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The Fourteenth Finance Commission (FFC) Major

Recommendations & Implications for Fiscal Federalism in India

Table of Content

1 The nature of shift ...................................................................................................................................... 2

2 Which states will gain? ............................................................................................................................. 3
3 Changed Equations ..................................................................................................................................... 3
4 Case of Bihar in the post FFC scenario ................................................................................................. 3
5 Restructuring of Centrally sponsored schemes(CSS) .................................................................... 3
6 FFC and Local Government ...................................................................................................................... 4
7 Amending FRBM (Fiscal Responsibility and Budget Management) Act .................................. 4
8 Pricing of Public Utilities ......................................................................................................................... 5
9 Balancing Fiscal Autonomy and Fiscal Space .................................................................................... 5
10 Conclusion ................................................................................................................................................. 5

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The Finance Commission is a Constitutional body formulated under Article 280 of the Indian Constitution. It is
constituted every five years by the President of India to review the state of finances of the Union and the States
and suggest measures for maintaining a stable and sustainable fiscal environment. It also makes
recommendations regarding the devolution of taxes between the Center and the States from the divisible pool
which includes all central taxes excluding surcharges and cess which the Centre is constitutionally mandated to
share with the States.
April 2015 to Mar 2020
The FFC has submitted its recommendations for the period 2015-16 to 2020-21.Some of the major
recommendations are as follows:

The FFC has radically enhanced the share of the states in the central divisible pool from the current
32 percent to 42 per cent which is the biggest ever increase in vertical tax devolution. The last two
Finance Commissions viz. Twelfth (period 2005-10) and Thirteenth (period 2010-15) had recommended a
state share of 30.5 per cent (increase of 1 percent) and 32 per cent (increase of 1.5 percent),
respectively in the central divisible pool.
The FFC has also proposed a new horizontal formula for the distribution of the states share in
divisible pool among the states. Relative to the Thirteenth Finance Commission, the FFC has
incorporated two new variables: 2011 population and forest cover; and excluded the fiscal discipline
variable.
The FFC has not made any recommendation Horizontal Devolution Formula in the 13th
concerning sector specific-grants unlike the and 14th Finance Commissions
Thirteenth Finance Commission.
Grants: Should be distributed to states for local Variable Weights accorded
bodies on the basis of the 2011 population data; the 13th 14th
grants be divided into two broad categories on the Population (1971) 25 17.5
basis of rural and urban population constituting Population (2011) 0 10
gram panchayats, and constituting municipal bodies Fiscal capacity/Income 47.5 50
distance
respectively.
Types of grants: A basic grant and a performance Area 10 15
Forest Cover 0 7.5
grant the ratio of basic to performance grant be Fiscal discipline
17.5 0
90:10, with respect to panchayats; and 80:20 in the Total
100 100
case of municipalities.
Rail Tariff Authority: Replacement of the advisory body with the statutory through required
amendments to the Railways Act 1989
Delinking of schemes: Eight centrally sponsored schemes (CSS) will be delinked from support from the
Centre; various CSS will now see a change in sharing pattern, with states sharing a higher fiscal
responsibility.

1 The nature of shift

The shift, however, as the distinguished chairman of the commission Y. V. Reddy has himself admitted, is
qualitative and not quantitative. In the aggregate, states have not gained and overall resources transferred to
them by the Centre have not increased. The seminal shift is in terms of composition of transfer.

This means that states will have more untied funds at their disposal and will be free to deploy them in the
manner they deem appropriate to their needs and concerns. Planning within states now assumes even greater
importance even if the Planning Commission has been abolished.

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2 Which states will gain?

States normally compare their shares with previous Finance Commissions to judge whether they have gained or
lost. Strictly speaking, this is not right because different Finance Commissions have used different formulae to
allocate the share of states to each individual state. The formula used in the Fourteenth Finance Commission is
not the same as that used by its predecessor and so the share of individual states cannot really be compared.

Reddys Commission, for instance, has given 7.5% weightage to forest cover, which had not been done by the
Thirteenth Finance Commission. As a result, some large states with low forest cover like Uttar Pradesh and Bihar
are complaining that their share in tax devolution has decreased. It has, but the basis for calculations has itself
undergone a change. Nevertheless, all the states stand to gain from FFC transfers in absolute terms.

