Agenda for the 16th Finance Commission

General Studies Paper -2

Context: The 16th Finance Commission chaired by  Dr. Arvind Panagariya  has begun its work.

About 16th Finance Commission

• The Government of India, with the approval of the President of India, has constituted the Sixteenth Finance Commission, in pursuance to Article 280(1) of the Constitution.
• It Focuses on devolution of the consolidated fund to states and local bodies.

Duration and Scope

• The 16th Finance Commission recommendations will cover a period of five years starting from April 1, 2026.
• Distribution of Tax Proceeds: Determine how taxes shared between the Union and States (under Part XII, Chapter I of the Constitution) should be distributed.
  • Allocate shares of these proceeds among the States.
• Grants-in-Aid Principles: Define principles governing grants-in-aid of State revenues from the Consolidated Fund of India.
  • Specify sums to be granted to States under Article 275 of the Constitution, excluding purposes specified in provisos to clause (1) of that article.
• Augmentation of State Consolidated Fund: Recommend measures to enhance the Consolidated Fund of a State.
  • This enhancement aims to supplement resources for Panchayats and Municipalities within the State, based on recommendations from the respective State Finance Commissions.
• Review of financing Disaster Management initiative : It is also mandated to review the present arrangements on financing Disaster Management initiatives, with reference to the funds constituted under the Disaster Management Act, 2005 (53 of 2005), and make appropriate recommendations thereon.

Existing Challenges and Issues

• Despite efforts by multiple Finance Commissions, financial support to Urban Local Bodies (ULBs) remains inadequate.
  • The fiscal health of municipalities is poor, affecting both city productivity and quality of life.
• Intergovernmental transfers (IGTs) to ULBs are only 0.5% of GDP, much lower than in other developing countries (2-5%).
  • For instance, South Africa allocates 2.6%, Mexico 1.6%, the Philippines 2.5%, and Brazil 5.1% of their GDPs to their cities.
  • Other Issues include predictability, earmarking, and horizontal equity of IGTs.
• Impact of Taxation System: Introduction of GST reduced ULBs’ tax revenue significantly.
  • State Finance Commissions recommended minimal IGTs from states to ULBs (about 7% of state revenue).
• Role of Census Data: Lack of updated Census data (2011 being the latest) hampers evidence-based fiscal devolution.
• Significant urbanization and migration to Tier-2 and 3 cities underscore the need for accurate data.
• Concerns with Parallel Agencies: Growth of parallel agencies undermines local governments financially and operationally.
  • Programs like MP and MLA Local Area Development Schemes distort federal structure roles.

Conclusion and Way Forward

• Cities contribute significantly to India’s GDP (66%) and government revenues (90%) and they are Essential for overall national development
• Therefore, The 16th FC must consider India’s urbanisation dynamism
• Migration to Tier-2 and Tier-3 cities underscores the importance of capturing demographic changes and infrastructure demands accurately.
• The 16th Finance Commission should prioritize recommending robust fiscal measures to strengthen ULBs financially.
• Stable IGTs are critical to supporting ULBs until they can enhance their own revenue generation capabilities.
• Property tax collection should be improved in parallel with State GST to enhance local revenues.

Emphasis on maintaining transparent accounts and efficient resource allocation for pollution control, primary healthcare, solid waste management, and drinking water facilities.