The Finance Commission is a constitutional body and a quasi-judicial institution in India, established by the President under Article 280 of the Constitution. It was first constituted in 1951 under the chairmanship of K.C. Neogy, to address the problem of fiscal imbalance between the Union and the States, which have separate responsibilities but overlapping or centralized taxation powers. The Commission is appointed every five years or earlier to define the financial relations between the central government and the state governments, thereby acting as the "balancing wheel of fiscal federalism".
The core mechanism of the Commission is to make recommendations to the President on three key areas, as outlined in Article 280(3): first, the vertical devolution of the net proceeds of taxes between the Union and the States; second, the horizontal devolution of these proceeds among the States themselves; and third, the principles governing the Grants-in-Aid of the revenues of the States from the Consolidated Fund of India, as per Article 275. The Commission also recommends measures to augment the Consolidated Fund of a State to supplement the resources of its Panchayats and Municipalities, based on the recommendations of the State Finance Commissions.
The Finance Commission connects directly to the concept of fiscal federalism and other constitutional provisions like Articles 268 to 281, which deal with the distribution of financial resources. Its role has evolved significantly, especially with the abolition of the Planning Commission (now NITI Aayog) and the implementation of the Goods and Services Tax (GST), which transferred many taxation powers to the GST Council. A major recent change occurred with the 14th Finance Commission (Chairman: Y. V. Reddy), which dramatically increased the States' share in the divisible pool of central taxes from 32% to 42% for the period 2015-2020, a move that significantly boosted the financial autonomy of the States. The most recent, the 16th Finance Commission, was constituted on December 31, 2023, and is chaired by Arvind Panagariya. The 16th Finance Commission has maintained the vertical devolution share at 41% but has revised the horizontal devolution formula by introducing a 10% weight for a State's contribution to GDP.