The 20th Finance Commission of India, established in February 2024, marks a significant step in the ongoing process of fiscal federalism in the country. Chaired by Arvind Panagariya, former Vice Chairman of NITI Aayog, the commission is tasked with recommending the principles governing the distribution of tax revenues between the Union Government and the States for the five-year period commencing April 1, 2026.
The commission’s mandate is broad and complex, encompassing a detailed assessment of the current state of the Union and State finances. It must consider factors such as revenue mobilization efforts, expenditure commitments, and the overall fiscal discipline of both levels of government. Critically, the 20th Finance Commission will analyze the impact of various policies and programs on the fiscal sustainability of states, including centrally sponsored schemes and disaster management initiatives.
A key responsibility lies in recommending the vertical devolution of taxes – the share of central taxes that should be allocated to the states as a whole. This is a politically sensitive area, as states invariably seek a larger share to address their developmental needs and bridge fiscal deficits. The Commission will likely grapple with balancing the demands of states with the central government’s need to finance its own essential functions, including defense, infrastructure, and social welfare programs.
Equally important is the horizontal devolution – the formula for distributing the divisible pool of taxes among the individual states. This is often the most contentious aspect, as states compete for resources based on various criteria. Past Finance Commissions have used factors like population, area, per capita income, and fiscal discipline to determine the allocation. The 20th Finance Commission is expected to review these criteria and potentially introduce new ones to better reflect the changing economic landscape and address regional disparities. Considerations might include demographic performance, environmental protection efforts, and progress towards achieving Sustainable Development Goals (SDGs).
Beyond tax devolution, the Commission will also make recommendations on grants-in-aid to states under Article 275 of the Constitution. These grants are intended to address specific needs of states, such as covering revenue deficits or financing sector-specific projects. The 20th Finance Commission will need to assess the criteria for awarding these grants and ensure they are targeted effectively to address genuine fiscal needs and promote equitable development.
The Commission’s recommendations will have far-reaching consequences for the fiscal health and developmental trajectory of both the Union and the States. Its report, due to be submitted by October 31, 2025, will shape the financial relationship between the center and the states for the next five years, influencing investment decisions, social programs, and the overall economic growth of the country. The composition of the commission, comprising experts in economics, finance, and public administration, suggests a commitment to a rigorous and evidence-based approach to addressing the complex challenges of fiscal federalism in India.
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