Xii Finance Commission

The Twelfth Finance Commission (TFC), constituted in 2002 and chaired by Dr. C. Rangarajan, played a crucial role in shaping India’s fiscal federalism landscape. Its recommendations, covering the period from 2005-2010, significantly impacted the distribution of resources between the Union and State governments.

A key objective of the TFC was to address the fiscal imbalances prevalent in various states while promoting efficiency and equity in resource allocation. To achieve this, the Commission proposed a major restructuring of the tax devolution formula. Unlike previous commissions which relied heavily on population, the TFC placed greater emphasis on fiscal capacity and fiscal discipline. The formula it suggested incorporated criteria such as tax effort, infrastructure development, and special needs, alongside population. This shift aimed to incentivize states to improve their own revenue generation and manage their finances responsibly.

The TFC recommended increasing the share of the Union’s divisible tax pool to the states from 29.5% to 30.5%. While seemingly a modest increase, it represented a significant amount of additional resources flowing to the states over the five-year period. This enhanced devolution was intended to empower state governments to undertake development activities and address local needs more effectively.

Beyond tax devolution, the Commission also focused on grants-in-aid to states. It recommended a comprehensive framework for both revenue deficit grants and grants for specific purposes, such as education, health, and infrastructure. The revenue deficit grants were designed to help states with persistent fiscal deficits bridge the gap between their revenue and expenditure. The specific purpose grants, on the other hand, were aimed at incentivizing investments in key sectors and achieving national objectives.

Furthermore, the TFC made significant recommendations concerning debt relief and debt restructuring for state governments. Recognizing the burden of high debt on state finances, it proposed a debt consolidation and waiver scheme linked to fiscal reforms. This scheme incentivized states to implement measures such as eliminating revenue deficits and improving debt sustainability. By offering debt relief linked to performance, the Commission sought to encourage fiscal prudence and responsible financial management among states.

The TFC also addressed the issue of local bodies. It recommended increased financial assistance to Panchayati Raj Institutions and Urban Local Bodies to strengthen grassroots governance and improve the delivery of essential services at the local level. This reflected a commitment to decentralization and empowering local communities to participate in the development process.

In conclusion, the Twelfth Finance Commission’s recommendations had a profound impact on India’s fiscal federal structure. Its emphasis on fiscal capacity, fiscal discipline, and targeted grants-in-aid fostered greater equity and efficiency in resource allocation. The Commission’s focus on debt relief and local bodies further contributed to strengthening state finances and promoting decentralized governance. While the specific formula and recommendations have evolved in subsequent Finance Commissions, the underlying principles of equity, efficiency, and fiscal responsibility established by the TFC continue to shape India’s approach to fiscal federalism.