The 12th Finance Commission: A Key Review of Fiscal Federalism in India

The 12th Finance Commission (XII FC), constituted under Article 280 of the Indian Constitution, played a crucial role in shaping the fiscal landscape of the country. Chaired by Dr. C. Rangarajan, it submitted its report in 2004, outlining recommendations that governed the distribution of tax revenues and grants-in-aid from the Union Government to the States for the period 2005-2010.

A primary objective of the XII FC was to promote fiscal discipline and enhance the quality of public expenditure at both the central and state levels. The Commission strived to create a framework that incentivized states to manage their finances more efficiently and invest in crucial infrastructure and social sector programs.

One of the most significant recommendations of the XII FC was maintaining the states' share in the divisible pool of central taxes at 30.5%, the same level recommended by the preceding 11th Finance Commission. This aimed to provide stability and predictability in the revenue flow to the states. However, the XII FC also recommended a new formula for distributing this share among the states, placing greater emphasis on factors such as fiscal capacity distance, population, area, and infrastructure development. The formula aimed to address regional disparities and provide greater support to states lagging in economic and social development.

The Commission also addressed the issue of debt relief for states. It introduced a Debt Consolidation and Relief Facility (DCRF) linked to fiscal reforms. This facility offered states the opportunity to reschedule their debt owed to the central government, subject to them meeting pre-defined fiscal targets. The DCRF proved to be instrumental in reducing the debt burden of many states and encouraging fiscal responsibility.

Beyond tax devolution and debt relief, the XII FC made several recommendations related to grants-in-aid. These grants were intended to address specific needs and promote balanced development across the country. The Commission recommended grants for local bodies, particularly Panchayati Raj Institutions and Municipalities, to strengthen their capacity and enable them to deliver essential services more effectively. Furthermore, it recommended grants for specific sectors such as education, health, and infrastructure, with the aim of bridging gaps in service delivery and improving human development indicators.

The XII FC also emphasized the importance of sound financial management practices. It urged both the central and state governments to adopt accrual-based accounting systems, improve budgeting processes, and enhance transparency and accountability in public spending. By promoting good governance and fiscal prudence, the Commission aimed to ensure that public resources are used effectively and efficiently.

In conclusion, the 12th Finance Commission played a vital role in shaping the fiscal relationship between the Union and the States in India. Its recommendations on tax devolution, debt relief, grants-in-aid, and fiscal management practices had a significant impact on the financial health of the states and their ability to deliver essential services to their citizens. The Commission's focus on fiscal discipline, equity, and balanced development laid a foundation for more sustainable and inclusive growth in the years that followed.