3 Changed Equations

The FFC seeks to fundamentally alter the Centre-State funding patterns to give boost to the idea of
"cooperative federalism". For instance Central assistance for critical developmental programmes being
implemented by states relating to health, child development, education, rural drinking water, housing etc
has been reduced drastically by about Rs 75,000 crore in the budget for 2015-16..
However, the union government has argued that the reduction of Rs 75,000 crore in the central funding of
development programmes is more than compensated with the States receiving an additional Rs1,85,000
crore from the total taxes and duties collected by the Centre. The States will get an additional Rs1,00,000
crore on a net basis every year.
The States will have to show results on the ground while implementing their own exclusively designed
development programmes in health, education, agriculture, sanitation, housing and drinking water. In future
they cannot really complain that the Centre is not giving enough funds for these programmes.
One apprehension is what if regional leaders resort to wasteful expenditures like laptops distributed by the
UP government some years ago. Another argument is crony capitalism and corruption is far more rampant in
State politics which does not even get captured by the CAG which is mostly focused on big cases of Central
corruption.

4 Case of Bihar in the post FFC scenario

Bihars inter se share in the FFC award, compared to the Thirteenth Finance commission, has declined, the flow
of resources to that extent would be lower for Bihar during the FFC award period. However, there has been an
absolute increase in tax devolution to Bihar to the tune of more than Rs 12,600 crore in the fiscal year 201516
due to the increase in vertical devolution to 42%.

5 Restructuring of Centrally sponsored schemes(CSS)

In the last decade, the proliferation of big-ticket CSS has emerged as the key fiscal strategy to transfer grants
to States. The States having to fund these schemes with a higher matching contribution. And, they may have
to bear the same burden of CSS conditionalities, reducing fiscal autonomy and the available untied fiscal
space.
Restructuring is not only important from the perspective of State finances. It is also about getting the
expenditure priorities right for both the Union and the State governments. Therefore FFC recommend Eight
centrally sponsored schemes (CSS) to be delinked from support from the Centre and various CSS will now
see a change in sharing pattern, with states sharing a higher fiscal responsibility.
As articulated in the 14th commissions report, between 2002-05 and 2005-11, revenue expenditure by the
Union Government on State List subjects increased from an average of 14 per cent to 20 per cent, and on
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 Concurrent List subjects from an average of 13 per cent to 17 per cent. This implies a reduction in
expenditure, in percentage terms, on Union List subjects.
The Union government should move its focus from spending on overlapping functional domain to subjects
that squarely fall in the functional domain of the Union, as in the Union List, and limit its intervention on the
State List and Concurrent List on subjects of national priority having a consideration of externality.

6 FFC and Local Government

The FFC has given the refreshing title local governments as against local bodies used by the previous
commissions to the chapter dealing with grants to the third tier of government.
The 14th FC has given due consideration to the fiscal federalism framework in India by devolving a larger
amount to local governments. The 14th FC has recommended a grant-in aid for local governments that is
equal to an estimated 3% of the divisible pool. This is higher than the recommended allocation of 2.5% by
the 13th FC.

Equity is and should be the overarching concern of any federal polity worth the name. It is the underlying
rationale for federalism. For inter se distribution of local government grants to the states, the FFC uses the
2011 population with weight of 90% and area 10%. The choice of 2011 population has adversely affected
states like Kerala, Tamil Nadu etc. who have undertaken family planning to contain population.
The effort of the Thirteenth Finance Commission to divide local government grants into basic unconditional
grants and conditional performance grants was meant to incentivise the laggards. To avail of performance
grants, the PRIs had to fulfill six conditionalities and urban local bodies nine. The FFC has not only reduced
the share of performance grants to 10% from 34%, the conditionalities are also made less demanding.

