Recomendations of the 14th Finance commission

Recomendations of the 14th Finance commission

Article 280 of the Constitution of India requires the Constitution of a Finance Commission every five years, or earlier.  For the period from 1st April, 2015 to 31st March, 2020,  the 14th Finance Commission (FFC) was constituted by the orders of President on 2nd January, 2013 and submitted its report on 15th December, 2014.

The Finance Commission is required to recommend the distribution of the net proceeds of taxes of the Union between the Union and the States (commonly referred to as vertical devolution); and the allocation between the States of the respective shares of such proceeds (commonly known as horizontal devolution).

Some of the important recommendations of the 14th finance commission are as follows:

  • The fourteenth finance commission is of the view that tax tax devolution should be the primary route of resources to the states. The commission recommends to increase the tax devolution of the divisible pool to states to 42% for years 2015 to 2020. This is 10% more compared to 32% target set by 13th financial commission.
  • The commission recommended that the new tax devolution should be the primary route of transfer of resources to States since it is formula based and thus conducive to sound fiscal federalism. However, to the extent that formula-based transfers do not meet the needs of specific States, they need to be supplemented by grants-in-aid.
  • The commission came up with new formula to divide the 42% share of the divisible pool between the states.
  • The commission followed the method adopted by the 12th commission and put the floor limit at 2 percent for smaller States and assigned 15 percent weight.
  • The commission assigned 7.5 per cent weight to forest cover as the new criteria to balance the benefit of the huge ecological benefits and the opportunity cost in terms of area not available for other economic activities that becomes indicator of fiscal disability.
  • The commission felt that allocation based on dated population data is not fair, and assigned a 17.5 percent weight to the 1971 population and assigned 10 percent a weight to the 2011 population to capture the demographic changes since 1971, both in terms of migration and age structure.
  • The commission assigned 50% weight to income distance as it is the only measure of fiscal capacity. It is the distance of actual per capita income of a state from the state with the highest per capita. The commission calculated the income distance following the method used the 12th commission. A three-year average (2010-11 to 2012-13) per capita comparable GSDP has been taken for all the twenty-nine states. Income distance has been computed by taking the distance from the state having highest per capita GSDP. Goa had the highest, followed by Sikkim. Since these two are very small states, income distance had been computed from the third, Haryana. Goa, Sikkim and Haryana are assigned the same distance as obtained for Haryana.
  • The grants by Union government are to be used only on the basic services within the functions assigned to them by legislation, water supply, sanitation, sewerage, storm water drainage, solid waste management, street lighting, local body roads and footpaths, parks, playgrounds etc. The Commission fixed the total size of the grant to be Rs. 2,87,436 crore for the period 2015-20, constituting an assistance of Rs. 488 per capita per annum at an aggregate level. Of this, the grant for panchayats is Rs. 2,00,292.2 crore and for municipalities is Rs. 87,143.8 crore.
  • The Commission recommended that distribution of grants shall be given to the States using 2011 population data with weight of 90 percent 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.
  • Each grant has two components, basic and performance. The commission recommends that 50 per cent of the basic grant for the year is to be released to the State as the first installment of the year. The remaining basic grant and the full performance grant for the year may be released as the second instalment for the year. The State Government have to release the grants to the local bodies within fifteen days of it being credited to their account by the Union Government. In case of any delay, the State Governments have to pay the installment with interest paid from its own funds.
  • 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. The grants for Panchayats should go only to them without any share for other levels of government in State. State Governments has to take care of the needs of the other levels and districts. Grants for gram panchayats with in a State will be distributed using the formula chosen by a state finance commission. In case the SFC formula is not available, then the share of each gram panchayat will be on the basis on 2011 population with a weight of 90 per cent and area with a weight of 10 per cent.
  • In the case of municipalities, the division between basic and performance grant will be on a 80:20 basis. The basic grant for urban local bodies will be divided into tier-wise shares and distributed across each tier, the municipal corporations, municipalities (the tier II urban local bodies) and the nagar panchayats (the tier III local bodies) using the formula given by a state finance commission. In case the SFC formula is not available for urban local bodies, shares of each of the three tiers will be on the basis of population of 2011 with a weight of 90 percent and area with a weight of 10 percent, and then distributed among the entities in each tier in proportion using same formula.
  • The commission recommended the Union to establish GST compensation fund. This compensation is to be used to address 100% of the shortfall in the first year, 75% in the second year and 50% in the third year. This additional fiscal burden on the Union government has to be taken as investment to get yields in the medium and long run.
  • The financing of the NDRF had been from levying cess on some selected items and some of them will be subsumed by GST. The commission recommended the Union Government to ensure an assured source of funding. The commission recommended to consider tax exemption to private contributions to the NDRF. The commission recommended all States to contribute 10 per cent and Union with the remaining 90 per cent. Considering the need for regard to state-specific disasters, the commission recommended that up to 10 per cent of the funds available under the SDRF can be used by States for natural disasters that they consider to be ‘disasters’ within the local context in the State and which are not included in the notified list of disasters of the Ministry of Home Affairs.


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