SEBI Grade A Phase I and Phase II Course: Facebook: Telegram

SEBI Grade A Phase I and Phase II Course : https://www.oheyo.
com/sebi-grade-a-securities-market-special-module
Facebook : https://www.facebook.com/groups/892893897518645/ Telegram : https://t.me/TargetRBI2018
SEBI eBooklet #1B
Finance
Commission
Centre-State Relations and Finance Commission
Introduction : Under Article 280 of the Constitution of
India, the President is to appoint a Finance Commission,
once in every five years, to look into the financial relations
between the Union and the States. The Commission will
recommend :
■ as to the allocation of the net proceeds of taxes
between the Union and the States which are to be
divided between them and the allocation between
the States of the respective shares of such proceeds;
■ the principles which should govern the grants-in-
aid of the revenues of the States out the consolidated
Fund of India;
■ the measures needed to augment the Consolidated
Fund of a State to supplement the resources of
the Panchayats in the State on the basis of the
recommendations made by the Finance Commission
of the State;
■ the measures needed to augment the Consolidated
Fund of a state to supplement the resources of
Municipalities in the State on the basis of the
recommendations made by the Finance Commission
of the State;
■ any other matter referred to the commission by the
Course by : MR. SUSHEEL A RAGADE (Ex. Manager Reserve Bank of India) BE (E&T), MBA (Finance), NET JRF (Management), NET JRF
(Economics), BFM (IIM, Bangalore), FEM (IIM, Bangalore) 2
SEBI Grade A Phase I and Phase II Course : https://www.oheyo.com/sebi-grade-a-securities-market-special-module
Enlight Education | SEBI eBooklet #1B
President in the interests of sound finance.

Composition of the Finance Commission
The Finance Commission which will be headed by
a Chairperson will have four other Members who are
selected from amongst:
i) those who are, have been, or are qualified to be
Judges of a High Court; or,
ii) have knowledge of Government finances or
accounts, or,
iii) have had experience in administration and financial
expertise; or,
iv) have special knowledge of Economics.
The report of the Finance Commission is to be laid in
both Houses of Parliament.
Task of the Finance Commission
While making the recommendations, Finance
Commission has to take into account the following factors:
• the resources of the Central and State Governments
for the five year period under reference;
• the levels of tax and non-tax revenues likely to be
reached by the Centre and the States;

• the demands on the resources of the Central
Government on account of the expenditure on
civil administration, defence, internal and border
security, debt-servicing, and other expenditure and
liabilities;
• the resources of the State Governments and the
demands on such resources under different heads
such as administration, law and order, welfare
and development, and the impact of debt levels on
resource availability, particularly in states stressed
by debt;
• level of subsidies required, having regard to the
need for sustainable and inclusive growth, and
equitable sharing of subsidies between the Central
Government and State Governments;
• balancing the receipts and expenditure on revenue
account of all the States and the Union, and
generating surpluses for capital investment;
• the taxation efforts of the Central Government
and each State Government and the potential for
additional resource mobilization to improve the
tax-Gross Domestic Product ratio in the case of the
Union and tax-Gross State Domestic Product ratio
in the case of the States.
Division of Financial Poi/Veers
Under the division of financial powers in the Indian
state, there is sharp imbalance between the powers of the
Centre and the States and local bodies to tax and raise
revenues, and the responsibilities and resultant financial
liabilities devolving on them. As the more potential
revenue sources lie with the Centre, viz., the income
tax, excise, and customs duties, there is a high degree
of concentration of revenues in favour of the Centre. The
assignment of a large share of responsibilities involving
expenditure to lower governmental levels has resulted
in a vertical fiscal imbalance necessitating transfer of
resources from the Centre to the States.
While the arrangement worked rather smoothly in the
first two decades, problems emerged in the 1980’s with
rising deficits both at the Centre and the States. Successive
Finance Commissions have been recommending increasing
sums of grants-in-aid and transfer of tax revenues to the
States.
Finance Commissions from 1952
So far, starting from 1952, there have been 14
Finance Commissions. The work and reports of the first
twelve Commissions covered the period from 1952 to
2010. The 13th Commission, headed by Dr. Vijay Kelkar,
was constituted in 2007 and it made recommendations
for the period 2010 to 2015. The Fourteenth Finance
Commission, headed by Dr. Y. V. Reddy, was constituted
in 2013 to make recommendations for the period 2015-
20.
The recommendations of the 12th Finance Commission,
headed by Dr. C. Rangarajan, for the period 2005-10
covered tax devolution, grants to States, debt relief,
financing of relief expenditure, and related matters. The

