To ensure a fair distribution of revenue and resources, the Finance Commission carries out two types of functions: 

• Preparatory functions: It is responsible for collection/collation of data, analysis of data, evaluation of state of finances of union and state governments, discussion/studies leading to preparation of background papers etc. Data collected from these exercises helps the Commission in determining the actual status of finances and deciding criteria for recommendations.
• Recommendatory functions:  Recommendations of the Finance Commission are designed to improve quality of public spending and fostering fiscal stability. The Finance Commission is tasked with advising the President on:
  • Vertical and horizontal distribution of revenue: The distribution of revenue both vertically and horizontally: The Finance Commission advises the President on how to share the net tax revenues between the Centre and the States (vertical devolution) as well as how to allocate the respective shares of such revenues among the States (horizontal devolution).
  • Grants-in-Aid: Under Article-275, it is the duty of the Commission to recommend principles that should govern the grants-in-aid to States out of the Consolidated Fund of India by the Centre.
  • For local bodies: The Commission may propose measures to enhance the Consolidated Fund of State to support the finances of Panchayats and Municipalities based on recommendations from the State Finance Commission. This provision was added by the 73rd and 74th Constitutional Amendment Act, 1992.
  • Other matters: Apart from above mentioned functions, it is the duty of Commission to give advice to the President on any other matter referred to by the President in the interest of sound finance.

The recommendations made by the Finance Commission are advisory in nature and it is not an obligation on the Union Government to implement its recommendations. However, there is a convention that governments generally accept its recommendations and implement them though a Presidential order.

Powers and Procedure of Finance Commission

The Finance Commission has certain powers in exercising its functions like:

• The Commission can determine its own procedure and in performing its functions have all the powers of a civil court under Code of Civil Procedure, 1908.

• The Commission can summon and enforce the attendance of witnesses.
• It can require the production of any document.
• It has the authority to request any public documents from any court or office.

Report of Finance Commission

The Finance Commission presents its report to the President, who then submits it to both Houses of Parliament along with an explanatory note about the actions taken regarding its recommendations.

15th Finance Commission

The 15th Finance Commission was constituted by the President on 27th November, 2017 under chairmanship of N.K. Singh. It had an onerous task on its hands because; it had to take into consideration the significant impact of pandemic on economy and resources. Its major recommendations were:

• Vertical devolution of taxes: Vertical devolution means transfer of revenues from Union to states. In 15th Finance Commission recommendations, the share of states in the central divisible pool was kept at 41% against earlier 42% (because of newly formed UTs of Jammu and Kashmir and Ladakh). 
• Criteria for horizontal distribution: Horizontal distribution means distribution of revenue among various states. To achieve this, the 15th Finance Commission assigned the greatest importance to income distance, which is the disparity of a state’s gross state domestic product compared to the one with the highest gross state domestic product

Finance Commission as a permanent body

Several experts have recommended that the Finance Commission be established as a permanent, ongoing institution rather than a temporary one. This need arises because every time a Finance Commission is formed, it must start anew, facing challenges such as recruiting temporary staff, organizing workflows, meeting tight deadlines, and handling various administrative and financial obstacles. Therefore, continuous functioning of the Commission is essential for consistent data updates, monitoring fiscal responsibility by both Union and States throughout the year, and providing the President with timely recommendations based on real-time analysis. This is crucial to mitigate the widening gap between affluent and underprivileged states.

Conclusion

The sanctity and importance of the Finance Commission lies in the fact that it forms the fulcrum which balances intergovernmental financial relations of our federation. The Finance commission has taken an All India approach and has constantly evolved the criteria for devolution to help the poorer states.  Since the rich states are able to attract investment, the poor states need fiscal stimulation or a fiscal push to overcome the growing disparities between the rich and poor states. 

Thus, to promote the principles of Sabka Sath, Sabka Vikas, and Sabka Vishwas, it becomes increasingly vital for this institution to adopt an inclusive approach in its operations.

The overall criteria for horizontal distribution is as follows: