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Fifteenth Finance Commission (XV-FC)

About XV-FC

• The President constituted it under Article 280 (Outlines the Key Responsibilities of the Finance Commission) of the Indian Constitution on November 27, 2017.
  

• Shri N. K. Singh is the chairman of the Commission. He is a former member of parliament and former secretary of the Government of India.
  
  
• The commission had to deliver two reports.
  • The first report was tabled in February 2020.
  • The last report was submitted on February 1, 2021.
    
    
• Its period of deliberation ran from the end of 2017 until the end of October 2019.
  
  
• The 15th FC was established during a period of significant fiscal federalism reforms.
  • The Planning Commission has been replaced by NITI Aayog.
  • GST changes will be implemented.
  • The elimination of both planned and unplanned expenditures
    
    
• The report is divided into four volumes.
  • Volumes I and II, like before, comprise the main report and its annexes.
  • Volume III is devoted to the Union Government and delves further into major departments, as well as the medium-term difficulties and the road plan ahead.
  • The States are the exclusive focus of Volume IV. It examined each state's finances and developed state-specific considerations to meet the primary difficulties that each state faces.
    
    
• The primary study has 117 basic recommendations in all. Vols. III and IV contain several reform proposals for Union ministries and state governments, respectively.
  
  
• Recommendations
  • The distribution of tax proceeds between the central government and the states
  • The principles that govern state aid grants
  • Measures should be taken to supplement the states' unified fund.
  • Examine the impact of the 14th Finance Commission's proposals on the center's budgetary status.
  • Examine the center's and states' debt levels and propose a path map.
  • Examine the economic impact of GST.
  • Recommend performance-based incentives for states based on, among other things, their efforts to decrease population, increase ease of doing business, and limit spending on populist measures.
  • The recommendations will be in effect for five years, from 2021-22 to 2025-26.
  • Recommendations involve:

Key recommendations of XV-FC

    1. Vertical devolution (tax devolution of the centre to the states.

• The vertical devolution from the center to the states, which was earlier 42%, has now been reduced to 41%.
  
  
• Earlier, J&K, which was a State, also used to get vertical devolution, but since it's a UT now, it will not get 41%. Actually, out of the 42% earlier, J&K's share was around 0.85%, So now J&K and Ladakh will get 1% outside the vertical devolution. and 41% will be for the states (except J&K and Ladakh). So, effectively, there is no change for states.
• The 1% that will be given to J&K and Ladakh is for their special needs. 

• As per the "Jammu and Kashmir Reorganization Act 2019," the new union territory of Jammu and Kashmir will  become the first and only UT to get a share of central taxes awarded by the Fifteenth Finance Commission.
• Ladakh will be treated as a Union Territory and receive grants only from the central government, according to the Act, and not from the Central Taxes awarded by the Finance Commission.

• UTs are not intended for vertical devolution, whether or not they have their own assembly or legislature.

• UTs get grants from the central government, or the Union Home Ministry, to be specific. As a result, the two UTs with their own legislatures, Delhi and Puducherry, receive only grants from the finance commission and no other financial assistance.

    2. Horizontal Devolution (allocation of net taxable income among the states)

• By widely allocating suitable weightages, the Commission aims to reconcile the concepts of expenditure requirements, equity, and performance in setting the criteria for horizontal sharing. The need-based principles would clearly cover population, area, forest, and ecosystem factors.
• Income distance: The distance between a state's income and the state with the greatest income. The income of a state was calculated as the average per capita GSDP during a three-year period between 2016-17 and 2018-19. To preserve parity across states, a state with a lower per capita income will get a larger share.

1. 1. Demographic performance: The Commission's Terms of Reference obliged it to provide recommendations based on 2011 population statistics. As a result, the Commission based its recommendations on demographic figures from 2011. The demographic performance criterion has been used to recognize states for their efforts in population management. States with lower fertility ratios will receive better scores on this criterion. 
   2. Forest and ecology: This criteria was calculated by dividing each state's thick forest by the total dense forest of all states.
   3. Tax and fiscal efforts: This criterion has been used to reward states that are more efficient in collecting taxes. It is calculated as the ratio of average per capita own tax revenue to average per capita state GDP for the three years from 2016-17 to 2018-19.

Horizontal devolution criteria are given below:

• To recognize fiscal performance, XVFC has reintroduced the tax effort criteria.

1. This criterion has been used to reward states that are more efficient in collecting taxes.
2. It was calculated as the ratio of average per capita own tax revenue to average per capita state GDP for a three-year period from 2016-17 to 2018-19.

  3. Grants

There are five different types of grants. Except revenue deficit grants these are conditional and performance based grants.

• Revenue deficit grants 

(Revenue deficit is the difference between revenue, or current expenditures, and revenue collections, including tax and non-tax)

1. To alleviate revenue deficits, 17 states would receive grants totaling Rs 2.9 lakh crore (Rs 2,94,514 crore). On the basis of uniform norms for evaluating the revenues and expenditures of the states and the Centre.
2. An allocation of 1.92 percent of the gross revenue receipts of the Union as revenue deficit grants to specific States.

• Grants for local governments

It comprises funding for municipal services and local government entities, as well as performance-based awards for new city incubation and health grants to local governments.

1. For fiscal years 2021-26, the total allocation to local governments should be Rs. 4,36,361 crore.

    2. Basic grants are only recommended for cities/towns with fewer than a million people. For cities with populations of one million or more, all funds are awarded.

1. • The amount of MCF is connected to these cities' performance in improving air quality and satisfying service level norms for urban drinking water delivery, sanitation, and solid waste management.

