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States and the Finance Commission: Balancing Equity and Growth

Syllabus:

GS-2:

Centre-State Relations, Indian Constitution , Co-operative Federalism , Constitutional Bodies.

Focus:

The Sixteenth Finance Commission, chaired by Arvind Panagariya, is addressing fiscal challenges in India, focusing on equitable resource distribution between States and the Union. Its recommendations will impact the financial autonomy of States like Tamil Nadu and influence the country’s economic trajectory.

Introduction: The Role of the Sixteenth Finance Commission

• The Tamil Nadu government recently hosted the Sixteenth Finance Commission, chaired by Arvind Panagariya.
• The Commission aims to address India’s fiscal challenges, focusing on the relationship between States and the Union.
• The outcomes of this commission will shape India’s fiscal landscape for the next five years and influence its economic future.

Understanding the Finance Commission of India (FCI):

• Constitutional Body: Constituted by the President of India under Articles 280 and 281.
• Non-Permanent: Established every fifth year or as needed.
• Primary Role: Recommends the distribution of financial resources between the Union and State Governments.

Composition & Qualifications

• Members: Chairman and four members appointed by the President.
• Qualifications: Includes experience in public affairs, finance, administration, economics, or judiciary.

Functions

• Vertical Devolution: Allocation of tax proceeds between Centre and States.
• Horizontal Distribution: Equitable allocation of funds among States.
• Grants-in-Aid: Transfers for specific needs, like infrastructure or social welfare.

Fiscal Federalism

• Promotes Fiscal Autonomy: Enhances State independence through financial resources.
• Cooperative Federalism: Encourages collaboration between Centre and States.
• Reduces Inequality: Provides more funds to backward States to foster balanced development.

About 16th Finance Commission of India:

• Constitution:
• Constituted on 31.12.2023, chaired by Shri Arvind Panagariya.
• Recommendations to be submitted by 31.10.2025, covering the 2026-2031 award period.
• Terms of Reference:
• Tax Distribution: Allocation of net tax proceeds between Union and States.
• Grants-in-Aid: Principles and sums for State grants under Article 275.
• Panchayat and Municipality Resources: Augmenting State funds based on State Finance Commission recommendations.
• Disaster Management: Reviewing and suggesting improvements to financing structures under the Disaster Management Act, 2005.

Global Economic Shifts and Opportunities:

• Significant global economic trends like “friendshoring” and “reshoring” are reshaping international trade and investment.
• These trends present opportunities for India and Tamil Nadu, but balancing equitable redistribution with incentivizing growth is crucial.
• The Finance Commission must strike a balance between fairly redistributing resources and supporting high-performing States like Tamil Nadu.

Equity and Growth in Resource Distribution

• Since the formation of the Finance Commissions, there has been a focus on equitable resource distribution between the Union and States.
• Previous Finance Commissions have sought to increase the States’ share of resources through vertical devolution and horizontal devolution for underdeveloped States.
• However, challenges persist in achieving the objectives of fair redistribution, as outcomes have not always aligned with these goals.

Resource Allocation for Progressive States

• States, particularly progressive ones like Tamil Nadu, should receive a larger share of resources to ensure continued growth.
• Financial strain on States has been aggravated by the rising costs of centrally sponsored schemes and insufficient devolution.
• A proposed solution is to increase States’ share of central taxes to 50%, ensuring greater fiscal autonomy and supporting locally relevant schemes.

Strengthening State Autonomy and Local Development

• Increasing fiscal autonomy for States can enhance their ability to implement development projects tailored to local needs.
• A substantial devolution of resources would allow States like Tamil Nadu to address regional disparities and implement effective governance.
• Empowering States financially can lead to more efficient execution of centrally funded schemes and better alignment with local priorities.

Long-Term Economic Growth and Sustainability

• The Finance Commission’s decisions will influence India’s long-term economic trajectory, focusing on inclusive growth and sustainable development.
• Ensuring that progressive States like Tamil Nadu have the resources needed for infrastructure, education, and healthcare is key to maintaining growth.
• Addressing the challenges of urbanization and an aging population will be vital to maintaining a robust economy and preventing stagnation in these States.

Addressing Challenges for Progressive States:

• Progressive States like Tamil Nadu face unique challenges, including a higher median age and an aging population.
• The decline in consumption-based tax revenue and the rising costs of supporting an aging population demand new fiscal strategies.
• Tamil Nadu’s rapid urbanization, which is expected to see a 57.3% urban population by 2051, requires dedicated resources for infrastructure development.
• The Finance Commission’s decisions must consider long-term sustainability, ensuring that growth is inclusive and adaptable to demographic changes.
• Unequal Resource Distribution: There is a persistent gap between the objectives of equitable resource allocation and the actual outcomes, leading to inefficiencies in addressing fiscal needs across States.
• Strain on Progressive States: States like Tamil Nadu face unique challenges such as an aging population and urbanization, which strain their fiscal capacity and hinder growth.
• Increased Fiscal Burden: The rising cost of supporting centrally sponsored schemes, along with insufficient devolution from the Union, places a significant financial strain on States, affecting their ability to meet developmental needs.
• Declining Tax Revenue: States with higher median ages, such as Tamil Nadu, are witnessing a decline in consumption-based tax revenue, which limits their ability to generate funds for development.

Way Forward:

• Progressive Resource Allocation: Implement a progressive allocation method that rewards high-performing States, ensuring they have the necessary resources to continue driving national growth.
• Enhanced Devolution: Increase the States’ share of central taxes to 50%, empowering them with greater fiscal autonomy to address local challenges and fund relevant initiatives.
• Focus on Urbanization: Allocate resources for infrastructure development in rapidly urbanizing States to ensure sustainable growth and long-term economic stability.
• Support for Demographic Challenges: Introduce policies that assist States with aging populations by creating tax revenue opportunities and improving welfare funding.

Conclusion: Vision for a Balanced Fiscal Future:

• The mandate of the Finance Commission goes beyond fiscal arithmetic; it involves shaping a future where every State contributes to and benefits from national progress.
• The decisions made will impact millions of lives and determine India’s path toward becoming one of the world’s leading economies.
• By addressing both the challenges of progressive States and the need for equitable resource allocation, the Finance Commission has the potential to foster a more balanced and sustainable economic growth model for the nation.

Source: The Hindu

Mains Practice Question:

Discuss the challenges faced by progressive States like Tamil Nadu in the context of the Finance Commission’s fiscal devolution. Suggest measures to address these challenges and promote equitable growth across States.

Associated Article:

https://universalinstitutions.com/sixteenth-finance-commission-establishes-advisory-panel-for-broadened-scope/