Introduction

In the Constitution, most broad-based taxes are assigned to the Union; the States are assigned taxes with lower buoyancy with the exception of tax on sale on purchase of goods. The States are assigned functional responsibilities which include law and order, land administration, agriculture, irrigation, education, health, industries, etc., which touch upon the lives of citizens.  Thus, there is a vertical imbalance between the financial powers and the functional responsibilities assigned to the States. . In addition to vertical imbalances, there are horizontal imbalances across States in terms of per capita income levels and other development indicators. To address these imbalances, Article 280 of the Constitution provides for the appointment of a Finance Commission within two years from the commencement of the Constitution and thereafter, at the expiration of every fifth year or earlier. 

The functions of the Finance Commission as mandated by the Constitution are to make recommendations on a) the distribution between the Union and the States of the net proceeds of union taxes, b) the distribution between the States of their respective shares and c) the principles which should govern grants-in-aid to the States.  Any other matter can be referred to the Commission by the President in the interests of sound finance.  Following the 73^rd and 74^th amendments to the Constitution in 1993, an additional mandate of recommending measures to augment the Consolidated Fund of a State to supplement the resources of panchayats and municipalities was assigned to the Finance Commission. 

The above constitutional mandates are reproduced as such in the Terms of Reference (ToR) of the Finance Commissions.  Over the years, there has been an expansion in the list of additional matters referred to the Finance Commission.  Though the stipulation of considerations that should govern the work of a Finance Commission was not envisaged in the Constitution, for the first-time considerations were inserted in the ToR of the second Finance Commission and over the years, there has been an expansion in the stipulation of considerations. So far, 15 Finance Commissions have been appointed. The recommendations of the Finance Commissions are normally given for a period of five years.  For vertical distribution of Union tax revenue, the Finance Commissions follow a normative approach to assess the expenditure needs and revenue raising capacities of the Union and the States.  In addition to tax devolution, the Finance Commissions have also been recommending revenue deficit grants to those States which are assessed to have deficits on their revenue accounts post tax devolution.  Finance Commissions also recommend grants for calamity relief, local bodies and for other purposes. 

Reports of the 13^th-15^th Finance Commissions 

1. 13^th Finance Commission
Explanatory Memoranda
The Thirteenth Finance Commission recommended an increase in the share of States in sharable Central taxes from 30.5 to 32 per cent.  For the purpose of inter-se distribution of tax devolution, the Commission assigned a weightage of 25 per cent to population, 10 per cent to area adjusted, 17.50 per cent to fiscal discipline and 47.50 per cent to fiscal capacity distance.

2. 14^th Finance Commission – Report
The Fourteenth Finance Commission adopted a path breaking approach to the vertical distribution of shareable taxes between the Union and the States. After taking into account the Constitutional provisions, functional and expenditure responsibilities of the Union and the States, increase in the share of non-divisible cesses and surcharges in the gross tax revenue of the Centre, transfers through Centrally Sponsored Schemes, plan and non-plan grants, the Commission expressed the view that tax devolution should be the primary channel of resource transfers to the States. Accordingly, the Commission recommended an increase in tax devolution from 32 to 42 per cent to serve the objectives of higher unconditional transfers to States and at the same time, maintaining the prevailing aggregate transfers to States at about 49 per cent of gross revenue receipts of the Centre. 
The higher tax devolution recommended by the Commission subsumes normal plan assistance, special plan assistance and also State and sector specific grants. The following criteria was adopted by the Commission for arriving at the inter-se shares of States in tax devolution. 

Criteria and Weights

Criteria	Weight (per cent)
Population	17.5
Demographic change	10.0
Income Distance	50.0
Area	15.0
Forest Cover	7.5

3. 15^th Finance Commission

• 15^th FC Report for 2020-21
• 15^th FC Report for 2021-26 (Complete Report)
  • Main Report Volume – I
  • Annexure Volume – II
  • Union Volume – III
  • The States Volume – IV
  • Explanatory Memorandum FC for 2021-26

Taking into account the global uncertainties, short-term transitional difficulties in the implementation of GST and slow down in the growth of the economy, the Commission submitted two reports, the first report for the year 2020-21 and the final report for the years 2021-26.  In its first report, the Commission recommended devolution of 41 per cent of the net proceeds of divisible pool of Union taxes taking into account that the State of Jammu & Kashmir had become a union territory.  The Commission recommended special grants to three States namely, Karnataka, Mizoram and Telangana as the Commission projected that the sum of tax devolution and revenue deficit grant would decline from 2019-20 to 2020-21 for these States.  However, this recommendation was not accepted by the Union Government. 

In its final report for the five-year period, the Commission retained tax devolution to States at 41 per cent of the divisible pool of Central taxes.  The criteria adopted by the Finance Commission for arriving at the horizontal distribution is as follows:

Criteria and Weights assigned for Horizontal Devolution

Criteria	Weight (percent)
Population	15.0
Area	15.0
Forest and ecology	10.0
Income Distance	45.0
Tax and fiscal efforts	2.5
Demographic performance	12.5
	100.0

Departing from the approach of the Fourteenth Finance Commission, the Fifteenth Finance Commission recommended State specific and sector Specific grants. This recommendation was not accepted by the Union Government.