• Grants for disaster management

1. The Commission suggested that existing cost-sharing arrangements for disaster management funds be maintained between the center and the states.  
2. The cost-sharing arrangement between the central government and the states is as follows: 
1. 90:10 for the northeastern and Himalayan states, and
2. 75:25 for the other states.  
3. The total amount of state disaster management funds would be Rs 1.6 lakh crore (with the central government contributing Rs 1.2 lakh crore).

• Sector-Specific Grants

States will receive sector-specific grants totaling Rs 1.3 lakh crore for the following eight sectors: 

1. Health, 
2. School education, 
3. Higher education, 
4. Agricultural reform implementation, 
5. Maintenance of PMGSY roads, 
6. Judiciary,
7. Statistics, and 
8. Aspirational districts and blocks

Some of these awards will be performance-based.

• State-specific grants

1. The Commission proposed state-specific grants totaling Rs 49,599 crore. These will be distributed in the following areas: 

(i) social requirements, 

(ii) administrative governance and infrastructure, 

(iii) water and sanitation, 

(iv) cultural and historical monument preservation, 

(v) high-cost physical infrastructure, and 

(vi) tourism

1. The Commission proposed establishing a high-level committee at the state level to examine and supervise the use of state-specific and sector-specific funding.

  4. Fiscal roadmap

• Fiscal deficit and debt levels

1. The Commission recommended that the government reduce the fiscal deficit to 4% of GDP by 2025-26.  

It recommended a fiscal deficit ceiling (as a percentage of GDP) for states as 

1. 4% in 2021-22.
2. 3.5% in 2022-23
3. 3% during 2023-26

1. Extra annual borrowing worth 0.5% of GSDP will be allowed to states during the first four years (2021-25) if they implement power sector reforms such as 
1. Reducing operational losses,
2. Reducing revenue gaps, 
3. Reducing cash subsidy payments by implementing direct benefit transfer, and 
4. Tariff subsidies as a percentage of revenue are being reduced.
2. The Commission highlighted that the recommended approach for fiscal deficits for the centre and states will result in a reduction in overall liabilities.  It proposed the formation of a high-level inter-governmental committee to: 
1. Evaluate the Fiscal Responsibility and Budget Management Act (FRBM), 
2. Recommend a new FRBM framework for the centre and states, and 
3. Supervise its implementation.

• Revenue mobilization

1. Income and asset-based taxes should be enhanced to increase revenue. 
2. The coverage of measures relating to tax deduction and collection at source (TDS/TCS) should be broadened to prevent excessive reliance on income tax on salaried incomes. 
3. State-level stamp duties and registration fees have a lot of untapped potential. Computerized property records should be connected with transaction registration, and property market value should be recorded. Property valuation techniques should be streamlined by state governments.

• GST

1. GST's inverted duty structure between intermediate inputs and final outputs must be rectified. 
2. The revenue neutrality of the GST rate, which has been undermined by multiple rate structures and many downward revisions, should be restored. The rate structure should be rationalized by combining the 12% and 18% rates. 
3. States must increase field operations to broaden the GST base and ensure compliance.

• Finance management by the state governments

1. States should revise their fiscal responsibility legislation to maintain compliance with the central government's legislation, particularly the definition of debt. 
2. States should have additional options for short-term borrowings beyond the Reserve Bank of India's ways and means advances and overdraft facility.  States may establish an autonomous debt management unit to efficiently handle their borrowing programs. 

Some other recommendations

• Health

• States should boost health spending to more than 8% of their total budget by 2022.  
• By 2022, primary healthcare spending should account for two-thirds of overall health spending.  
• Centrally sponsored schemes (CSS) in health should be adaptable and innovative enough to allow states to experiment. CSS in health should shift its emphasis from inputs to outcomes. 
• A Medical and Health Service for everyone in India should be developed.

• Defense and Internal Security

• Keeping in mind the current strategic requirements for national security in the global environment, the commission has re-calibrated the proportionate proportions of Union and States in gross income collections in its approach. This will allow the Union to set aside funds for the specific funding structure proposed by XVFC.
• The Union Government may establish a specific non-lapsable fund, the Modernization Fund for Defense and Internal Security (MFDIS), in the Public Account of India. The planned MFDIS has a total indicative size of Rs. 2,38,354 crore for the period 2021-26.

• CSS 
• A threshold for yearly CSS allocation should be established below which CSS funding should be discontinued.
• The goal is to phase away CSS that has outlived its usefulness or has a little expense.
• All CSS should be evaluated by a third party within a specific timeline.
• The funding pattern should be established upfront in a clear manner and maintained throughout time.

Concerns related to 15th Finance Commission

• Population census, 2011

• Between 1971 and 2011, the southern states' proportion of India's population declined by 4 percentage points, while the northern states' share grew.
• The per capita income of AP, Telangana, TN, and Karnataka is about double that of Bihar, UP, MP, Rajasthan, and other states.
• There is no arguing that richer governments must support poorer states, yet the development gap has not reduced despite decades of assistance.
• The great bargain reached under GST has resulted in some rule-based revenue distribution between the center and states that is not reliant on the population of the states.
• After the abolition of the Planning Commission, the 15th FC becomes very important, but the ToRs (terms of reference) have been skewed in favor of the central government, such as the one dealing with the review of the enhanced allocation of funds due to 14th FC recommendations and its impact on the fiscal situation of the central government while keeping the imperatives of the national development program in mind.

Conclusion

• Giving 2011 population a lesser weightage
• Including the 1971 population as well
• Providing incentives to states that perform better in population control initiatives.
• It is premature to draw conclusions about the southern states' shares because the finance commission has yet to release the weights for several characteristics used to construct the horizontal formula.
• Equalization strategy, as used in Australia and Canada, in which financial resources are distributed to guarantee that services are delivered at equal levels in each state if the states make equivalent efforts to raise revenues 
• In the case of India, the Finance Commission uses a gap-filling method based on past expenditure and revenue trends.