The 12th Finance Commission: A Period of Fiscal Consolidation and Equitable Distribution

The 12th Finance Commission (XII FC), constituted under the chairmanship of Dr. C. Rangarajan, was responsible for recommending the principles governing the distribution of financial resources between the Union Government and the State Governments in India for the period spanning from April 1, 2005, to March 31, 2010. The Commission operated during a period of significant economic growth and focused primarily on fiscal consolidation and ensuring equitable resource allocation.

Key Recommendations and Objectives

A central objective of the XII FC was to promote fiscal discipline among both the Union and the States. It aimed to achieve this by incentivizing States to improve their revenue mobilization efforts and manage their expenditures more efficiently. A key feature was the emphasis on debt consolidation and reduction, acknowledging the substantial debt burden carried by many states.

The Commission retained the formula-based approach for devolution of taxes, but with certain refinements. The primary objective was to ensure a more equitable distribution of resources while also considering the specific needs and performance of individual states. This involved using indicators like population, income distance (the gap between a state’s per capita income and the highest per capita income among all states), area, infrastructure development, and fiscal discipline. This approach aimed to assist financially weaker states in catching up with their more prosperous counterparts.

Specific Recommendations and Impacts

One significant recommendation was the increase in the share of net proceeds of Union taxes to be devolved to the States, raising it from 29.5% to 30.5%. This was designed to provide States with greater financial autonomy and flexibility in implementing their development programs.

The XII FC also introduced performance-based grants for specific sectors such as education, health, and infrastructure. These grants were contingent on States achieving pre-defined targets in these sectors, thereby promoting efficiency and accountability in the utilization of public funds. A key recommendation was related to the Debt Consolidation and Relief Facility (DCRF) for States, aiming to reduce their debt burden. This involved rescheduling central government loans and providing debt relief linked to fiscal performance.

Furthermore, the Commission emphasized the importance of local bodies (Panchayats and Municipalities) and recommended grants to strengthen their financial position. These grants were intended to improve the delivery of basic services at the grassroots level and empower local governance.

Assessment

The recommendations of the XII FC were generally well-received, contributing to improved fiscal management by both the Union and the States. The increased devolution of funds provided States with greater resources for development, while the performance-based grants incentivized improved efficiency and outcomes in key sectors. The focus on debt consolidation helped many states alleviate their debt burden and improve their financial health.

However, some criticisms were also raised. Certain states felt that the formula for tax devolution, despite its refinements, still did not adequately address their specific needs and challenges. The implementation of performance-based grants also faced challenges, as some States struggled to meet the pre-defined targets. Overall, the XII FC played a crucial role in shaping the fiscal landscape of India during a period of economic transformation, promoting both fiscal responsibility and equitable resource distribution.