Syllabus: GS– III & V: Finance Commission

Why in the news?

The 16th Finance Commission has recommended a revised formula for the distribution of Central taxes among States, increasing Assam’s share and introducing new performance-based criteria. This is expected to significantly influence Assam’s fiscal stability, development spending, and economic growth.

Understanding the Finance Commission

The Finance Commission is a constitutional body established under Article 280 of the Constitution of India. It is constituted every five years to recommend how financial resources should be shared between the Centre and the States.

Its key functions include:

• Recommending the distribution of Central taxes between Centre and States (vertical devolution).
• Deciding how the States’ share is distributed among individual States (horizontal devolution).
• Suggesting measures to improve fiscal discipline and financial stability.

The 16th Finance Commission recommendations will apply from 2026 to 2031, directly affecting Assam’s finances.

Increased Tax Share and Fiscal Benefits for Assam

A major positive outcome for Assam is the increase in its share of Central taxes:

• Assam’s share increased from 3.128% (15th Finance Commission) to 3.26% (16th Finance Commission).
• States will collectively receive 41% of the divisible pool of Central taxes, strengthening fiscal federalism.
• This will increase Assam’s revenue, helping fund infrastructure, welfare schemes, and economic development.

This increased share reflects Assam’s improving economic performance and strategic importance.

New Devolution Formula: Focus on Economic Performance

The 16th Finance Commission has introduced a revised formula, with weights assigned to various factors:

• Income distance – 42.5%: Helps poorer States like Assam receive higher support.
• Population (2011 Census) – 17.5%: Reflects population-based needs.
• Demographic performance – 10%: Rewards population control efforts.
• Area – 10%: Larger States receive higher support due to administrative costs.
• Forest and ecology – 10%: Benefits forest-rich States like Assam.
• Contribution to Gross Domestic Product – 10%: Newly added factor rewarding economic growth.

This new criterion benefits Assam as it balances both development needs and economic performance.

Fiscal Discipline Targets: Ensuring Sustainable Growth

The Commission has emphasized fiscal consolidation, meaning reducing excessive borrowing and maintaining financial discipline.

Key recommendations include:

• The Central government fiscal deficit should be reduced to 3.5% of Gross Domestic Product by 2030–31.
• States’ fiscal deficit should be limited to 3% of Gross State Domestic Product.
• Off-budget borrowings must be stopped and included in official fiscal accounts.

Fiscal deficit refers to the gap between government expenditure and revenue, indicating borrowing levels.

Maintaining fiscal discipline ensures economic stability and investor confidence.

Impact on Assam’s Economy and Development

Assam’s economy is showing strong growth, supported by fiscal and policy measures.

Demand-side growth factors

• Increased government capital expenditure on infrastructure.
• Higher private investment and household consumption.
• Welfare schemes and direct benefit transfers improving liquidity.

Supply-side growth opportunities

• Agriculture remains dominant, but diversification into export-oriented crops can increase income.
• Growth in industrial sector and logistics infrastructure, including Special Economic Zones and Multi-Modal Logistics Parks.
• Expansion of the service sector, especially technology, tourism, and logistics.

These developments will increase employment, income, and economic stability.

Important Economic Terms Explained

• Fiscal deficit: The difference between government expenditure and revenue, indicating borrowing requirements.
• Gross State Domestic Product: Total value of goods and services produced within a State.
• Vertical devolution: Sharing of tax revenue between Centre and States.
• Horizontal devolution: Distribution of tax revenue among different States.
• Fiscal consolidation: Efforts to reduce fiscal deficit and maintain financial stability.

Challenges and Way Forward for Assam

Despite increased financial support, Assam must address key challenges:

• High dependence on Central transfers (50–60% of State revenue).
• Need to improve tax collection and formalisation of economy.
• Need to attract foreign investment through ease of doing business reforms.
• Strengthening district-level development to reduce regional inequality.

Better fiscal management will ensure sustainable long-term growth.

Exam Hook – 

Key points:

• Finance Commission is established under Article 280.
• States receive 41% of Central taxes as per current recommendations.
• Assam’s share increased to 3.26% under 16th Finance Commission.
• Fiscal deficit limits: 3% for States, 3.5% for Centre by 2030–31.
• New criterion includes Gross Domestic Product contribution.

Mains Question:
Discuss the role of the Finance Commission in strengthening fiscal federalism and examine its impact on Assam’s economic development.

One-line wrap

The 16th Finance Commission’s revised tax-sharing formula and fiscal reforms will strengthen Assam’s financial stability and accelerate its journey towards sustainable economic growth.

Source