7 Amending FRBM (Fiscal Responsibility and Budget Management)

Act

FFC recommended that the Union Government should consider making an amendment to the FRBM Act to
omit the definition of effective revenue deficit from 1 April 2015.
It recommended an amendment to the FRBM Act inserting a new section mandating the establishment of an
independent fiscal council to undertake ex-ante assessment of the fiscal policy implications of budget
proposals and their consistency with fiscal policy and Rules. In addition, the Union Government take
expeditious action to bring into effect Section 7A of the FRBM Act for the purposes of ex-post assessment.
FFC recommended that the State Governments may amend their FRBM Acts to provide for the statutory
flexible limits on fiscal deficit.

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8 Pricing of Public Utilities

FFC recommended that 100 per cent metering be achieved in a time-bound manner for all electricity
consumers as already prescribed statutorily. The Electricity Act, 2003, currently does not have any provision
of penalties for delays in the payment of subsidies by State Governments. Therefore, the Act be
suitably amended to facilitate levy of such penalties.
In order to provide financial autonomy to the SERCs, the Electricity Act, 2003, provides for the establishment
of a State Electricity Regulatory Commission Fund by State Governments.The FFC reiterated the importance
of financial independence of the SERCs and suggested all States to constitute a SERC Fund, as statutorily
provided for.
It endorse the initiative to set up a Rail Tariff Authority (RTA) .The RTA is expected to lead an era of
rationalisation of fares and freight structures for improving the fare-freight ratio and gradually brining down
cross subsidisation between different segments.
It recommend the setting up of independent regulators for the passenger road sector whose key functions
should include tariff setting, regulation of service quality, assessment of concessionaire claims, collection
and dissemination of sector information, service-level benchmarks and monitoring compliance of concession
agreements.
It endorsed that all States, irrespective of whether Water Regulatory Authorities (WRAs) are in place or not,
consider full volumetric measurement of the use of irrigation water. FFC reiterated the recommendations of
the FC-XIII and urge States which have not set up WRAs to consider setting up a statutory WRA, so that the
pricing of water for domestic, irrigation and other uses can be determined independently and in a judicious
manner.

9 Balancing Fiscal Autonomy and Fiscal Space

The spirit behind the FFC recommendations is to increase the automatic transfers to the states to give them
more fiscal autonomy .There is concern that fiscal space or fiscal consolidation path of the Centre would be
adversely affected. However, to ensure that the Centres fiscal space is secured, the suggestion is that there will
be commensurate reductions in the Central Assistance to States (CAS) known as plan transfers.

The Economic Survey 2014-15 notes that CAS transfers per capita are only mildly progressive. This is a
consequence of plan transfers moving away from being Gadgil formula-based to being more discretionary in the
last few years. Greater central discretion evidently reduced progressivity. A corollary is that implementing the
FFC recommendations would increase progressivity because progressive tax transfers would increase and
discretionary and less progressive plan transfers would decline.

10 Conclusion

The FFC has made far-reaching changes in tax devolution that will move the country toward greater fiscal
federalism, conferring more fiscal autonomy on the states. This will be enhanced by the FFC-induced imperative
of having to reduce the scale of other central transfers to the states. In other words, states will now have greater
autonomy on the revenue and expenditure fronts.

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 VISION IAS
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14th Finance Commission and Fiscal Transfer

I feel more and more that we must function more from below than from the top too much of centralization
means decay at the roots and ultimately a withering of branches, leaves and flowers.

Pandit Jawaharlal Nehru

We want to promote co-operative federalism in the country. At the same time, we want a competitive
element among the states. I call this new form of federalism Co-operative and Competitive Federalism

Prime Minister Narendra Modi

Fundamentals Of Finance Commission

The Finance Commission is a Constitutional body formulated under Article 280 of the Indian Constitution. It is
constituted every five years by the President of India to review the state of finances of the Union and the States
and suggest measures for maintaining a stable and sustainable fiscal environment.

Functions

1. Distribution of net proceeds of taxes between Centre and the States, to be divided as per their
respective contributions to the taxes.
2. Determine factors governing Grants-in Aid to the states and the magnitude of the same.
3. To make recommendations to president as to the measures needed to augment the Consolidated Fund
of a State to supplement the resources of the panchayats and municipalities in the state on the basis of
the recommendations made by the Finance Commission of the state.

