Constitution of the Sixteenth Finance Commission

Constitution of the Sixteenth Finance Commission

    

The Government of India, in adherence to Article 280(1) of the Constitution, has established the Sixteenth Finance Commission, appointing Dr. Arvind Panagariya, former Vice-Chairman of NITI Aayog and Professor at Columbia University, as its Chairman.

• Specific terms of reference have been outlined, including the distribution of tax proceeds between the Union and States, principles governing grants-in-aid to States, and measures to bolster State funds for local bodies like Panchayats and Municipalities.
• The Commission has also been tasked with reviewing disaster management financing arrangements under the Disaster Management Act, 2005, and making recommendations for improvements.
• The Commission has been requested to make its report available by 31st October, 2025.

Why in News?

Recently, the Union Cabinet has given the green light to the terms of reference (ToR) for the Sixteenth Finance Commission.

• This commission holds the critical responsibility of recommending the formula for revenue distribution between the Centre and the States for the upcoming five-year period starting from April 1, 2026.

What are the Major Terms of Reference for 16th Finance Commission?

• Division of Tax Proceeds: Recommending the distribution of taxes between the Union Government and the States under Chapter I, Part XII of the Constitution.
  • This includes the allocation of shares among the States from these tax proceeds.
• Principles for Grants-in-Aid: Establishing the principles governing grants-in-aid to the States from the Consolidated Fund of India.
  • This encompasses determining the amounts to be provided to the States as grants-in-aid, specifically under Article 275 of the Constitution, for purposes beyond those outlined in the provisos to clause (1) of that article.
• Enhancing State Funds for Local Bodies: Identifying measures to enhance the Consolidated Fund of a State.
  • This is aimed at supplementing the resources available to Panchayats and Municipalities within the State, based on recommendations made by the State's own Finance Commission.
• Evaluation of Disaster Management Financing: The Commission may review the current financing structures related to Disaster Management initiatives.
  • This involves examining the funds created under the Disaster Management Act, 2005, and presenting suitable recommendations for improvements or alterations.

What is the Finance Commission?

• About:
  • The Finance Commission in India is a constitutional body established under Article 280 of the Indian Constitution.
    • Its primary function is to recommend the distribution of financial resources between the central government and the state governments.
  • The Fifteenth Finance Commission was constituted on 27th November, 2017. It made recommendations covering the period of six years commencing on 1st April, 2020 through its Interim and Final Reports.
    • The recommendations of the Fifteenth Finance Commission are valid up to the financial year 2025-26.
• Criteria for Devolution:

Criteria	14th FC (2015-20)	15th FC (2020-21)	15th FC (2021-26)
Income Distance	50.0	45.0	45.0
Area	15.0	15.0	15.0
Population (1971)	17.5	-	-
Population (2011)#	10.0	15.0	15.0
Demographic Performance	-	12.5	12.5
Forest Cover	7.5	-	-
Forest and Ecology	-	10.0	10.0
Tax and fiscal efforts*	-	2.5	2.5
Total	100	100	100

Note

'Population (1971)' was considered only for the 14th Finance Commission, while 'Population (2011)' and 'Tax and fiscal efforts' were introduced by the 15th Finance Commission. The figures represent the weightage in percentage for each criterion during the specified periods.

• Key Recommendations of 15th Finance Commission:
  • Share of States in Central Taxes: The Commission proposed maintaining the states' share in central taxes at 41% for the 2021-26 period, a slight reduction from the 42% allocated during 2015-20 by the 14th Finance Commission.
    • This 1% adjustment aims to accommodate the newly formed union territories of Jammu and Kashmir and Ladakh from the central resources.
  • Fiscal Deficit and Debt Levels: The Commission recommended that the Centre aims to limit its fiscal deficit to 4% of GDP by 2025-26.
    • For states, it advised specific fiscal deficit limits as a percentage of Gross State Domestic Product (GSDP) for different years within the 2021-26 period.
    • States not fully utilizing the sanctioned borrowing limits in the initial four years (2021-25) can access the remaining amount in subsequent years.
  • Other Recommendations:
    • Defense and Internal Security Funding: The report suggests establishing a Modernisation Fund for Defence and Internal Security (MFDIS), non-lapsable and funded primarily through the Consolidated Fund of India and other sources.
    • Centrally Sponsored Schemes (CSS): Recommendations include setting a threshold for annual CSS allocations, third-party evaluations, transparent funding patterns, and stable financial allocations to phase out redundant schemes.