16th Finance Commission - Terms of Reference

The Finance Commission of India plays a crucial role in shaping the fiscal relationship between the central government and the states. The commission is appointed every five years to recommend the distribution of financial resources among states and identify the principles that govern the allocation of funds. The 16th Finance Commission, constituted in 2020, holds particular significance as it operates in a dynamic economic and political landscape.

Terms of Reference for the Sixteenth Finance Commission

The Finance Commission will make recommendations to the following matters:

Distribution of Net Proceeds of Taxes

The group will recommend the distribution between the Union and the States of the net proceeds of taxes outlined in Chapter I, Part XII of the Constitution. This includes the allocation of respective shares of such proceeds among the States.

Principles Governing Grants-in-Aid

Terms of Reference will also represent the principles guiding grants-in-aid from the Consolidated Fund of India to the States’ revenues. Additionally, it will specify the sums to be disbursed to the States as grants-in-aid under Article 275 of the Constitution, excluding the purposes mentioned in the provisos to clause (1) of that article.

Resource Augmentation for Panchayats and Municipalities

It will identify measures necessary to augment the Consolidated Fund of a State. This augmentation aims to supplement the resources available to Panchayats and Municipalities within the State, aligning with the recommendations made by the State’s Finance Commission.

Review of Disaster Management Financing

The Finance Secretary and Secretary are also authorized to review the existing arrangements for financing Disaster Management initiatives, particularly about funds established under the Disaster Management Act, 2005 (53 of 2005). It may provide suitable recommendations to enhance the effectiveness of these financing mechanisms.

It is mandated to present its comprehensive report by the 31st day of October 2025. This report will cover a period of five years, commencing on the 1st day of April 2026. It will be instrumental in guiding the fiscal policies and resource allocations for both the Union and the States.

Transition to the GST System

The implementation of the Goods and Services Tax (GST) marks a significant transformation in India’s taxation structure. The shift from a production-oriented tax system to a consumption-oriented one requires a reassessment of fiscal federalism to harmonize with this updated tax framework.

Consolidation of Indirect Tax Authority

Considering the substantial shifts in the tax environment, it is imperative for the Commission to conduct a comprehensive evaluation of the consolidation of indirect tax authority between the Union and states within the framework of the GST system.

Revise Tax Allocation Guidelines

The Commission should conduct a detailed examination and revision of tax allocation principles, particularly concerning the divisible pool, unresolved Integrated Goods and Services Tax (IGST), and settlement frequencies, in accordance with the structure of the GST.

Final Thoughts

The 16th Finance Commission’s Terms of Reference outline a comprehensive approach to ensure a balanced and equitable distribution of resources in India. The commission will play a pivotal role in fostering financial stability and inclusive development across the country by addressing income distribution, tax devolution, grants, and more.

Key takeaways

• The Commission will recommend how to share the money collected from taxes between the national government and the states.
• The Commission will also determine ways to increase a state’s main fund.
• The commission will also check and improve how funds can be used for Disaster Management initiatives.