Composition

The Chairman of the Finance Commission is selected among people who have had the experience of public
affairs. The other four other members are selected from people who:

1. Are, or have been, or are qualified, as judges of High Court, or

2. Have knowledge of Government finances or accounts, or
3. Have had experience in administration and financial expertise, or
4. Have special knowledge of economics

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Procedure and Powers of the Commission

The Commission has the power to determine their own procedure and has all powers of the civil court as per the
Court of Civil Procedure, 1908. Hence, it can

1. summon and enforce the attendance of any witness or ask any person to deliver information or produce
a document, which it deems relevant.

2. Ask for the production of any public record or document from any court or office.

Terms Of Office Of Members

Every member will be in office for the time period as specified in the order of the president, but is eligible for
reappointment provided he has, by means of a letter addressed to the president, resigned his office.

Salaries and Allowances of the members

The members shall be paid Salaries and Allowances as per the provisions made by the Central Government.

14th Finance Commission Recommendations

The Fourteenth Finance Commission (FFC) was appointed on 2nd January, 2013under the chairmanship of Dr. Y.
V. Reddy. The major recommendations given by FFC are shown in the image below:

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 42% + 3% Grants in aid for local government

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Changes From The 13th Finance Commission

1. Increase In Share Of Divisible Pool

The FFC has radically enhanced the share of the states in the central divisible pool from the current
32 % to 42 % which is the biggest ever increase in vertical tax devolution.
The last two Finance Commissions viz. 12th and 13th had recommended a state share of 30.5 %
(increase of 1 %) and 32 % (increase of 1.5 %), respectively in the central divisible pool.

2. New Horizontal Formula

The FFC has also proposed a new horizontal formula (Shown in Table below )for the distribution of
the states share in divisible pool among the states. There are changes both in the variables
included/excluded as well as the weights assigned to them.
Relative to the 13th FC, the FFC has incorporated two new variables: 2011 population and forest
cover; and excluded the fiscal discipline variable.

Fiscal Capacity/Income Distance Fiscal Discipline

The income distance criterion was first used by
12th FC, and it implicitly applies a single average
tax-to-GSDP ratio to determine fiscal capacity
distance between states. The 13th FC changed the
formula slightly
and recommended the use of separate averages
for measuring tax capacity, one for general
category states (GCS) and another for special
category states (SCS).
Fiscal discipline as a criterion for tax devolution
was used since 11th FC to provide an incentive to
states managing their finances prudently. The
index of fiscal discipline is arrived at by comparing
improvements in the ratio of own revenue
receipts of a state to its total revenue expenditure
relative to the corresponding average across all
states.

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Implications Of FFC Recommendations For Fiscal Federalism

1. Increase In Total Transfer

The total increase in FFC transfers in FY2015-16 from FY2014-15 is estimated to be about 2 lakh crores
(both from tax devolution and FFC grants).

2. Distributional Effects On States

All states stand to gain from FFC transfers in absolute terms. However, to assess the
distributional effects, the increases should be scaled by population, Net State Domestic Product
(NSDP) at current market price, or by states own tax revenue receipts.
The biggest gainers in absolute terms under GCS are UP, West Bengal and MP while for SCS it is
J&K, HP, and Assam. A better measure of impact is benefit per capita.
The major gainers in per capita terms turn out to be Kerala, Chhattisgarh and MP for GCS and
Arunachal Pradesh, Mizoram and Sikkim for SCS.
The FFC transfers have more favorable impact on the states (only among the GCS) which are
relatively less developed which is an indication that the FFC transfers are progressive i.e. states
with lower per capita NSDP receive on average much larger transfers per capita.
The significant impact due to increase in the divisible pool is on states like UP, Bihar, MP, West
Bengal and Andhra Pradesh (United) while states like Arunachal Pradesh, Chhattisgarh, MP,
Karnataka and Jharkhand are the major gainers due to a change in the horizontal devolution
formula which now gives greater weight to a states forest cover.

3. Fiscal Autonomy Of State Increased

The spirit behind the FFC recommendations is to increase the automatic transfers to the states to
give them more fiscal autonomy, and this is ensured by increasing share of states from 32 to 42 %
of divisible pool which will increase the flow of untied resources (or resources transferred without
condition) to States.
Estimates show that post the 14th commission award, the untied statutory transfers would be
more than 70 % of the aggregate resource transfers from the Union to the States.

