Finance Commission — Law of Taxation Notes

Finance Commission

The Union collects the largest taxes, but the States do most of the day-to-day spending on health, roads and schools. Who decides how the central pool is split so a poorer State is not starved? A constitutional body appointed every five years — the Finance Commission under Article 280.

What the Finance Commission is and does

The Finance Commission is a body the President must constitute every five years (or earlier if needed) under Article 280 to recommend how the financial resources of the Union and the States are shared. It is the balancing wheel of Indian fiscal federalism.

Article 280(1): “The President shall, within two years from the commencement of this Constitution and thereafter at the expiration of every fifth year or at such earlier time as the President considers necessary, by order constitute a Finance Commission…”

Composition. A Chairman and four other members, appointed by the President. Parliament prescribes their qualifications; the Chairman is usually a person with experience in public affairs, and members have expertise in finance, economics or administration.

Functions (Art. 280(3)) — its recommendations cover:

1. The distribution of the net proceeds of taxes that are to be shared between the Union and the States, and the allocation among the States of their respective shares (vertical and horizontal devolution).
2. The principles governing grants-in-aid to the States out of the Consolidated Fund of India (Art. 275).
3. Measures to augment the Consolidated Fund of a State to supplement the resources of panchayats and municipalities (added by the 73rd/74th Amendments).
4. Any other matter referred to it by the President in the interests of sound finance.

Nature of its recommendations. The Commission’s recommendations are advisory / recommendatory — not binding — but by convention the Union accepts them, and they are laid before Parliament. GST-era relevance: even after GST centralised indirect-tax rate-setting in the GST Council, the Finance Commission still divides the shareable central taxes and recommends grants, so it remains central to Centre-State finance.

In Simple Terms: Every five years the President sets up a five-member Finance Commission (Art. 280) to advise how central tax money is split between the Union and the States, and among the States. Its advice is not binding, but the government almost always follows it.

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Case Laws

• Jagjit Singh v State of Punjab (2006) — recognised the constitutional role of the Finance Commission in the scheme of fiscal devolution (referred to in Centre-State finance disputes).

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