India to be a “Union of States”. In effect, India is a federation consisting of one National or Union Government and a number of Governments of the federating units such as the states and the Union Territories.
In such a composite polity, it is essential that the financial resources should be divided between the Union Government and the government of the federating units.
The Finance Commission of India was formed on 22nd November, 1951. The Finance Commission has been provided for by the Indian constitution as part of the scheme of division of financial resources between the two different sets of governments.
- The role Finance Commission in India is to act as an instrument to divide proceeds of divisible taxes between the states and the Union government or in cases of taxes that are collected by the centre but the proceeds of which are allocated between the states, to determine the principles of such allocation.
- The Finance commission of India also determines the principles of governing the grants-in-aids of the revenues of states out of the consolidated fund of India. It is an important function of the Indian Finance Commission.
- Thirdly the commission has the duty of considering any matter referred to the commission by the President in the interest of sound finance.
The President under Article 280 lays the recommendations of the finance commission before each House of the Parliament with an explanatory note as to the action to be taken on the recommendations.
It should be noted that chapter XII, Article 280 of the Indian constitution do not exhaust the entire gamut of financial relations between the Union and the States. The Finance Commission distributes of proceeds of Income tax between the union and the states. But, taxes on the emoluments of the central government are attributable only to the union territories.
Under Article 280 (C), the President may refer any matter to the Finance commission in the interest of “sound finance.” Till now the President of India has asked the commission to make recommendations on the principles governing distribution of the net proceeds of estate duty in respect of property Tax on Railway fare and excise duties on sugar and tobacco etc. The President also sought recommendations on the rates of interest, and terms of repayment of loans to the various states by the government of India.
Till now, fourteen Finance Commissions have made their recommendations. They focus on the financial relations between the State government and the Central government. These recommendations steadily increase share of the state governments in the proceeds of the income tax. They also increased gradually the amount of grants-in-aids to be given to the states. As a result the states now enjoy considerable degree of financial autonomy so necessary for the proper functioning of the federation.
The Chairman of the Fourteenth Finance Commission is Dr. Y.V. Reddy. He previously held the prestigious position of the Governor of Reserve Bank of India (RBI). The Fourteenth Commission has given more importance on demographic transition. It has also recommended that the government of coastal states should get appropriate share of taxes collected from the production of minerals of territorial waters.
The Finance Commission as an autonomous body has served a splendid purpose. In as complex a polity as India is, it acted as an agency to bring about co-ordination and co-operation that is so important in the working of a federal system.
Category: Important Commissions in India
As has been pointed out earlier, the constitutional requirements of setting up a Finance Commission is an original idea. According to this, the President should, within two years from the inauguration of the Constitution and thereafter on the expiry of every fifth year or at such earlier intervals as he thinks necessary, constitute a Finance Commission.
The Commission will consist of a Chairman and four other members who are all to be appointed by the President. As the Commission has to be constituted at regular intervals, a certain measure of continuity in the work of these Commissions is ensured. And each Commission profits by the work of its predecessors.
According to Article 280, the Finance Commission has to make recommendations to the President on two specific matters and on "any other matter referred to the Commission by the President in the interests of sound finance."
The two specific matters are:
(i) The distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them and the allocation between the States of the respective shares of such proceeds; and
(ii) The principles which should govern the grant-in-aid of the revenues of the States out of the Consolidation Fund of India.
The Constitution makes it mandatory under Article 270 to divide taxes on income other than agricultural income between the Union and the States. For this purpose, taxes on income exclude corporation tax and any surcharge which may be levied for Union purposes.
To the extent that the proceeds of taxes in income represent proceeds attributable to Union Territories or to taxes payable in respect of Union emoluments, they are retained by the Union.
The Constitution also contains in Article 272 an enabling provision under which, if Parliament so prescribes by law, Union duties of excise other than duties of excise on medicinal and toilet preparations may be divided.
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. Parliament is not a directly concerned with the assignment and distribution of income-tax.
Article 275 deals with the grants-in-aid of the revenues of the State. These grants-in-aid are to be provided by law of Parliament; but clause (2) of this Article states that until provision is made by law, the President may exercise this power by order.
His power is, however, conditioned by the proviso "that after a Finance Commission has been constituted no order shall be made under this clause by the President except after considering the recommendations of the Finance Commission."
No reference to the Commission is necessary, if the grants-in-aid are provided by the law of Parliament or if the President considers that no State is in need of assistance. The President did, however, refer the matter to all the Finance Commissions for their recommendations.