4. Fiscal Space Of Centre - Not Much Affected

There is concern that fiscal space or fiscal consolidation path of the Centre would be adversely
affected as Centre has to shed 42% of the share. However, it must be realized that there is no
significant rise in the devolution as there will be commensurate reductions in the Central
Assistance to States (CAS) known as plan transfers.
The Centre should not have much difficulty in meeting its fiscal consolidation plan as the actual
increase in tax devolution to states is only 3 to 4 %.
Thus, there is more like a qualitative shift to the States, rather the quantitative shift.

5. Impact On Centrally Supported Schemes

A major issue, post Budget 2015-16, is the sharp decline in allocations to the social sector in the
form of various conditional grants to the States. This decline has happened to accommodate a
large increase in tax devolution. As per the Budget estimates, enhanced tax devolution should

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 result in an increase in the flow of untied funds to the tune of Rs.1,86,150 crore and a reduced
flow of grants to the tune of Rs.87,730 crore.

This decline in grants has happened in two categories: in a specified list of schemes where the
Centres contribution has been reduced, implying a corresponding increase in contribution by the
States and for a set of schemes where Central support has been withdrawn. Important schemes in
the first category are the RKVY, the ICDS, Swachh Bharat Abhiyaan and allocation for elementary
education under the MDM and the SSA. Major schemes delinked from Central support are the
JNNURM, the BGRF and Normal Central Assistance.

This change in the structure of grants has also to be viewed in the context of a restructuring of
Centrally Sponsored Schemes (CSS), which is a right step.

Conclusion

FFC has made far-reaching changes in tax devolution that will move the country toward greater fiscal
federalism, conferring more fiscal autonomy on the states. This will be enhanced by the FFC-induced imperative
of having to reduce the scale of other central transfers to the states. In other words, states will now have greater
autonomy on the revenue and expenditure fronts. The numbers also suggest that this renewed impulse toward
fiscal federalism need not be to the detriment of the centers fiscal capacity. A collateral benefit of moving from
Central Assistance To States(CAS) to FFC transfers is that overall progressivity will improve.

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 VISIONIAS
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14th Finance Commission

Table of Content

1. A Brief Introduction of Finance Commission .......................................................................................................... 2

2. Fourteenth Finance Commission ............................................................................................................................ 2
3. Major recommendations of FFC ............................................................................................................................. 2
3.1. Sharing of Union Taxes .................................................................................................................................... 2
3.2. Local Governments .......................................................................................................................................... 2
4. Comparison with 13th Finance Commission .......................................................................................................... 3
5. Criticism .................................................................................................................................................................. 3

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transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise,
without prior permission of Vision IAS

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1. A Brief Introduction of Finance Commission
Article 280 of the Constitution of India provides for a finance commission as a quasi-judicial body. It is
constituted by the President of India every fifth year. It consists of a chairman and four other members to be
appointed by the president.
It makes recommendations about the following to the President of India:
The distribution of the net proceeds of taxes between the centre and the states and the allocation between
the states of the respective shares of such proceeds
The principles that should govern the grants in aid to the states by the centre
The measures needed to augment the consolidated fund of states to supplement the resources of the local
governments in the states on the basis of the recommendations made by the State Finance Commissions.
Any other method referred to it by the President in the interests of the sound finance.
The recommendations made by finance commission are only advisory in nature and hence, are not binding on
the government.

