Recommendations of the 15th Finance Commission

Context: The report of the Fifteenth Finance Commission, along with an Action Taken Report, was recently tabled in Parliament.

Relevance:
Prelims: Economic and Social Development Sustainable Development, Poverty, Inclusion, Demographics, Social Sector initiatives, etc.
Mains: GS-III 

• The Finance Commission is a Constitutionally mandated body that is at the centre of fiscal federalism.
• Under Article 280, of the Constitution, the President of India is required to constitute a Finance Commission at an interval of five years or earlier, its core responsibility is to evaluate the state of finances of the Union and State Governments, recommend the sharing of taxes between them, lay down the principles determining the distribution of these taxes among States.
• Its working is characterized by extensive and intensive consultations with all levels of governments, thus strengthening the principle of cooperative federalism.
• Its recommendations are also geared towards improving the quality of public spending and promoting fiscal stability.
• The first Finance Commission was set up in 1951 and there have been fifteen so far. Each of them has faced its own unique set of challenges.
• The Fifteenth Finance Commission was constituted on 27 November 2017 against the backdrop of the abolition of the Planning Commission (as also of the distinction between Plan and non-Plan expenditure) and the introduction of the goods and services tax (GST), which has fundamentally redefined federal fiscal relations.

• The Fifteenth Finance Commission (15th FC)’s ToR was unique and wide-ranging in many ways.
• The Commission was asked to recommend performance incentives for States in many areas like the power sector, adoption of DBT, solid waste management etc.
• Another unique ToR was to recommend a funding mechanism for defence and internal security.
• 15th FC’s Report is organised in four volumes:
  • Volume I and II, as in the past, contain the main report and the accompanying annexes.
  • Volume III is devoted to the Union Government and examines key departments in greater depth, with the medium-term challenges and the roadmap ahead.
  • Volume IV is entirely devoted to the States. We have analysed the finances of each State in great depth and have come up with State-specific considerations to address the key challenges that individual States face.
  • In total, main report has 117 core recommendations. Vol-III and IV has numerous suggested reforms for the Union ministries and State governments respectively.

Criteria for Devolution (compared to 14th FC):

Recommendation of the 15th Finance Commission of India that was tabled on 1st February 2021 are:

