What can local bodies expect from the 16th FC?

Why is it in News?

• On November 17, the 16th Finance Commission submitted its report to the President of India.
• Key expectations:
  • Vertical devolution (share of Union taxes to States) and
  • Horizontal distribution formula across States (Article 280).
• Important focus: recommendations for panchayat & municipal finances (Art. 280(3)(bb) & (c)).

Relevance

• GS 2: Polity & Governance (73rd/74th Amendments, fiscal decentralisation, local government)
• GS 3: Economy (fiscal federalism, vertical–horizontal devolution, public finance)
• GS 2: Centre–State Relations (role of Union FC vs SFCs)

Constitutional Framework for Finance Commissions

Union Finance Commission (UFC) – Article 280

• Constituted every 5 years.
• Mandate includes:
  • Vertical & horizontal tax devolution.
  • Measures to strengthen State finances.
  • Augment the Consolidated Fund of States for panchayats & municipalities.

State Finance Commissions (SFCs) – 73rd & 74th Amendments

• Each State must set up an SFC every 5 years.
• Recommends:
  • Local share in State taxes.
  • Assignment of revenue handles.
  • Conditional/unconditional grants.
  • Devolution of functions & functionaries.

Local Governments: Functional & Fiscal Architecture

Functions

• Assigned through the 11th Schedule (29 subjects) for panchayats & 12th Schedule (18 subjects) for municipalities.
• However:
  • These lists are illustrative, not mandatory.
  • States decide actual functional assignments → wide inter-State variation.

Revenue Powers

• Local bodies collect:
  • Property tax
  • Advertisement tax
  • Market fee, tolls, user charges, etc.
• But large mismatch exists between:
  • Revenue capacity
  • Expenditure responsibilities (water, sanitation, public health, rural roads, asset maintenance).

Impact

• States often assign functions without funds & staff →
  • Operational inefficiency
  • Dependence on higher-level transfers
  • Weak service delivery
  • Fiscal deficits at local levels.

Role & Challenges of SFCs

• Over 100 SFC reports submitted across States.
• Major issues:
  • Delays in constitution & report submission.
  • Poor record of acceptance by State legislatures.
  • Recommendations often ignored or partially implemented.
• Result: local bodies must rely heavily on Union FC transfers, not States.

What Previous Union Finance Commissions Did

Key Pattern

• Six UFCs have issued local government recommendations so far.
• Persistent issues:
  • Could not quantify actual resource needs of 2.7 lakh panchayats & 5,000 municipalities.
  • Relied on ad hoc lump-sum grants.

13th FC (Turned Point)

• Introduced formula-based transfers:
  • Grant as a percentage of the divisible pool.
  • Rationale:
    • Inflation neutrality
    • Buoyancy with Union tax revenues
• Consulted legal experts; pushed for predictable growth-linked transfers.

14th & 15th FCs (Reversal of 13th FC Approach)

• Returned to lump-sum grants.
• Introduced conditionalities:
  • “Basic” (unconditional)
  • “Performance-based” (conditional)
• Problem:
  • Each FC changed reform conditions, creating discontinuity.
  • 13th FC: 6 conditions (mostly unmet by States).
  • 14th FC: new and unrelated set of conditions.
  • 15th FC: different conditions again.

Core Issues in Local Government Fiscal Federalism

1. Vertical–Horizontal Imbalance

• Local governments do not have predictable, adequate revenue streams.
• Functional responsibilities grow but revenue handles remain restricted.

2. Assignment Problem

• No dedicated constitutional list for:
  • Local functions
  • Local revenue sources
• States exercise wide discretion → fiscal asymmetry.

3. Overdependence on Union FC

• Weak SFC implementation forces panchayats/municipalities to rely on central transfers.

4. Conditionality Instability

• Reform-linked grants change every 5 years →
  • No continuity
  • No long-term incentive alignment.

What Is Expected from the 16th Finance Commission?

• Move beyond ad hoc or lump-sum grants.
• Assess actual resource requirements of 2.7 lakh panchayats & 5,000 municipalities.
• Provide stable, formula-driven, buoyancy-linked transfers.
• Standardise performance conditions instead of frequent redesign.
• Strengthen local bodies as institutions of:
  • Economic development
  • Social justice

Comprehensive Significance

• Strengthens decentralised governance, core to the 73rd & 74th Amendments.
• Potentially creates India’s first consistent, long-term local fiscal framework.
• Aligns local governance with national goals:
  • Drinking water
  • Sanitation
  • Public health
  • Rural/urban infrastructure.

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