Finance Commission (Article 280)

The Finance Commission is a body set up by the President of India every five years under Article 280 of the Constitution. Its main job is to recommend how the money the Centre collects through taxes should be shared between the Centre and the states, and then among the states. It also recommends grants (extra help money) for states and for local bodies like panchayats and municipalities.

You can think of it as a neutral referee who decides, once every five years, how the national tax cake is cut.

Why does India need it?

In India, the Centre collects most of the big taxes, like income tax, corporation tax and the central part of GST. But the states do most of the spending on things people use daily: police, hospitals, schools, roads and water. This gap between "who earns" and "who spends" is called vertical fiscal imbalance. States are also very unequal: some are rich, some are poor.

Without a fair, regular and neutral system, the Centre could share money based on favour, and poorer states would fall further behind. The Finance Commission fixes this with a formula that everyone can see.

Where did it come from?

The idea of sharing central taxes with provinces existed even under British rule (for example, the Government of India Act, 1935 had provisions for sharing income tax). The makers of our Constitution made it a permanent, constitutional body through Article 280. Parliament then passed the Finance Commission (Miscellaneous Provisions) Act, 1951, which sets the qualifications of members.

The First Finance Commission was set up by a Presidential order dated 22 November 1951, under the chairmanship of K.C. Neogy. Since then, a new Commission has been set up roughly every five years.

What does Article 280 say?

In simple words:

• Article 280(1): The President sets up a Finance Commission within two years of the Constitution starting, and then at the end of every fifth year, or earlier if needed.
• Who is in it: A Chairman and four other members, all appointed by the President.
• Article 280(2): Parliament can make a law on members' qualifications and how they are chosen. This is the 1951 Act.
• Article 280(3): The Commission recommends on:
• (a) how the net proceeds of shareable taxes are divided between the Centre and the states, and how the states' share is divided among states;
• (b) the principles for grants-in-aid to states from the Consolidated Fund of India (these are given under Article 275);
• (bb) steps to increase a state's funds so it can support its panchayats, based on the State Finance Commission's advice (added by the 73rd Amendment);
• (c) steps to increase a state's funds so it can support its municipalities, based on the State Finance Commission's advice (added by the 74th Amendment);
• (d) any other matter the President refers to it "in the interests of sound finance".
• Article 281: The President places the Commission's recommendations before both Houses of Parliament, along with a note (an explanatory memorandum) on what action the government has taken.

Who can be a member?

Under the 1951 Act, the Chairman must have experience in public affairs. The four other members are chosen from people who:

1. are, have been, or are qualified to be High Court judges; or
2. have special knowledge of government finances and accounts; or
3. have wide experience in financial matters and administration; or
4. have special knowledge of economics.

How does the sharing work?

The work happens in two steps.

• Step 1, vertical devolution: The Commission decides what share of the divisible pool of central taxes goes to all states together. The divisible pool is the central tax money left after removing cesses, surcharges and the cost of collecting taxes. Cesses and surcharges are kept out because of Article 270, which was rewritten by the 80th Amendment Act, 2000.
• Step 2, horizontal devolution: The Commission then divides the states' share among the states using a formula. Each factor in the formula (income, population, area, forest and so on) gets a weight.

A simple example: suppose the divisible pool is ₹100. If the Commission says states get 41%, then ₹41 goes to all states together. That ₹41 is then split among states. A poorer state with more people gets a bigger slice.

Recent Commissions at a glance

• 14th Finance Commission (Chair: Y.V. Reddy, for 2015-20): raised the states' share from 32% to 42%, the biggest jump ever, and moved towards untied money.
• 15th Finance Commission (Chair: N.K. Singh, for 2021-26): kept the share at 41%. The 1% cut was an adjustment for the new Union Territories of Jammu and Kashmir, and Ladakh, which are funded by the Centre.
• 16th Finance Commission (Chair: Arvind Panagariya, for 2026-27 to 2030-31): set up on 31 December 2023; report given to the President on 17 November 2025 and tabled in Parliament on 1 February 2026. It kept the states' share at 41%.