1. Maintaining vertical devolution at 41%:
   • It has recommended maintaining the vertical devolution at 41% the same as in the report for 2020-21.
   • It would help in maintaining predictability and stabilizing the resources, especially during COVID times.
   • It is at the same level of 42% of the divisible pool as recommended by 14th FC. However, it has made the required adjustment of about 1% due to the changed status of the erstwhile State of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir.
2. On GST:
   • GST accounts for 35% of the gross tax revenue of the Union.
   • GST accounts for around 44% of own tax revenue of the States.
   • On Gross Tax Revenue:
     • There is a drop of 1.7% points in the gross tax revenue after excluding GST cess collection in comparison to 2016-17 figures.
     • The impact of this drop could be seen in the tax devolution to states.
   • Gross Tax Revenue Assessment 2021-26:
     • It is expected to be 135.2 lakh crore, out of which the divisible pool is estimated to be 103 lakh crore.
3. On Horizontal Devolution:
   • The criteria and the weights assigned for horizontal devolution are:
     • Population: 15%
     • Area: 15%
     • Forest & Ecology: 10%
     • Income Distance: 45%
     • Tax and Fiscal Efforts: 2.5%
     • Demographic Performace: 12.5%
   • The commission has also re-introduced the tax effort criterion to reward fiscal performance.
4. On Revenue Deficit Grants (RDG):
   • Revenue deficit grants emanate from the requirement to meet the fiscal needs of the States on their revenue accounts that remain to be met, even after considering their own tax and non-tax resources and tax devolution to them.
   • Revenue Deficit is defined as the difference between revenue or current expenditure and revenue receipts, which includes tax and non-tax.
   • It has recommended post-devolution revenue deficit grants amounting to about Rs. 2.94 lakh crores over the five-year period ending FY26.
   • The number of states qualifying for the revenue deficit grants decreases from 17 in FY22, the first year of the award period to 6 in FY26, the last year.
5. Sector-specific grants:
   • Sector-specific grants of Rs 1.3 lakh crore will be given to states for eight sectors:
     1. health,
     2. school education,
     3. higher education, 
     4. implementation of agricultural reforms,
     5. maintenance of PMGSY roads, 
     6. judiciary,
     7. statistics, and
     8. aspirational districts and blocks.  A portion of these grants will be performance-linked.
6. State-specific grants:
   • The Commission recommended state-specific grants of Rs 49,599 crore. These will be given in the areas of:
     1. social needs,
     2. administrative governance and infrastructure, 
     3. water and sanitation,
     4. preservation of culture and historical monuments,
     5. high-cost physical infrastructure, and 
     6. tourism. 
   • The Commission recommended a high-level committee at the state-level to review and monitor utilisation of state-specific and sector-specific gran
7. Fiscal Space for Centre:
   • Total 15th Finance Commission transfers (devolution + grants) constitutes about 34% of estimated Gross Revenue Receipts to the Union, leaving adequate fiscal space to meet its resource requirements and spending obligations on national development priorities.
8. On Local Governments:
   • Rs. 4,36,361 crore is the total grant given to the local governments for the period of 2021-26. Out of the total grant; Rs.450 crore is dedicated to the shared municipal services. The grants to local bodies will be made available to all three tiers of Panchayat- village, block, and district.  
   • Grants to Rural Local Bodies:
     • A total sum of Rs. 2,36,805 crore is a grant for the rural local bodies. 
   • Grants to Urban Local Bodies:
     • Rs.1,21,055 crore is the total grant for the urban local bodies. 
     • Of these total grants, Rs. 8,000 crore is performance-based grants for incubation of new cities and Rs. 450 crore is for shared municipal services. 
     • Urban local bodies have been categorised into two groups, based on population, and different norms have been used for the flow of grants to each, based on their specific needs and aspirations.
     • Basic grants are proposed only for cities/towns having a population of less than a million. For Million-Plus cities, 100% of the grants are performance-linked through the Million-Plus Cities Challenge Fund (MCF).
     • MCF amount is linked to the performance of these cities in improving their air quality and meeting the service level benchmarks for urban drinking water supply, sanitation and solid waste management.
   • Grants for Health to be Channelised through Local Governments:
     • Rs. 70,051 crore stands for the Health grant to the local governments.
     • The health grants will be provided for:
       1. conversion of rural sub-centres and primary healthcare centres (PHCs) to health and wellness centres (HWCs),
       2. support for diagnostic infrastructure for primary healthcare activities, and
       3. support for urban HWCs, sub-centres, PHCs, and public health units at the block level. 
   • Grants to local bodies (other than health grants) will be distributed among states based on population and area, with 90% and 10% weightage, respectively. 
   • The Commission has prescribed certain conditions for availing these grants (except health grants). 
   • The entry-level criteria include:
     • publishing provisional and audited accounts in the public domain,
     • fixation of minimum floor rates for property taxes by states and improvement in the collection of property taxes (an additional requirement after 2021-22 for urban bodies). 
   • No grants will be released to local bodies of a state after March 2024 if the state does not constitute State Finance Commission and act upon its recommendations by then.
9. On Health:
   • The commission has suggested increasing the state expenditure on health by 8% by 2022.
   • The commission suggested prioritizing the creation of All India Health Services/All India Medical Services on the pattern of the UPSC Civil Services.
   • National Medical Council is suggested to develop small courses on wellness clinic, basic surgical procedures, anaesthesia, obstetrics and gynaecology, eye, ENT etc. for MBBS doctors.
   • AYUSH to be encouraged as an elective subject for medicine undergraduates.
   • The Allied and Healthcare Professions Bill should be passed at the earliest.
10. On Higher Education:
    • The 15th finance commission has recommended two subtypes of higher education grants:
    • Promotion of online education:
      • Rs. 5,078 crore is a total sum of grant for the promotion of online education.
    • Development of professional courses in regional languages:
      • The commission’s recommendation is in line with the New Education Policy 2020. Rs. 1,065 crore has been allocated for the development of these courses from 2021-26.
      • Two colleges in each state should convert their learning material and pedagogy into the recognized regional language.
11. On Defence:
    • Keeping in view the extant strategic requirements for national defence in the global context, 15th FC has, in its approach, re-calibrated the relative shares of Union and States in gross revenue receipts.
    • This will enable the Union to set aside resources for the special funding mechanism that 15th FC has proposed.
    • The Union Government may constitute in the Public Account of India, a dedicated non-lapsable fund, Modernisation Fund for Defence and Internal Security (MFDIS).
    • The total indicative size of the proposed MFDIS over the period 2021-26 is Rs. 2,38,354 crore.
12. On Disaster Risk Management:
    • The fifteenth finance commission recommended maintaining the contribution of states to the State Disaster Risk Fund (SDRF) to be 25% except by the NE States (10%)
    • It has seen no changes since the 13th Finance Commission recommended the same arrangement.
    • Creation of Mitigation Funds both at central and state levels. The Mitigation Fund should be used for those local level and community-based interventions which reduce risks and promote environment-friendly settlements and livelihood practices.
    •  
    • The 15th FC has recommended the total corpus of Rs.1,60,153 crore for States for disaster management for the duration of 2021-26, of which the Union’s share is Rs. 1,22,601 crore and States’ share is Rs. 37,552 crore.
    • It has recommended six earmarked allocations for a total amount of Rs. 11,950 crore for certain priority areas, namely,
    • two under the NDRF (Expansion and Modernisation of Fire Services and Resettlement of Displaced People affected by Erosion) and
    • four under the NDMF (Catalytic Assistance to Twelve Most Drought-prone States, Managing Seismic and Landslide Risks in Ten Hill States, Reducing the Risk of Urban Flooding in Seven Most Populous Cities and Mitigation Measures to Prevent Erosion).

