law the
qualifications of the members of the Commission and method of their selection. The Chairman
of the Finance Commission is selected among persons who have had the experience of public
affairs, and four other members are selected among persons who- are, or have been, or are
qualified as judges of High Courts of India, or have knowledge of finance, or have vast
experience in financial matters and are in administration, or have knowledge of economics. All
the appointments are made by the Indian President. A member can be disqualified on the
following grounds- when a member is found to be of unsound mind, is involved in a vile act or if
his interests are likely to affect the functioning of the Commission.

The tenure of the office of the Member of the Finance Commission is specified by the President
of India and in some cases the members are also re-appointed. The members shall give part
time or whole time service to the Commission as scheduled by the President. The salary of the
members of the Finance Commission is according to the provisions led down by the
Constitution of India.

Powers, Functions and Responsibilities

Under the Constitution, the basis for sharing of divisible taxes by the Centre and the States and
the principles governing grants-in-aid to the states have to be decided by the Commission every
five years. The President can refer to the Commission any other matter in the interest of sound
finance. The recommendations of the Commission together with an explanatory memorandum
as to the action taken by the Government on them are laid before each house of Parliament.
The Commission has to evaluate the increase in the Consolidated Fund of a state to affix the
resources of the Panchayat in the state. It also has to evaluate the increase in the Consolidated
Fund of a state to affix the resources of the Municipalities in the state.

The Commission has been given adequate powers in the exercise of its function and within its
area of activity. It has all the powers of the Civil Court as per the Code of Civil Procedure, 1908.
It can call any witness, or can ask for the production of any public record or document from any
court or office. It can ask any person to give information or document on matters as it may feel
to be useful or relevant. It can function as a civil court in discharging its duties.
Functions
The Finance Commission is required to make recommendations to the president of India on the
following matters:

• The distribution of the net proceeds of taxes to be shared between the Centre and the states,
and the allocation between the states of the respective shares of such proceeds.

• The principles that should govern the grants-in-aid to the states by the Centre (i.e., out of the
consolidated fund of India).

• The measures needed to augment the consolidated fund of a state to supplement the
resources of the panchayats and the municipalities in the state on the basis of the
recommendations made by the state finance commission.

• Any other matter referred to it by the president in the interests of sound finance.

Till 1960, the commission also suggested the grants given to the States of Assam Bihar Orissa
and West Bengal in lieu of assignment of any share of the net proceeds in each year of export
duty on jute and jute products. These grants were to be given for a temporary period of ten
years from the commencement of the Constitution.

The commission submits its report to the president. He lays it before both the Houses of
Parliament along with an explanatory memorandum as to the action taken on its
recommendations.

Since the commission has to be constituted at regular intervals, a certain measure of continuity
in the work of these commissions is ensured. Each commission benefits by the work of previous
commission. Finance commission has to make recommendations to the President on two
specific matters and on any other mater referred to the commission by the president in the
interest of Sound Finance. The two specific matters are as follows: How the net proceeds of
taxes should be distributed between the Union and States? On what principles, the grants-in-
aid of the revenues of the State out of the Consolidated Fund of India should be give to needy
states? The President, after considering the recommendations of the Finance Commission with
regard to income tax, prescribes by order the percentages and the manner of distribution. So,
parliament is not directly concerned with the assignment and distribution of the income tax.

Impact of the Planning Commission

The Constitution of India envisages the Finance commission as the balancing wheel of fiscal
federalism in India. However, its role in the Centre-state fiscal relations has been undermined
by the emergence of the Planning Commission, a non-constitutional and a non-statutory body.
Dr P V Rajamannar, the Chair¬man of the Fourth Finance commission, highlighted the
overlapping of functions and responsibilities between the Finance Commission and the Planning
Commission in federal fiscal transfers in the following way. The reference in Article 275 to
grants-in¬ aid to the revenues of states is not confined to revenue expenditure only. There is no

legal warrant for excluding from the scope of the Finance Commission all capital grants; even
the capital requirements of a state may be properly met by grants-in-aid under Article 275,
made on the recommendations of the Finance Commission.

The legal position, therefore, is that there is nothing in the Constitution to prevent the finance
commission from taking into consideration both capital and revenue requirements of the states
in formulating a scheme of devolution and in recommending grants under Article 275 of the
Constitution. But the setting up of Planning Commission inevitably has led to a duplication and
overlapping of functions, to avoid which a practice has grown which has resulted in the
curtailment of the functions of the finance commission.

As the entire plan, with regard to both policy and programme, comes within the purview of the
Planning Commission and as the assistance to be given by the Centre for plan projects either by
way of grants or loans is practically dependent on the recommendations of the Planning
Commission, it is obvious that a body like the Finance Commission cannot operate in the same
field. The main functions of the Finance Commission now consist in determining the revenue
gap of each state and providing for filling up the gap by a scheme of devolution, partly by a
distribution of taxes and duties and partly by grants-in-aid.

Advisory Role
It must be clarified here that the recommendations made by the Finance Commission are only
of advisory nature and hence, not binding on the government. It is up to the Union government
to implement its recommendations on granting money to the states. To put it in other words, ‘It
is nowhere laid down in the Constitution that the recommendations of the commission shall be
binding upon the Government of India or that it would give rise to a legal right in favour of the
beneficiary states to receive the money recommended to be offered to them by the
Commission. As rightly observed by Dr. P.V. Rajamannar, the Chairman of the Fourth Finance
Commission, “Since the Finance Commission is a constitutional body expected to be quasi-
judicial, its recommendations should not be turned down by the Government of India unless
there are very compelling reasons.
Relevance of Finance Commission
The importance of the Finance Commission as a Constitutional instrument is capable of settling
many complicated financial problems that affect the relations of the Union and States. This is
evident from the recommendations of the last 14 finance Commissions appointed so far. Report
of Finance Commission in Parliament Article 281 says that President shall cause every
recommendation made by the Finance Commission under the provisions of this Constitution
together with an explanatory memorandum as to the action taken thereon to be laid before
each House of Parliament.

Recommendations
Finance Commission does not tell the Union Government on how to increase its funds. Its work
is to make recommendations on distribution between the Union and the States of the net
proceeds of taxes and the principles which should govern the grants-in-aid of the revenues of
the States out of the Consolidated Fund of India and the sums to be paid to the States which
are in need of assistance by way of grants-in-aid of their revenues.

Regarding States
Finance Commission suggests the measures needed to augment the Consolidated Fund of a
State to supplement the resources of the Panchayat and Municipalities in the State on the basis
of the recommendations made by the Finance Commission of the State.

On Panchayat and Municipalities

The role of the Finance Commission has widened after the 73rd and 74th Constitutional
amendments to recognise the rural and urban local bodies as the third tier of government.
Article 280 (3) (bb) and Article 280 (3) (c) of the Constitution mandate the Commission to
recommend measures to augment the Consolidated Fund of a State to supplement the
resources of Panchayats and Municipalities based on the recommendations of the respective
State Finance Commissions (SFCs). This also includes augmenting the resources of Panchayat
and municipalities.