Under Article 280(3) (b) the Finance Commission has the duty of making recommendations "to the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India."
Under Article 280(3) (c) the President may refer to the Commission any matter which he considers to be in the interests of sound finance. Under this provision, they were asked to make recommendations as to the principles which should govern the distribution, among the States, of the net proceeds in any financial year of
(a) The estate duty in respect of property other than agricultural land;
(b) The tax on railway fares; and
(c) The additional duties of excise on mill-made textiles, sugar and tobacco (including manufactured tobacco), to be levied in replacement of the sales taxes and those articles.
In case of the last item, the Commission had been asked to recommend the amount which should be assured to each State as the income now derived by it from the levy of the sales taxes on these commodities.
The importance of the Finance Commission as a constitutional instrument capable of settling many complicated financial problems that affect the relationship of the Union and the States may be seen from the recommendations of the last eleven Commissions.
The present system of allocation of finance between the Union and the States is almost entirely the result of these recommendations,
The chief merit of the work of the Commission lies in its impartial and objective outlook as a steadying force in the finances of the federal system and its ability to take the question of distribution of finances out of the vortex of federal State political pressures and controversies.
In fact, the Commission acts as a buffer between the Union and the States, checking the clamorous, finance- hungry States bent upon applying their political pressure on the Union, and, at the same time, ma'' the latter give as much as possible to the needy States. It will be almost impossible for the Union to go against the recommendations of the Commission.
The Constitution also embodies a number of special provisions which seek to establish a certain amount of immunity from taxation by the State Governments on the income and property of the Union and vice versa. Further it contains several detailed provisions dealing with miscellaneous financial matters.
To examine the financial relations between the Union and the States is indeed to traverse difficult terrain. The provisions are detailed, often expressed in difficult and clumsy legal terminology. Moreover, almost every general proposition is qualified or modified by exceptions or limitations.
Nevertheless, these detailed provisions have one solid merit, that of eliminating the possibility of much litigation which has been the bane of the older federations.
Critics of the bulkiness of the Constitution should take special note of this. It is a striking feature of the working of the Constitution that the volume of litigation in this field has been negligible.
Thus, the financial provisions of the Constitution have on the whole avoided the pitfalls of other federal Constitutions. This has been achieved by sharply demarcating the tax jurisdictions of each authority Union and State in order that conflicts in the concurrent zone of tax jurisdiction may not arise.
The Constitution has not followed the simple dichotomy of direct and indirect tax commonly followed in some federations. Both direct and indirect taxes have been allocated to the Union and the States.
The rationale of the division is the fundamental principles of federal finance, namely, efficiency and suitability. The principle of adequacy has been met by the provision dealing with federal grants- in-aid.
The framework of the entire financial fabric is based upon the assumption of Union-State co-ordination, so that the fiscal relations between the Union and the States may be harmonious.
Viewing the Union-State relationship in the financial field as a whole, one finds that it is in harmony with the general nature of Indian federalism, namely, the tendency for centralisation.
The Union Government is financially stable and stronger than the State Governments. This was necessary to facilitate the planned development of the country as a whole and to check parochial and even separatist tendencies in the economic activities within individual States.
As it is, the States are, in view of their limited resources, bound to look up to the Union for financial aid for most if not all developmental projects. Naturally, they will have to follow the lead of the Union and often even submit to its dictation.
This is not a happy situation from the point of view of the States. Perhaps in the initial stages of development of India as a new politically independent country (after 1947) this was necessary both to ensure the unity of the nation and the balanced development of the different regions.
But during the last five decades the pattern of Indian economy has undergone considerable change. The States today feel that if they have to pursue their developmental objectives satisfactorily, they should have greater financial resources.
And this is possible only if either the Centre gives them a larger share of the Central revenues or allowing them to have more taxation powers, if necessary, through constitutional amendment.
It is not likely that the Centre would agree with either of these demands readily. But there is indication to believe that these demands are bound to gather momentum and strength in the days to come.
Financial relations between the Union and the States, especially in a developing economy, cannot remain static for long. Adjustments will have to be made in the light of the changing pattern of the economy.
Legislative enactments on taxation cannot be made for all time to come. After all, the relationship between the Central Government and the States in a federal system is a dynamic one; and the problems arising out of this relationship cannot be solved once for all any more than the problems of life itself.
The appointment of the Sarkaria Commission, (1983) to go into the entire question of Centre-State relations and make appropriate recommendations is significant in this context and was a step in the right direction.
The Commission's recommendations have been widely welcomed by different sections of public opinion in the country but not much has yet been done to implement them.