Recommendations for fiscal roadmap

1. Fiscal deficit and debt levels
   • The Commission suggested that the centre bring down fiscal deficit to 4% of GDP by 2025-26. For states, it recommended the fiscal deficit limit (as % of GSDP) of:
     1. 4% in 2021-22,
     2. 3.5% in 2022-23, and
     3. 3% during 2023-26. 
   • If a state is unable to fully utilise the sanctioned borrowing limit as specified above during the first four years (2021-25), it can avail the unutilised borrowing amount (calculated in rupees) in subsequent years (within the 2021-26 period).
   • Extra annual borrowing worth 0.5% of GSDP will be allowed to states during the first four years (2021-25) upon undertaking power sector reforms including 
     1. reduction in operational losses,
     2. reduction in revenue gap,
     3. reduction in payment of cash subsidy by adopting direct benefit transfer, and 
     4. reduction in tariff subsidy as a percentage of revenue.
   • The Commission observed that the recommended path for fiscal deficit for the centre and states will result in a reduction of total liabilities of: 
     1. the centre from 62.9% of GDP in 2020-21 to 56.6% in 2025-26, and
     2. the states on aggregate from 33.1% of GDP in 2020-21 to 32.5% by 2025-26. 
   • It recommended forming a high-powered inter-governmental group to:
     1. review the Fiscal Responsibility and Budget Management Act (FRBM),
     2. recommend a new FRBM framework for the centre as well as states, and oversee its implementation.
2. Revenue mobilisation: 
   • Income and asset-based taxation should be strengthened. 
   • To reduce excessive dependence on income tax on salaried incomes, the coverage of provisions related to a tax deduction and collection at source (TDS/TCS) should be expanded. 
   • Stamp duty and registration fees at the state level have large untapped potential. 
   • Computerised property records should be integrated with the registration of transactions, and the market value of properties should be captured. 
   • State governments should streamline the methodology of property valuation.
3. GST:
   • The inverted duty structure between intermediate inputs and final outputs present in GST needs to be resolved. 
   • Revenue neutrality of GST rate should be restored which has been compromised by multiple rate structure and several downward adjustments. 
   • Rate structure should be rationalised by merging the rates of 12% and 18%. 
   • States need to step up field efforts for expanding the GST base and for ensuring compliance.
4. Financial management practices:
   • A comprehensive framework for public financial management should be developed. 
   • An independent Fiscal Council should be established with powers to assess records from the centre as well as states. The Council will only have an advisory role. 
   • A time-bound plan for phased adoption of standard-based accounting and financial reporting for both centre and states should be prepared while eventual adoption of accrual-based accounting is being considered. 
   • The centre as well as states should not resort to off-budget financing or any other non-transparent means of financing for any expenditure. 
   • A standardised framework for reporting contingent liabilities should be devised.
   • Both centre and states should strive to improve the accuracy and consistency of macroeconomic and fiscal forecasting.
   • States should amend their fiscal responsibility legislation to ensure consistency with the centre’s legislation, in particular, with the definition of debt. 
   • States should have more avenues for short-term borrowings other than the ways and means of advances and overdraft facility from the Reserve Bank of India. 
   • States may form an independent debt management cell to manage their borrowing programmes efficiently. 