Commission recommended that the share of the States
in the net proceeds of shareable central taxes would be
30.5 per cent during 2005-10 as against 29.5 per cent
fixed by the Eleventh Commission for the period 2000-05.
For this purpose, additional excise duties in lieu of sales
tax on textiles, tobacco, and sugar are treated as part of
the general pool of central taxes. The 12th Commission
recommended that indicative amount of overall transfer
to States may be fixed at 38 per cent of the central gross
revenue receipts, as against 37.5% of the gross revenue
receipts of the Central Government recommended by the
Eleventh Commission for 2000-05.
The 13th Commission recommended that share of the
States in net proceeds of shareable central taxes shall be
32 per cent during the financial years from 2010-11 to
2014-15. The 14th Commission (covering the period 2015-
20) has recommended that States’ share in net proceeds
of tax revenues be 42 per cent, a huge jump from the 32
per cent recommended by the 13th Commission. This is
the largest change ever in the percentage of devolution, an
unprecedented increase which would endow and empower
States with more resources. This devolution would be of
the order of 5.24 lakh crore in 2015-16. Another 3.04

lakh crore would be transferred by way of grants and Plan
transfers.
Transfer of Central Schemes to States
Against the background of larger devolution of funds
to States after accepting the 14th Finance Commission
recommendations, the Centre has decided, in consultation
with States, to transfer many of the centrally sponsored
schemes (CSS) to be undertaken by the States within
their resources. The amount of funds in each CSS which
States can spend on their discretion within the overall
parameters of the main scheme, known as Ilexi-funds’,
has also been proposed to be raised to 25 per cent from
10 per cent. However, some States still want the Centre to
share a greater burden of the these schemes.
15th Finance Commission
The government has set up the 15th Finance
Commission.. What are the main tasks before the 15th
Commission?
The government has appointed 15th Finance
Commission in December 2017. It will make
recommendations on tax devolution and grants for the
period 2020-25. It is headed by N.K. Singh with four other
members.
Core tasks for the Commission
Apart from the core tasks listed as per Constitutional
mandate, viz., devolution of taxes, grants ip aid to be given
to states and measures to supplement the consolidated
funds of states to supplement the resources of urban and

rural local bodies, the Commission has been asked to
make recommendations on other crucial issues.
Population Criteria
An important difference from the earlier Commissions
is that while the past Commissions were asked to take into
account 1971 population while deciding the devolution
formula, the 15th Commission has been asked to use
the 2011 population. The 14th Commission was asked
to take into account 1971 population and subsequent
demographic changes. The shift to latest demographics
can be justified since expenditure by states on public
goods has to be linked to number of citizens. But this
may be a sore point for the southern states which have
been more successful in reducing their rate of population
growth.
Other tasks before the 15th Commission
Fiscal Targets : The
Commission is expected
to recommend new fiscal
targets for the Union
and state governments.
While the states have,
by and large, complied
with the targets, the
Centre has not been
able to stick to them.
After the 14th Finance
Commission proposed a
fiscal roadmap, the Fiscal Review Committee, headed by N

