<p><strong>Why in News?</strong></p>
<p>The report of the Fifteenth Finance Commission, along with an Action Taken Report, was recently tabled in Parliament<br />
• The Finance Commission is a constitutional body formed by the President of India to give suggestions on centre-state financial relations.<br />
• The Fifteenth Finance Commission (XVFC)’s Term of Reference (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.<br />
• Another unique ToR was to recommend funding mechanism for defence and internal security.</p>
<p><strong>Recommendations:</strong></p>
<p><strong>[A]Devolution of taxes to states:</strong><br />
• The criteria used by the Commission to determine each state’s share in central taxes is Census 2011 population, income distance, demographic performance, forest and ecology and tax Effort<br />
(i) Vertical Devolution<br />
• The share of states in the centre’s taxes is recommended to be decreased from 42% during the 2015-20 period to 41% for 2020-21. <br />
• The 1% decrease is to provide for the newly formed union territories of Jammu and Kashmir, and Ladakh from the resources of the central government.<br />
<strong>(ii) Horizontal Devolution:</strong><br />
On horizontal devolution, XVFC agreed on the Census 2011 population.</p>
<p><strong>[B]Grants in Aid:</strong><br />
<strong>• The following grants will be provided to states: </strong><br />
(i) Revenue deficit grants: The Commission recommended revenue deficit grants for 14 states <br />
(ii) Grants to local bodies: The total grants to local bodies for 2020-21 has been fixed at Rs 90,000 crore, of which Rs 60,750 crore is recommended for rural local bodies (67.5%) and Rs 29,250 crore for urban local bodies (32.5%).<br />
o This allocation is 4.31% of the divisible pool. This is an increase over the grants for local bodies in 2019-20, which amounted to 3.54% of the divisible pool.<br />
o The grants will be divided between states based on population and area in the ratio 90:10. The grants will be made available to all three tiers of Panchayat- village, block, and district.<br />
<strong>(iii) Disaster management grants: </strong>The Commission recommended setting up National and State Disaster Management Funds (NDMF and SDMF) for the promotion of local-level mitigation activities. <br />
o The Commission has recommended retaining the existing cost-sharing patterns between the centre and states to fund the SDMF (new) and the SDRF (existing). <br />
o The cost-sharing pattern between centre and states is (i) 75:25 for all states, and (ii) 90:10 for north-eastern and Himalayan states.<br />
• The Commission has also proposed a framework for sector-specific and performance-based grants.<br />
Sector-specific grants for the following sectors will be provided in the final report: (i) nutrition, (ii) health, (iii) pre-primary education, (iv) judiciary, (v) rural connectivity, (vi) railways, (vii) police training, and (viii) housing<br />
Performance-based grants: Guidelines for performance-based grants include: (i) implementation of agricultural reforms, (ii) development of aspirational districts and blocks, (iii) power sector reforms, (iv) enhancing trade including exports, (v) incentives for education, and (vi) promotion of domestic and international tourism.<br />
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<p><strong>Recommendations on Fiscal Roadmap</strong><br />
<strong>1) Fiscal deficit and debt levels:</strong> It recommended that both central and state governments should focus on debt consolidation and comply with the fiscal deficit and debt levels as per their respective Fiscal Responsibility and Budget Management (FRBM) Acts.<br />
<strong>2) Off-budget borrowings:</strong> It recommended that both the central and state governments should make full disclosure of extra-budgetary borrowings. The outstanding extra-budgetary liabilities should be clearly identified and eliminated in a time-bound manner.<br />
<strong>3) Statutory framework for public financial management:</strong> The Commission recommended forming an expert group to draft legislation to provide for a statutory framework for sound public financial management system. It observed that an overarching legal fiscal framework is required which will provide for budgeting, accounting, and audit standards to be followed at all levels of government.<br />
<strong>4) Tax capacity: </strong>The Commission noted that tax revenue is far below the estimated tax capacity of the country. Further, India’s tax capacity has largely remained unchanged since the early 1990s. In contrast, tax revenue has been rising in other emerging markets. The Commission recommended: (i) broadening the tax base, (ii) streamlining tax rates, (iii) and increasing capacity and expertise of tax administration in all tiers of the government.<br />
<strong>5) GST implementation:</strong> The Commission highlighted some challenges with the implementation of the Goods and Services Tax (GST). These include (i) large shortfall in collections as compared to original forecast, (ii) high volatility in collections, (iii) accumulation of large integrated GST credit, (iv) glitches in invoice and input tax matching, and (v) delay in refunds.<br />
Other recommendations<br />
<strong>Financing of security-related expenditure:</strong> The ToR of the Commission required it to examine whether a separate funding mechanism for defence and internal security should be set up and if so, how it can be operationalised. In this regard, the Commission intends to constitute an expert group comprising representatives of the Ministries of Defence, Home Affairs, and Finance. The Commission noted that the Ministry of Defence proposed following measures for this purpose: (i) setting up of a non-lapsable fund, (ii) levy of a cess, (iii) monetisation of surplus land and other assets, (iv) tax-free defence bonds, and (v) utilising proceeds of disinvestment of defence public sector undertakings. The expert group is expected to examine these proposals or alternative funding mechanisms.<br />
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