Reliance on Solely 2011 Population Figures

• Sole reliance on the 2011 population figures would discriminate against states such as Kerala that have a better record of controlling population growth and reducing their share in the national population.
• It has added to the 2011 population figures a demographic criterion that favours states that have reduced fertility rates to lower levels.
• In the 14th FC’s recommendations, the 1971 population was given a 17.5% weight and the 2011 population a 10% weight when arriving at horizontal devolution figures.
• The 15th FC has dropped the 1971 consensus and given the 2011 population consensus a 10% weight and a fertility linked criterion a 12.5% weight.

Reduction in performance-based  grants

• Performance-Based Grants (PBGs) link performance in pre-determined areas with access to and size of funding, applying clear and transparent allocation formulas.
• The performance-based grants which were introduced by the Thirteenth Finance Commission earmarked 35% of local grants specifying six conditions for panchayats and nine for urban local governments and covered a wide range of reforms: from the establishment of an independent ombudsman to notifying standards for service sectors such as drinking water and solid waste management.
• The Fifteenth Finance Commission has reduced the performance-based grant to just ₹8,000 crore- and that too for building new cities, leaving out the Panchayati Raj Institutions (PRIs) altogether.
• The performance-linked grants were introduced by the Thirteenth Finance Commission and covered a wide range of reforms.
• The transformative potential in designing performance-linked conditionalities for improving the quality of decentralised governance in the context of different states is missed.

Missed opportunity to ensure minimum public services

• The Fifteenth Finance Commission failed to carry policy choices forward systematically.
• Articles 243G, 243W and 243ZD read along with the functional decentralisation of basic services like drinking water, public health care, etc., mandated in the Eleventh and Twelfth schedules demand better public services and delivery of ‘economic development and social justice at the local level.
• A good opportunity to ensure comparable minimum public services to every citizen irrespective of her choice of residential location has not been taken forward in an integrated manner.

Missing equalisation principle for the local government

• The Fifteenth Finance Commission claims that it seeks to achieve the “desirable objective of evenly balancing the union and the states”.
• It is not clear why there is no recognition of the third tier in this balancing act.
• It may be relevant to recall that the Alma-Ata declaration of the World Health Organization (1978) outlined an integrated, local government-centric approach with a simultaneous focus on access to water, sanitation, shelter and the like.
• There is no integrated approach in the recommendations of the Fifteenth Finance Commission about the local governments (in contrast to the recommendations of the Thirteenth Finance Commission).
• Although the Fifteenth Finance Commission stresses the need to implement the equalisation principle, it is virtually silent when it comes to the local governments.

Equity and efficiency sidelined

• The Fifteenth Finance Commission employed population (2011 Census) with 90% and area 10% weightage for determining the distribution of grant to States for local governments.
• The same criteria were followed by the Fourteenth Finance Commission.
• While this ensures continuity, equity and efficiency criteria are sidelined.
• Abandoning tax effort criterion incentivises dependency, inefficiency and non-accountability.

• A pair of balanced scales representing the Union of India and the States, the cover visual of the Fifteenth Finance Commission’s report for the period 2021-22 to 2025-26, seeks to highlight the Commission’s endeavour to maintain an equitable approach at a time when the Centre and States are facing unprecedented revenue stress and fiscal demands.
• The Centre has accepted much of the Commission’s broad recommendations, including giving States a 41% share of the divisible pool of taxes and revenue deficit grants of nearly ₹2.95-lakh crore for 17 States over the next five years.
• It has also acceded to the Commission’s suggestion to make grants towards urban and rural local bodies conditional upon States setting up their own finance commissions and publishing online the accounts of local bodies.
• And 60% of these grants will be further linked to these bodies’ providing sanitation and water services.
• There is an ‘in-principle nod to the panel’s suggestion to set up a non-lapsable dedicated fund to support defence and internal security modernisation- a response to the Centre’s belated request to examine if such a fund can be considered for funding defence Capex beyond normal Budget allocations.
• While the panel has suggested moving ₹1.53-lakh crore out of the Consolidated Fund of India over five years to partly finance this, the Centre has said the funding nitty-gritty will be examined later.
• States would monitor how the modalities here evolve, even as they have reason to fret about the Centre’s non-committal response to the Commission’s recommendations of sector-specific and other grants for them adding up to about ₹1.8-lakh crore.
• India lives in the States. If the Centre takes them along, it might help attain the balance envisaged by the Commission, which is needed to drive the country onto a double-engine growth trajectory from the current nadir.

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