Finance Commission of India

The Finance Commission is a constitutional body set up under Article 280 of the Constitution of India. Within two years of the Constitution coming into force, the President had to set up a Finance Commission, and after that at the end of every fifth year, or earlier if the President thinks it is needed.

The President appoints the Finance Commission's chairman and four other members. Parliament may lay down, by law, the qualifications that members must have and the way in which they are chosen.

The four other members are chosen from among people who:

• are, have been, or are qualified to be appointed as Judges of a High Court
• have special knowledge of the finances and accounts of government
• have wide experience in financial matters and in administration, or
• have special knowledge of economics.

Using the power given to it by the Constitution, Parliament passed the Finance Commission (Miscellaneous Provisions) Act, 1951. It requires the chairman of the Commission to be chosen from people who have had experience in public affairs.

What are the duties of the Finance Commission?

It is the duty of the Commission to make recommendations to the President on the following:

• the distribution between the Union and the states of the net proceeds of taxes that are to be, or may be, divided between them, and the allocation between the states of their respective shares
• the principles that should govern the grants-in-aid to the states out of the Consolidated Fund of India
• the measures needed to augment the Consolidated Fund of a state so as to add to the resources of the panchayats in that state, based on the recommendations of the state Finance Commission
• the measures needed to augment the Consolidated Fund of a state so as to add to the resources of the municipalities in that state, based on the recommendations of the state Finance Commission
• any other matter referred to it by the President in the interests of sound finance.

The Commission decides its own procedure and has the powers that Parliament gives it by law to carry out its work. Under Article 281, the President must place every recommendation of the Finance Commission before each House of Parliament, along with an explanatory memorandum on the action taken on it.

The way tax revenue is shared shows how legislative and administrative powers in India lean towards the Centre. The Centre's sources of revenue are large and spread out, while the states' revenues are more limited and their responsibilities are many, because the states have to run most welfare programmes.

As a result, the states depend on the Centre for financial support. They receive part of this support as grants, given on the basis of the Finance Commission's recommendations. Even so, the main responsibility for the well-being of citizens rests with the states.

At first glance, centralising financial control can look as if it goes against the federal spirit of the Indian Constitution. But it has to be understood against India's history and the need to keep the country united. The Central Government is finally responsible for the economic unity, and therefore the overall welfare, of the nation.

Grants have flowed to the states through more than one channel. The Finance Commission is a statutory constitutional body, whereas the old Planning Commission was only an executive body created by a government resolution, and it used to hand out plan grants to the states. The Planning Commission was replaced in 2015 by NITI Aayog, a policy think tank.

The 15th Finance Commission

What grants did the 15th Finance Commission recommend?

The Finance Commission's Terms of Reference ask it to make grant-in-aid recommendations to the states. In its report for 2020-21, these grants fell into three broad groups:

1. revenue deficit grants
2. grants to local governments
3. disaster management grants.

Because of the way tax devolution worked out, 14 states were expected to face a revenue shortfall. To make up for this, the Commission recommended that these 14 states receive revenue deficit grants totalling Rs 74,341 crore.

In addition, three states (Karnataka, Mizoram and Telangana) were given special grants totalling Rs 6,674 crore. These special grants were meant to make up for the fact that their combined total of tax devolution and revenue deficit grants in 2020-21 was less than in 2019-20.

For 2020-21, the Commission recommended a total grant to local bodies of Rs 90,000 crore. This was about 4.31 per cent more than the Rs 87,352 crore set aside for the same purpose in 2019-20.

Rural local bodies were to receive Rs 60,750 crore and urban local bodies Rs 29,250 crore. Panchayats at the village, block and district levels would receive these funds.

The Commission also called for National and State Disaster Management Funds to help with mitigation work at the community level. It recommended a grant of Rs 28,983 crore for the State Disaster Risk Management Fund and Rs 12,390 crore for the National Disaster Risk Management Fund.

Apart from this, there were guidelines for performance-based grants and sector-specific grants. For 2020-21, the Commission proposed a grant of Rs 7,375 crore for nutrition. Sector-specific grants in the final report were to cover:

1. nutrition
2. health
3. pre-primary education
4. the judiciary
5. railways.

Why it still matters

The Finance Commission is not just something from a textbook. A new one is at work right now, and it decides how money is split between the Centre and the states for the next five years.

The 16th Finance Commission, chaired by the economist Arvind Panagariya, was set up to cover the years 2026-27 to 2030-31. Its report was placed before Parliament along with the Union Budget in February 2026, and the government accepted its tax-sharing plan, which runs from 1 April 2026 to 31 March 2031.

The biggest debate was about vertical devolution: how much of the Centre's shareable tax pool should go to the states. Most states, including Maharashtra and Telangana, formally asked for the states' share to rise from 41 per cent to 50 per cent. They argued that their jobs in health, education and welfare keep growing, while the Goods and Services Tax has reduced their own power to raise taxes. The 16th Finance Commission kept the share at 41 per cent, the same as before, saying that a bigger share would squeeze the Centre's own finances.

There was one important change. For the first time, the formula that divides money among the states now gives weight to how much each state adds to India's GDP, and the report puts a strong focus on fiscal discipline. In all, the Commission recommended grants of about Rs 9.47 lakh crore over the five years. So the exact body described in these notes is deciding, right now, how schools, hospitals and local councils across India will be funded up to 2031. You can explore how India's economy works in the Learnacy Hub, read more Indian Polity notes, or browse all of our study resources.

Sources

1. PRS Legislative Research: Report of the 16th Finance Commission for 2026-31
2. Drishti IAS: 16th Finance Commission Report
3. Deccan Herald: States urge the 16th Finance Commission to raise their share of central taxes to 50 per cent

Key takeaways

• The Finance Commission is a constitutional body established by the President of India every five years to oversee financial matters.
• The group is led by a chairman with experience in public affairs and includes four other members with specific legal, financial, administrative, or economic expertise.
• A major duty of the Commission is to recommend how tax revenues should be shared between the central government and the states.
• States depend heavily on the central government for financial grants because they manage most welfare programs but have limited revenue sources.
• For the 2020-21 period, the 15th Finance Commission recommended specific grants to cover state revenue deficits, support local governments, and fund disaster management.

Test yourself

Which article of the Indian Constitution mandates the creation of the Finance Commission?

Article 280.

Who appoints the chairman and the members of the Finance Commission?

The President of India.

What organization replaced the Planning Commission in 2015?

NITI Aayog.