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The Role of the Finance Commission in Fiscal Federalism
- The Law Gurukul
- Jul 3, 2025
- 2 min read
Introduction
Fiscal federalism refers to the division of financial powers and responsibilities between different levels of government—central and state—in a federal system. In India, the Finance Commission (FC) plays a crucial role in maintaining fiscal balance by recommending how financial resources should be distributed between the Union and the states. This blog explores the functions, significance, and challenges faced by the Finance Commission in strengthening India’s fiscal federalism.
What is the Finance Commission?
Established under Article 280 of the Indian Constitution, the Finance Commission is a quasi-judicial body formed every five years. Its primary role is to recommend:
Vertical Devolution – The share of central taxes that should be given to states.
Horizontal Distribution – How these funds should be allocated among different states.
Grants-in-Aid – Additional financial support to states in need.
The recommendations of the FC ensure that states have adequate resources to meet their development needs while maintaining fiscal discipline.
Key Functions of the Finance Commission
Tax Devolution – Determines the percentage of central tax revenue (like income tax, GST) to be shared with states.
Fiscal Equalization – Ensures that poorer states receive more funds to reduce regional disparities.
Grants-in-Aid – Recommends financial assistance to states facing revenue deficits or special needs.
Local Body Financing – Since the 11th FC, it also allocates funds to Panchayats and Municipalities.
Reviewing Fiscal Health – Assesses the financial condition of the Centre and states to suggest improvements.
Finance Commission and Fiscal Federalism
India’s federal structure requires a fair distribution of financial resources to ensure cooperative federalism. The FC acts as an arbitrator to:
Balance Central and State Interests – Prevents fiscal dominance by the Centre.
Promote Equity – Ensures backward states get more funds for development.
Encourage Fiscal Responsibility – Recommends measures to control deficits and debt.
Example: 15th Finance Commission (2021-26) Recommendations
Tax Devolution – 41% of central taxes to states (slightly reduced from 42% in the 14th FC).
Performance-Based Incentives – States rewarded for population control, ease of doing business, and power sector reforms.
Disaster Management Funds – Allocated ₹1.6 lakh crore for disaster preparedness.
Challenges Faced by the Finance Commission
Overlap with NITI Aayog – The NITI Aayog also recommends funds for states, creating confusion.
GST Impact – Since GST is a shared tax, its revenue fluctuations affect state finances.
Political Influence – Allegations of bias in fund allocation to certain states.
Fiscal Deficits – States demand more funds but struggle with debt management.
Conclusion
The Finance Commission is the backbone of India’s fiscal federalism, ensuring fair and efficient resource distribution. While it has strengthened cooperative federalism, challenges like GST implementation and political pressures need addressing. As India moves towards a more decentralized economy, the FC’s role will remain pivotal in maintaining fiscal stability and equitable growth.
What are your thoughts on the Finance Commission’s role? Should states have more financial autonomy? Share your views in the comments!
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