Challenges Before the Sixteenth Finance Commission (FC)

GS2 – Polity – constitutional bodies

Context:
The Sixteenth Finance Commission is tasked with addressing fiscal challenges and shaping India’s economic trajectory amidst evolving global trends like friendshoring (relocating supply chains to friendly nations) and reshoring (bringing manufacturing back to the home country).

Mandate of the Sixteenth Finance Commission

1. Historical Role:
   • Focused on equitable redistribution of resources since 1951 through vertical (Union to States) and horizontal (among States) allocations.
2. Tax Revenue Sharing:
   • Recommend distribution of tax revenues for the five-year period starting April 1, 2026.
3. Grants-in-Aid:
   • Determine principles for granting aid from the Consolidated Fund of India to States.
4. Urban Local Bodies:
   • Recognize their contribution to economic development and recommend increased allocations.
5. Disaster Management:
   • Suggest improved financing mechanisms for disaster management.
6. Climate Change:
   • Propose funding for climate mitigation and adaptation measures.
7. Fiscal Discipline:
   • Advise on enhancing fiscal discipline and efficient public expenditure.

The FC’s decisions will significantly impact India’s economic growth and equitable development.

Issues with Current Redistribution Policies

1. Horizontal Devolution:
   • Balancing equitable resource allocation for less-developed States while promoting overall national growth.
2. Challenges for Progressive States:
   • Demographic Changes:
     • States like Tamil Nadu face declining tax revenues due to ageing populations and rising costs, risking the “middle-income trap.”
   • Urbanisation:
     • Rapid urbanisation in Tamil Nadu (projected at 57.3% by 2031) demands increased funding for infrastructure to sustain growth.
3. Decline in Devolution:
   • Despite the 15th FC recommending 41% vertical devolution, actual devolution fell to 33.16% due to the Union’s rising reliance on cesses and surcharges, which are not shareable with States.

Need for Progressive Resource Allocation

1. Present Shortcomings:
   • States need greater fiscal autonomy to promote local development.
2. Proposed Reforms:
   • Advocate for increasing devolution of gross central taxes to 50%.
3. Performance-Based Allocation:
   • Resource allocation tied to States’ contributions to national growth.

Way Forward

1. Enhanced Resource Allocation:
   • Empower States through performance-based resource distribution to encourage economic growth.
2. Urban and Demographic Strategies:
   • Address urbanisation and demographic challenges by dedicating funds for infrastructure and population management in progressive States.
3. Balanced Distribution:
   • Ensure equitable resource sharing while expanding the national economy.
4. Strengthened Policy Frameworks:
   • Support high-performing States with targeted strategies to sustain their role as growth drivers.

A balanced and forward-looking approach by the Sixteenth Finance Commission will ensure that resource allocation promotes equitable growth while addressing the unique challenges of progressive and less-developed States alike.