K Singh, was asked to revisit it for the period up to 2023.
It is to be seen if the targets to be set by the Commission
will be broadly similar to what the K K Singh Committee
recommended. (See under N K Singh Committee on FRBM
Act and Fiscal Policy on pg. 14.18-9 for more on this).
Review of funds devolution : Another task is to
review the impact of the liberal increase in the devolution
of funds to the States/UTs from 32 per cent to 42 per cent
recommended by the 14th Commission. This is relevant
in the context of the imperative of national development
programme including New India 2022. While the fiscal
health of the Union government is important for overall
macro performance of Indian economy, close look is
needed on State finances given the tight fiscal position of
the states.
Goods and Services Tax (GST) : The task before this
Commission is unique since the rules and position of
fiscal federalism has undergone a profound change with
the introduction of GST. The Commission has to assess
the impact of GST on the Centre and the States, including
payment of compensation by the Centre to the States for
possible loss of revenue for five years and on abolition
of cesses. This new tax being a destination levy, shifts
the incidence of tax from production to consumption and
hence the distribution of indirect taxes between different
states could change significantly. As the power to levy
GST rests with the GST Council, states have limited
manoeuverability.
Performance-based transfer of funds to States :

An important task under the Terms of Reference of the
Commission is to examine linking transfer of funds to
a range of parameters, such as efforts made by States
to deepen GST, how quickly a state moves towards the
replacement level of fertility (i.e., Total Fertility Rate - TFR
- of 2.1), eliminate power sector losses, improve the ease of
doing business, adoption of direct benefit transfer (DBT)
and progress in sanitation. These parameters clearly
reflect the policy preferences of the Union government.
To sum up, the major focus of the Finance Commission
has to be to strengthen cooperative federalism, frame the
parameters needed to shift public spending in the desired
direction and, at the same time, to ensure that fiscal
discipline and stability is maintained.
Implications of Taxing Agriculture Sector
India does not tax income from agriculture. Should
India levy tax on income from agriculture? Give arguments
for and against it. India does not tax income derived from
agriculture by farmers. This issue has been debated by
some economists and examined by expert committees
and there have been arguments for and against it. Some
states Tamil Nadu, Kerala, Bihar and West Bengal - had
levied tax on income from agriculture. While some of
them levied tax on income from plantations. Some other
states did introduce agricultural tax only to roll it back.
Historically speaking, there have been studies and reports
of Expert Committees on this sensitive issue - sensitive
because agriculture is the main lifeline of the nation with
bulk of the population in rural areas dependent on it and

its vulnerabilities due to recurring vagaries of nature and
consequent distress to farming community.
• An early attempt on this issue dates back to 1947
when an expert committee on financial provisions
to the Constituent Assembly suggested consulting
States on it.
• The 1972 Committee on Taxation of Agricultural
Wealth and Income, headed by the noted
economist K N Raj, had comprehensively examined
the issue. Raj committee had recommended
imposing a progressive ‘Agricultural Holdings Tax`
on agriculturists, taxing income from livestock,
poultry, dairy farming etc., including income
from agriculture in respect of assessees paying
non-agricultural tax and levying a wealth tax on
agricultural property.
• The Task Force on Direct and Indirect Taxes under
Dr. Vijay Kelkar had also examined the issue in
2002, and observed that States should be persuaded
to pass a resolution authorizing the Centre to pass
a:. tax on agricultural income that would then be
assigned to the respective states.
• Bibek Debroy, economist and Member, NITI Aayog
has suggested at agricultural income above a
certain threshold may be taxed.
Arguments for taxing income from agriculture
• Agricultural income above a certain threshold
should be taxed. There are large landholdings which
fetch substantial income and equity demands that

they should be liable to pay tax.
• There is an anomaly in exempting agricultural
income from being taxed, especially where such
income is substantial, when income tax is levied on
non-agricultural incomes.
• A study of cooperative farms by the erstwhile
Planning Commission showed incidence of tax
avoidance as mechanized farms with hired labour
took advantage of the exemptions provided to
cooperative farms. That evasion grew over the
decades. In assessment year 2014-15, for instance,
nine of the top ten claimants for tax exemption
of agricultural income were corporations and the
tenth was a state government department.
• The Tax Administration Reform Commission
report of 2014 observed that agricultural income
of non-agriculturists is being increasingly used as
a conduit to avoid tax and for laundering funds,
resulting in leakage to the tune of crores in revenue
annually.
• According to the 70th round of National Sample
Survey, over 86 per cent of agricultural households
have land holdings of less than 2 hectares. Low-
income farmers would obviously fall outside the
ambit of an equitable tax regime. But there is no
justification to exempt those who derive substantial
income from agricultural sources. It is due to the
pressure brought to bear on governments by the
political class and the rural elite, many of whom are

