Ans. Article 280 of the constitution provides for a finance commission which is a quasi-judicial body. It is a body responsible for giving recommendations on the distribution of tax revenues between the Union and the States and amongst the States themselves.

Constitution of Finance commission

The Finance Commission is constituted by the President under Article 280 of the Constitution.
It is constituted at the end of every fifth year or earlier, as deemed necessary by the President.
The Parliament may, by law, determine the requisite qualifications for appointment as members of the Commission and the procedure for their selection.
It shall consist of a Chairman and four other members to be appointed by the President. They hold office for such period as specified by the president in his order.

Functions of Finance commission

Distribution of net proceeds of taxes: The distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them and the allocation between the States of the respective shares of such proceeds;
Principle for Grant-in-aid: The principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India;
Measures to augment CFS: The measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State;
Others: Any other matter referred to the Commission by the President in the interests of sound finance.

Primary criteria used by the Finance Commission of India for devolving funds to states:

Income Distance: It measures the distance of a state's per capita income from the highest per capita income among states. States with lower per capita income receive a higher share to promote balanced development.
Population: Initially based on the 1971 Census, the 15th Finance Commission shifted to using the 2011 Census data. o Population size influences the allocation of funds, with larger states typically receiving more funds due to their higher demographic burden.
Forest and Ecology: States with larger proportions of dense forest areas relative to the total forest cover across all states receive higher allocations, reflecting environmental conservation efforts.
Demographic Performance: Introduced to incentivize states for effective population control measures, this criterion rewards states that achieve lower fertility rates.
Tax Effort: States that demonstrate better tax collection efficiency relative to their potential receive higher scores, encouraging fiscal discipline and effective governance.

Significance of the above criteria in ensuring equitable and balanced allocation of financial resources across different states:

Economic Equity: By prioritizing states with lower incomes, it helps reduce economic disparities and promotes more balanced development across regions.
Population-Driven Resource Allocation: Allocating funds based on population size ensures that states with larger demographics receive adequate resources to meet the needs of their citizens.
Environmental Conservation: Recognizing states' efforts in environmental conservation encourages sustainable practices and ensures resources are directed to preserve natural habitats.
Effective Population Management: Rewarding states for effective population management encourages measures that promote stable population growth and demographic stability.
Fiscal Responsibility: Encouraging efficient tax collection promotes fiscal responsibility and ensures states have sufficient revenue to fund developmental initiatives.
Equitable Distribution: Tax efforts ensures that states with varying levels of development and demographic challenges receive fair and proportional financial support.
Regional Balance: Helps maintain a balance in development across different regions of the country by considering diverse factors like income levels, population dynamics, and environmental priorities.

Emerging challenges and limitations faced by Finance commission

Data gaps and inconsistencies: The finance commission rely on official data sources to assess performance of the Union and states, but these data are often incomplete and inconsistent.
Intersecting domains: There is an overlap in the domain of the Finance Commission and GST Council. The finance commission projections of state and central tax revenues, and recommendations based on them will be impacted by decisions taken by the GST Council.
Imbalance in resource and demand: The resources are limited while the demands on them are virtually unlimited.
Huge fiscal imbalances: Making recommendations for tax sharing and grants in a fiscally stressed situation and in a politically surcharged environment will require the Commission to tread the path with utmost care.
Balancing equity and efficiency: While states with lower fiscal capacity require more support, overemphasis on equity might discourage states from improving their own revenue generation and fiscal management.
Problem of incentivizing states: Incentivising the States, particularly the fiscally stressed ones, for prudent fiscal behaviour would be a major challenge. The related issue is of framing the next-generation fiscal rules.
Demand for centralization of expenditure: The recent demands for greater centralization of expenditure assignment is another issue.
Competing interests and demands: The finance commission have to balance the competing interests and demands of various stakeholders, such as the Union government, state governments, local bodies, civil society groups, etc.

Conclusion: Despite the changing fiscal environment and considerable expansion in its functions, the institution of the Finance Commission has ensured smooth functioning of Centre State fiscal relations. Fiscal federalism will always remain a work in progress and the institution of the Finance Commission, as in the past, will have to continue to deal with the changing environment and emerging challenges.

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