2. Fourteenth Finance Commission

The 14th Finance Commission (FFC) was appointed under the Chairmanship of Dr. Y. V. Reddy.
Its Terms of References are as Follows:
Primary objectives as mentioned above
Principles which would govern the quantum and distribution of grants-in-aid(non-planned grants to states
The measures to augment state government finances to supplement the finances of local government
To review the state of finances, deficit and debt conditions at different levels of government

3. Major recommendations of FFC

3.1. Sharing of Union Taxes
Increasing the share of tax devolution to 42 per cent of the divisible pool would serve the twin objectives of
increasing the flow of unconditional transfers to the States and yet leave appropriate fiscal space for the
Union to carry out specific purpose transfers to the States.
No minimum guaranteed devolution to the States.
As service tax is not levied in the State of Jammu & Kashmir, proceeds cannot be assigned to this State.
3.2. Local Governments
Local bodies should be required to spend the grants only on the basic services within the functions assigned
to them under relevant legislations.
Distribution of grants to the States using 2011 population data with weight of 90 per cent and area with
weight of 10 per cent. The grant to each state will be divided into two, a grant to duly constituted Gram
panchayats and a grant to duly constituted Municipalities, on the basis of urban and rural population of that
state using the data of census 2011.
The grants to be divided in two parts - a basic grant and a performance grant for duly constituted gram
panchayats and municipalities. In the case of gram panchayats, 90 per cent of the grant will be the basic
grant and 10 per cent will be the performance grant. In the case of municipalities, the division between basic
and performance grant will be on an 80:20 basis.
The grants should go only to those gram panchayats, which are directly responsible for the delivery of basic
services, without any share for other levels using the formula given by the recent SFC. Similarly, the basic
grant for urban local bodies will be divided into tier-wise shares and distributed across each tier, namely the

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 Municipal corporations, Municipalities (the tier II urban local bodies) and the Nagar panchayats (the tier III
local bodies) using the formula given by the respective SFCs.
In case the SFC formula is not available, then the share of each gram panchayat as specified above should be
distributed across the entities using 2011 population with a weight of 90 per cent and area with a weight of
10 percent. In the case of urban local bodies, the share of each of the three tiers will be determined on the
basis of population of 2011 with a weight of 90 per cent and area with a weight of 10 per cent and then
distributed among the entities in each tier in proportion to the population of 2011 and area in the ratio of
90:10.
Performance grants are being provided to address the following issues: (i) making available reliable data on
local bodies' receipt and expenditure through audited accounts; and (ii) improvement in own revenues.

4. Comparison with 13th Finance Commission

Enhanced the share of the states in
the central divisible pool from 32%
(by 13th FC) to 42% which is the
biggest ever increase in vertical tax
devolution.
It has not made any
recommendation concerning
sector-specific grants unlike the
13th FC.

5. Criticism
Social sector allotment is reduced.
Backward Regions Grant Fund (BRGF) is wound up. Bihar which got 30% weightage for funding through this
criterion will be badly affected. Bihar being among least developed states it is a matter of concern to the
economy. It is likely to affect the Gross Domestic State Product (GDSP) of Bihar adversely.
Pruning of Planning Commission to be NITI Ayog has led to loss of plan grants to states which are performing
well. Karnataka stands to lose plan grants. Rashtriya Krishi Vikas Yojna which contributed significantly to
agricultural productivity and transformation is removed through the process which will affect the sector. To
compensate for all this some extra funding will have to be mobilized by the GOI which caused it. States can
ask for higher untied grants for the reason.
With GOI revenue as a percentage of GDP is shrinking by 1% which makes devolution of funds to states
questionable. How the GOI estimates and plans to face its increasing expenditure in the situation is to be
seen. IT export income has declined to 6 year low this year due to inward bound policies of the west and
USA.
With back ward region grants discontinuation, absence of plan funds to states, reduction of social sector
funding and decline in central kitty will all lead to larger estimable inequities in the devolution of funds to
states in addition to other diversities. So there could be surging fiscal inequalities among the states. How
cooperative federalism can be ushered in given the situation is not clear.
May be 42% unconditional grants are expected to do the job. But this devolution will give a free hand to
states to operate the finances. Inequities with freedom to states are what could be expected.
Good amount of devolution is ordered to local bodies and more clarity of flow is also directed. But there is
no sanction against default in devolution of funds to local bodies. So as always, flow of funds to local bodies
is not ensured. There is no preventive measure against dependence on states either. A special body for
monitoring cooperative federalism is advised which may or may not happen.
In brief there is sacrifice of equity principle in the process of extending a flat unconditional grant of 42%.This
may cause federal chaos instead of cooperative federalism unless additional and strong institutional
arrangement is made to guard the objectives of the present governance.

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