Dividing the Nation's Revenue: The Finance Commission's Role in Vertical and Horizontal Fiscal Federalism

Finance Commission

The Finance Commission draws its existence from Article 280 of the Indian Constitution. It is classified as a quasi-judicial body and is constituted by the President of India every five years, or earlier if the President deems it necessary. The related constitutional provisions are:

• Article 280 — Establishment and composition of the Finance Commission
• Article 281 — Recommendations of the Finance Commission

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The Commission comprises:

• One Chairman
• Four other Members

All are appointed by the President. Their tenure is fixed by the President through a formal order. Members are eligible for reappointment.

Qualifications

The Constitution empowers Parliament — not the Constitution itself — to prescribe qualifications and the selection process. Parliament has done so through the Finance Commission (Miscellaneous Provisions) Act, 1951.

Chairman: Must have experience in public affairs.

Four Members must be drawn from persons who are:

1. A sitting or eligible judge of a High Court
2. Specialists in government finance and accounts
3. Persons with wide experience in financial matters and administration
4. Economists with special knowledge of economics

Exam Trap: The Constitution does not itself specify qualifications — it delegates this power to Parliament. This is a frequently tested distinction.

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The Finance Commission makes recommendations to the President on the following:

1. Tax Devolution

Determining how the net proceeds of shareable central taxes are to be divided between the Centre and the states, and how each state's share is to be allocated among themselves.

2. Grants-in-Aid

Laying down the principles that should govern grants-in-aid given to states from the Consolidated Fund of India.

3. Augmenting State Consolidated Funds

Recommending measures to strengthen the Consolidated Fund of a State so that it can adequately support Panchayats and Municipalities. This is done on the basis of recommendations made by the respective State Finance Commissions.

This function was added by the 73rd and 74th Constitutional Amendment Acts of 1992, which gave constitutional recognition to local bodies.

4. Any Other Matter

The Commission may also address any other matter referred to it by the President in the interests of sound public finance.

Historical Note

Until 1960, the Commission also recommended grants to the states of Assam, Bihar, Odisha, and West Bengal in place of a share in the export duty on jute and jute products. These grants were transitional, covering a ten-year period from the Constitution's commencement.

Submission of Report

The Commission submits its report to the President, who then places it before both Houses of Parliament along with an explanatory memorandum detailing the action taken on the recommendations.

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A critical and frequently tested feature: the recommendations of the Finance Commission are not legally binding on the Government of India. They are purely advisory in character.

• No constitutional provision compels the Union Government to implement the Commission's recommendations.
• States do not acquire any legal right to receive the amounts recommended by the Commission.
• It is entirely the Union Government's discretion whether to act on the recommendations.

However, as noted by Dr. P.V. Rajamannar, Chairman of the Fourth Finance Commission:

Since the Finance Commission is a constitutional quasi-judicial body, its recommendations should not be set aside without very compelling reasons.

This reflects the moral and constitutional weight its recommendations carry, even in the absence of enforceability.

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The Constitution envisions the Finance Commission as the balancing wheel of fiscal federalism in India — a key mechanism for ensuring equitable distribution of resources between the Centre and states.

Challenge from the Planning Commission

The Finance Commission's role was historically undermined by the erstwhile Planning Commission, a body that was:

• Non-constitutional (no constitutional provision)
• Non-statutory (not created by any Act of Parliament)

The Planning Commission also handled fiscal transfers to states (through plan grants), leading to a significant overlap with the Finance Commission's domain. Dr. Rajamannar explicitly flagged this duplication in the Fourth Finance Commission Report (1965).

With the abolition of the Planning Commission in 2014 and its replacement by NITI Aayog, this overlap has been substantially reduced, restoring the Finance Commission's primacy in Centre-state fiscal transfers.

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• Article 280 establishes the Finance Commission; Article 281 deals with its recommendations.
• The Commission is a quasi-judicial, constitutional body — not a statutory or executive body.
• Qualifications are fixed by Parliament (statute), not the Constitution.
• Recommendations are advisory only — no legal enforceability.
• The 73rd and 74th Amendments (1992) added the function related to augmenting state funds for local bodies.
• The Finance Commission is constituted every five years or earlier at the President's discretion.
• The Planning Commission (now replaced by NITI Aayog) historically caused functional overlap with the Finance Commission in federal fiscal transfers.