FINANCE COMMISSION fiscal federalism

fiscal federalism and tax devolution



CONSTITUTIONAL OBLIGATION - The Finance Commission is a constitutional body formed by the President of India, under provisions of Article.280, having 5 members including the chairman to provide suggestions on,

  1. Distribution of the net proceeds of taxes between the Union and the States.
  2. Principles which should govern the grants in aid to the states.
  3. Any other matter referred to the Commission by the President.


Over and above the above, the FC also recommends grants to states based on revenue needs, grants for local governments and grants for specific purposes e.g. health sector grants etc. Thus, there are two broad channels of transfer of funds under the FC umbrella – i) devolution of taxes, and ii) grants.

Other transfers of money, whether they are through FC grants, or through channels outside the FC (like schemes from central government ministries) impose policy priorities set by the central government over the state governments, compromising the latter’s fiscal flexibility or the ability to spend money as the state government deems fit.

FINANCE COMMISSION changing policies journey so far


The Constitution stipulates tax collection and split principle between the central government and the state governments. Apart from above the central government as well as the state governments to raise revenues from different sources of taxation.

The central government gets to collect more taxes while the state governments end up with the bigger portion of the expenditure, leading to a mismatch.

Only those taxes that form part of divisible pool are shared with the states. What this means is that all the taxes collected by the central government aren’t shareable with the state governments.

  • Till 1995, only union excise duties and personal income taxes made up the divisible pool – till the tenth FC which tabled its report in 1995, only union excise duties and personal income taxes made up the divisible pool. Under this arrangement, 85% of the personal income taxes and 40-45% of excise duties were shared with the state governments.
  • divisible pool expanded to include all central taxes - In 2000, the tenth FC recommended a constitutional amendment to expand the divisible pool to all central taxes. The central government accepted this recommendation and the 80th Amendment was passed making a certain portion of  central government taxes shareable with the state governments, effective retrospectively from April 1, 1996.
  • Till 2015, 32% of the divisible pool was shared with the states.
  • The 14th FC increased the share of the state governments in the divisible pool to 42%. At the same time, the sector-specific grants were eliminated. This decision was primarily in response to grievances expressed by the state governments. State governments prefer funding through devolution since such transfers are unconditional.
  • Surcharges and cess increase from 10% in 2010-11 to 25% in 20222-23 over the last decade, which do not need to be shared with the state governments, have become 25% of all government tax revenues.
  • A cess is tax on a tax imposed by the central government attached to a specific purpose.
  • A surcharge is also a tax on a tax, but is not tied to a specific purpose like a cess.

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