large landowners, command substantial income
and can fetch votes in large chunks in elections
and have vested interests, that they remain outside
the tax net.
• A crop-specific levy on landholdings above a
threshold, assessed and implemented at the
panchayat level for accuracy and flexibility, could
be considered with the added incentive of tax
yields being ploughed back into agricultural sector
infrastructure — for facilities like irrigation, water
conservation, soil rejuvenation, etc.
• Where ‘contract farming’ is being done by farmers,
in. group or otherwise, and in collaboration with
corpoates and multinationals, appropriate levy
could be collected keeping in view cost-income
considerations.
Arguments against taxing income from agriculture
• Given the extent of the informality that stilt exists
in the agricultural sector, implementation of an
agricultural tax would admittedly not be easy.
Evolving crop-specific norms of returns to land
poses problems.
• Taxing agriculture pose a problem everywhere
and more so in developing countries like India..
Records of inputs, yields, costs incurred, etc. are
not maintained except in the plantation sector or
where contract farming is done. Transactions by
farmers are done in cash and not through banking
channels making verification and assessment of

income difficult.
• Agriculture in India being largely dependent on
monsoon which is quite unpredictable, it is highly
subject to the vagaries of nature. In years of erratic
monsoon or drought, farmers incur heavy losses.
• Apart from the periodic adverse impact of nature,
volatility in prices of agricultural commodities,
due to both domestic and international factors,
farmers incur losses. In fact, the government has
to subsidise and support major crops through a
policy of ‘Minimum Support Price’ (MW). In these
circumstances, it becomes unjust to tax farmers.
• Farming has increasingly become unremunerative
and unprofitable due to rising costs, declining soil
fertility, lack of water and irrigation facility, heavy
debts incurred and inability of farmers to repay
loans, etc. The country has been witnessing acute
distress in large parts of rural areas resulting in
even farmer suicides on a substantial scale. In
the above scenario, there is not much scope to
introduce taxes on agriculture.
Conclusion
To sum up, taxing agricultural income in India poses
many problems, save in the case of organized plantations
and on contract farming. Also, the prosperity of the rural
population and rural sector is critical for the performance
of the industrial and tertiary sectors and has an overall
impact on the performance of the economy. Any taxes, if
at all, levied on agriculture has to be done prudently and
with caution since, as already pointed out, this sector is
vital lifeline of the nation on which a large section of the
population is dependent and any adverse impact on it will
set off a chain reaction in the economy.
Sound fiscal policy and macroeconomic stabilization
measures should be accompanied by economic reforms to
increase productivity and international competitiveness of
the industry. Increased savings and investment, reduction
of public debt, and avoiding unproductive expenditure are
prerequisites for rapid growth. While growth is necessary,
there is a compelling moral case for progress with equity
and inclusiveness for without them, large sections of the
people will be left behind in the process.

SEBI Grade A Phase I and Phase II Course: Facebook: Telegram

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

SEBI Grade A Phase I and Phase II Course: Facebook: Telegram

Uploaded by

Copyright:

Available Formats

SEBI Grade A Phase I and Phase II Course : https://www.oheyo.

President in the interests of sound finance.

reached by the Centre and the States;

financing of relief expenditure, and related matters. The

the order of 5.24 lakh crore in 2015-16. Another 3.04

funds of states to supplement the resources of urban and

fiscal roadmap, the Fiscal Review Committee, headed by N

Performance-based transfer of funds to States :

bulk of the population in rural areas dependent on it and

fetch substantial income and equity demands that

political class and the rural elite, many of whom are

channels making verification and assessment of

You might also like