14th Finance Commission: A Paradigm Shift in Fiscal Federalism

The 14th Finance Commission (FFC), constituted under the chairmanship of Dr. Y.V. Reddy, submitted its report for the period 2015-2020, marking a significant departure from previous commissions in its approach to fiscal federalism in India. Its recommendations aimed to strengthen cooperative federalism by devolving a larger share of central taxes to states, enhancing local governance, and promoting fiscal discipline.

Key Recommendations and their Impact:

Increased Devolution of Taxes:

The FFC recommended a substantial increase in the share of states in the divisible pool of central taxes, from 32% to 42%. This was the most significant recommendation and was accepted by the Union Government. The increase aimed to provide states with greater financial autonomy and flexibility to plan and implement their development programs according to their specific needs and priorities.

This higher devolution led to a considerable increase in the resources available to states, enabling them to invest more in infrastructure, social sectors like education and healthcare, and poverty alleviation programs. It also reduced their dependence on discretionary grants from the Union Government, fostering a more predictable and stable financial environment.

Criteria for Horizontal Distribution:

The FFC retained the principle of equity and efficiency in its formula for distributing the states’ share of taxes. The criteria and their respective weights were modified compared to the 13th Finance Commission, giving greater weightage to population (17.5%), demographic change (10%), income distance (50%), area (15%), forest cover (7.5%) and tax effort (5%). The inclusion of demographic change and forest cover as specific criteria reflected the growing importance of population management and environmental sustainability.

The changes in the formula aimed to provide a more balanced distribution of resources, taking into account the varying needs and capacities of different states. While the formula continued to favor poorer states, the inclusion of forest cover incentivized states to protect their forests and promote ecological balance.

Local Governance:

The FFC emphasized the importance of strengthening local governments (Panchayats and Municipalities) and recommended grants for these bodies. The grants were intended to improve basic services, infrastructure, and capacity building at the local level.

The commission stipulated conditions for accessing the grants, such as the timely conduct of local body elections, the establishment of State Finance Commissions, and the transfer of functions, finances, and functionaries to local bodies. These conditions aimed to promote greater decentralization and empower local governments to address the needs of their communities effectively.

Fiscal Discipline and Responsibility:

The FFC stressed the need for fiscal discipline and recommended measures to improve the financial management practices of both the Union and state governments. It encouraged states to adopt a medium-term fiscal framework and to improve their debt management.

Impact and Assessment:

The 14th Finance Commission’s recommendations had a far-reaching impact on the fiscal landscape of India. The increased devolution of taxes provided states with greater financial autonomy and enabled them to pursue their development objectives more effectively. The emphasis on local governance and fiscal discipline contributed to strengthening the overall framework of fiscal federalism in the country. However, some states expressed concerns about the changes in the distribution formula, arguing that it disadvantaged them.

Overall, the 14th Finance Commission’s report represented a significant step forward in promoting cooperative federalism and empowering states to play a more active role in India’s development process.