Finance Commission of India
Let’s begin with a simple question —
“Who decides how the taxes collected by the Central Government are shared with the States?”
That crucial responsibility lies with the Finance Commission of India —
the body often called the “Balancing Wheel of Fiscal Federalism.”
⚖️ Constitutional Basis
The Finance Commission is established under Article 280 of the Constitution of India.
It is described as a quasi-judicial body, meaning:
- It is not purely administrative,
- Nor purely judicial,
- But a body that gives fair, reasoned, and balanced recommendations after considering all sides — especially the fiscal needs of the Centre and the States.
🕰️ Periodic Constitution
- The President of India constitutes the Finance Commission every five years,
or earlier if necessary. - Till now, 15 Finance Commissions have been set up (the 15th was chaired by N.K. Singh).
Each Commission submits a report recommending how the financial resources of India — mainly taxes and grants — should be distributed between the Union and the States.
👥 Composition of the Finance Commission
As per Article 280:
- Members
- It consists of a chairman and four other Members.
- All are appointed by the President of India.
- Tenure
- They hold office for the period specified by the President in the order of appointment.
- They are eligible for reappointment.
- Qualifications
Parliament has prescribed qualifications through law —
The Chairman should be a person with experience in public affairs, and the four Members must be chosen from the following fields:
| Field | Description |
| 1. Judiciary | A High Court judge or one qualified to be appointed as such |
| 2. Finance & Accounts | Specialized knowledge of government finance and accounts |
| 3. Administration | Wide experience in financial administration |
| 4. Economics | Special knowledge of economics |
⚙️ Functions of the Finance Commission
Article 280(3) specifies four key functions — let’s simplify each one:
1. Distribution of Taxes
It recommends:
- How the net proceeds of taxes are to be shared between the Centre and the States (called Vertical Devolution), and
- How the States’ share is to be divided among individual States (called Horizontal Distribution).
In short, “Who gets how much tax revenue?” — this is decided by the Finance Commission.
2. Grants-in-Aid to States
It recommends the principles governing the grants-in-aid that the Centre should provide to States from the Consolidated Fund of India,
mainly to support States with weaker finances.
3. Support to Local Bodies
Since the 73rd and 74th Amendments (1992) introduced Panchayats and Municipalities,
the Finance Commission now also recommends:
- Measures to augment the Consolidated Fund of each State
to supplement the resources of Panchayats and Municipalities,
based on the recommendations of the State Finance Commissions.
4. Other Financial Matters
The President may refer any other matter related to financial soundness or Centre–State fiscal relations to the Commission.
📝 Note:
Earlier, till 1960, the Finance Commission also recommended special grants to States like Assam, Bihar, Odisha, and West Bengal in lieu of their share in export duties on jute and jute products — this was transitional and lasted only ten years after the Constitution came into force.
📄 REPORT AND ACTION TAKEN
- The Finance Commission submits its report to the President.
- The President lays it before both Houses of Parliament,
along with an Action Taken Memorandum (ATM) — explaining what decisions were taken on its recommendations.
⚖️ Advisory Role of the Commission
This is very important for conceptual clarity.
The Finance Commission’s recommendations are advisory, not binding.
- The Union Government may accept or reject any part of the report.
- There is no legal right for any State to demand the money recommended by the Commission.
The Supreme Court clarified:
“It is nowhere laid down in the Constitution that the recommendations of the Finance Commission shall be binding upon the Government of India.”
However —
as Dr. P.V. Rajamannar, Chairman of the Fourth Finance Commission, rightly observed:
“Since the Finance Commission is a constitutional and quasi-judicial body, its recommendations should not be turned down by the Government unless there are very compelling reasons.”
In other words, even if not legally binding, the recommendations carry moral and constitutional weight.
⚖️ The Role in Fiscal Federalism
The Finance Commission plays a vital role in maintaining fiscal balance between the Centre and the States.
🧩 How?
- India is a Union of Unequal Units — some States are richer, some poorer.
- The Finance Commission ensures equitable distribution of national resources by using criteria like population, area, income distance, forest cover, etc.
Hence, it acts as the “Balancing Wheel of Fiscal Federalism.”
🧱 Finance Commission vs Planning Commission (Historical Context)
Before 2015, India also had the Planning Commission —
a non-constitutional, non-statutory body created by an executive resolution in 1950.
This led to overlapping roles:
- The Finance Commission handled statutory transfers (tax sharing, grants-in-aid).
- The Planning Commission handled plan transfers (financial assistance for development plans).
As a result, the Finance Commission’s role was somewhat undermined, as much of the fund flow to States came through the Planning Commission.
Dr. P.V. Rajamannar had criticized this overlap, saying that it blurred fiscal accountability between the Centre and the States.
In 2015, the Planning Commission was replaced by NITI Aayog (National Institution for Transforming India) —
a think tank that does policy coordination, not financial allocation.
This restored the Finance Commission’s central role in Centre–State fiscal relations.
🧠 In Simple Words
The Finance Commission is India’s constitutional referee for financial fairness.
It ensures that money collected by the Centre is fairly distributed among the States,
so that every part of India — rich or poor — can develop together.
Even though its recommendations are advisory, they form the moral and financial foundation of India’s fiscal federalism.