Finance Commission 4

Finance Commission and Local Bodies 

      Local governments, notably panchayati raj institutions (PRIs), once a neglected appendage of rural development departments, acquired “a habitation and a name” in the Indian federal polity after the 73rd and 74th Constitutional Amendments in 1993. It is significant that Article 280 of the Constitution that established the union finance commission (UFC) was altered as part of the two amendments, mandating the UFC to recommend



thereby affirming the organic link in Indian fiscal federalism.

      The principle of subsidiarity implies that matters are best handled by the least centralized competent authority. Following this, these institutions need to be adequately empowered–both functionally and financially—to enable them to fulfill the role envisaged for them in the Constitution. The State Finance Commissions (SFCs), which buttress the functioning of local bodies, also need to be strengthened so as to make their functioning more predictable and the process of implementing their recommendations more transparent.

      All the UFCs since the two amendments have been required through their terms of reference to make recommendations on the above. The 10th Finance Commission, although appointed before these amendments, became a fait accompli, and on its own recommended some ad hoc grants to local govern¬ments. The 13th FC  has made some significant departures from the past and made recommendations that could help to strengthen the process of democratic decentralization in the country if they are fully implemented.







13th FC on Local Bodies

      Performance Grant       The local grant recommended by the 13th FC has two components, a basic component and a performance-based component. The basic grant is equivalent to 1.5% of the previous year’s divisible tax revenue. All states will have access to this grant for all the five years (2010-15). The performance grant allocated to each state is subject to them fulfilling a nine-point conditionality package. This should help promote results-based accountability.



a. Role of SFC        One major contribution is the template prepared by 13th FC with the help of an expert committee to help future SFCs in preparing their reports. Although no SFC with a mind of its own will mechanically follow the template, this is a big step towards streamlining SFC reports in the future.



b. Amend Article 280       The 13th FC has recommended to amend Article 280(3)(bb) and (c) of the Constitution so that the words “on the basis of the recommendations of the finance commission of the State” are changed to “after taking into consideration the recommendations of the finance commission of the State”. This recommendation, already approved by several expert bodies fully appreciates the spirit of the clause that envisages an organic link in Indian fiscal





c. Parallel Agencies and bodies       The 13th FC rightly points out that parallel agencies and bodies are “emasculating local governments both financially and operationally”. Having constitutionally assigned a certain functional domain to local governments, which include “planning for economic development and social justice” and preparing a draft district development plan, it is for the union and state governments to help this process of decentralised planning and governance with funds, functionaries and technical support.



 Summary of Recommendations 

      Local bodies should be transferred 2.28% of the divisible pool of taxes after converting this share to grant-in-aid under Article 275.



      Article 280 (3) (bb) & (c) of the Constitution should be amended to make the recommendations of the State Finance Commissions less binding on state governments.

      Article 243(I) of the Constitution should be amended to empower states governments to constitute and direct state Finance Commissions to give their report before the National Finance Commission finalises its report.

      State governments should strengthen their local audit departments through capacity building.

      Bodies similar to the SFC should be set up in states which are not covered by Part IX of the Constitution (Panchayats).

      Local Bodies should be associated with city planning functions wherever other development authorities are mandated for this function.

      State governments will be eligible for the general performance grant and the special areas performance grant only if they comply with the prescribed stipulations.



 Some Shortcomings

      A large chunk of the performance grant, estimated to be Rs 29,826 crore, remaining unutilised by 2015 is a distinct possibility. If state governments do not take necessary legal and administrative action, everything will remain in cold storage.

      The 13th FC has given only a low weightage of 25% to population against a weightage of 47.5% to fiscal capacity distance and 17.5% to fiscal discipline, making a total weight of 65% for fiscally relevant criteria.

      The 13th FC has dispensed with the tax or revenue effort criterion with regard to local grants on the plea that credible data are not available. It had data for six years and it could have obtained better outcomes by using the tax or revenue effort criterion. The 13th FC criteria may be unfair as it is biased towards highly populated states.



continue to be so. Actually the 13th FC is only reiterating the sweeping, general comments against SFCs made by the

11th and 12th FC.

      The criteria chosen for inter se distribution of local grants leave many things to be desired and so is its silence on SFCs. The third tier has to be made an integral component of India’s federal public finance and UFCs of the future cannot afford to shirk that responsibility any more.