The 16th Finance Commission's formula (horizontal criteria)

• Income distance: 42.5% (was 45% under the 15th FC)
• Population (2011 Census): 17.5% (was 15%)
• Demographic performance: 10% (was 12.5%); now measured by population growth from 1971 to 2011
• Area: 10% (was 15%)
• Forest: 10% (same)
• Contribution to GDP: 10% (new criterion)
• Tax and fiscal effort: dropped (was 2.5%)

Other key 16th FC recommendations (as of 2026)

• Total grants of about ₹9.47 lakh crore, of which local body grants are about ₹7.91 lakh crore (rural about ₹4.35 lakh crore; urban about ₹3.56 lakh crore).
• Revenue deficit grants discontinued.
• Disaster management: Centre's share about ₹1.56 lakh crore; Centre-state cost sharing of 90:10 for north-eastern and Himalayan states and 75:25 for others.
• Fiscal path: Centre to bring its fiscal deficit to 3.5% of GDP by 2030-31; states to keep their fiscal deficit within 3% of GSDP; off-budget borrowings to stop and be shown in budgets.

Commonly confused concepts

• Finance Commission vs State Finance Commission: The Finance Commission (Article 280) is set up by the President and deals with Centre-to-state sharing. A State Finance Commission (Articles 243-I and 243Y) is set up by the Governor and deals with state-to-local body sharing. The Union Finance Commission uses the State Finance Commissions' reports while making its local body recommendations.
• Article 275 vs Article 282 grants: Article 275 grants are statutory grants given on the Finance Commission's advice, out of the Consolidated Fund of India. Article 282 grants are discretionary grants that the Centre or a state can give for any public purpose, without the Finance Commission.
• Finance Commission vs NITI Aayog: The Finance Commission is a constitutional body that is set up every five years. NITI Aayog (2015) is created by an executive resolution of the Union Cabinet. It is a think tank and does not decide tax sharing. Its predecessor, the Planning Commission, used to give plan grants.
• Divisible pool vs gross tax revenue: The states' 41% share is of the divisible pool, not of all central taxes. Because cesses and surcharges are outside it, states actually receive a smaller share of total central tax collections.

Issues, criticism and the way forward

• Cesses and surcharges: The Centre's use of cesses and surcharges has grown. Since they are not shared, states argue their real share is lower than the headline figure.
• North vs south debate: States with better population control and higher income often feel the formula punishes them, because weights on population and income distance send more money to poorer, more populous states. The 16th FC added "contribution to GDP" partly in response.
• Conditions on grants: Tied grants and entry conditions push reforms (like publishing audited accounts), but critics say they reduce states' freedom to spend on local priorities.
• Weak local data: Many local bodies do not publish accounts on time, which delays grants. Experts suggest stronger State Finance Commissions and digital, audited accounts for every local body.
• Way forward: Many experts suggest keeping cesses and surcharges within a limit, making grants more predictable, and building better state-level data so that the formula is fairer.

Concepts to Know

• Devolution: Passing money or power from a higher level of government to a lower level, for example from the Centre to the states.
• Divisible pool: The part of central tax money that can be shared with states. It leaves out cesses, surcharges and collection costs.
• Cess and surcharge: A cess is an extra tax collected for a specific purpose (like a health and education cess). A surcharge is a tax on a tax (an extra percentage on the tax already payable). Neither is shared with states.
• Grants-in-aid: Money given by one government to another to help it meet its needs, beyond its share of taxes.
• Untied vs tied grants: Untied grants can be spent on any local need. Tied grants can only be spent on fixed purposes, like water or sanitation.
• Income distance: A measure of how far a state's per person income is below the richest states. The poorer the state, the more money it gets under this criterion.
• GSDP (Gross State Domestic Product): The total value of goods and services produced in a state in a year. It is the state version of GDP.
• Fiscal deficit: The gap between what a government spends and what it earns (excluding borrowing). It shows how much the government must borrow.