The Government of India has planned to set up the 16th finance commission by the November end. The Finance Secretary of the Government of India TV Somanathan revealed this. The finance commission will be responsible for deciding the tax ratio or the amount of tax the Centre and the States share. The new tax rule will be applicable for five years from 1st April 2026. The government is in the process of finalising the tax distribution. The government may consider the conditions related to the flow of financial dealings between local bodies located in big cities and villages to ensure the proper usage of cash and funds.
What is a Finance Commission?
The Finance Commission is a constitutional body that gives the formula for distributing government finances between central and state governments based on the terms of reference. Article 280 of the constitution governs this law. The article states that the president has the power to form the finance commission. The commission is valid for five years. The 16th finance commission will apply from April 2026 to March 2031.
Terms Of Reference
The finance commission decides how much cash or tax will be given to states and centres based on a certain formula, assigning different weightage to different terms of reference. It is the Finance Ministry of the Government of India that determines the terms of reference.
The government will request the finance commission to distribute the resources between different states of India and give more importance to the Human Development Index (HDI), Sustainable Development Goals (SDGs) and climate goals before determining the tax distribution formula.
Tax Distribution Formula of the 15th Finance Commission
The finance commission determines the tax and financial resources distribution based on certain formulas. It gives more importance to some factors that may have more weightage than other factors. The 15th Finance Commission gave a major weightage of about 45% to income and 12.5% weightage to demographic performance. It gave 15% weightage each to the area and population. Forests and ecology are given 10% weightage, while the tax efforts of states get 2.5% weightage. These factors are also known as terms of reference. The concerned authority has revealed that the terms of reference for the new finance commission will be declared very soon.
Challenges in front of the 16th Finance Commission
The leading financial institutions of India, the Reserve Bank of India, and the finance commission of different states have reported a lack of funds in the local bodies. They have noticed that Municipal bodies do not use the funds in the right way. Also, they use the wrong accounting procedures. Thus, the new finance commission will face a challenge in this area. The government wants the municipal bodies to get more financial resources than they currently have.
Government’s expectations from the 16th Finance Commission
The Government of India may request the 16th Finance Commission to analyse the conditions associated with financial transfers between Municipal bodies located in cities and rural areas. It will also request the commission to include the Human Development Index as a term of reference for determining the tax distribution. In addition, it will also ask the Commission to consider Sustainable Development Goals and Climate Goals as terms of reference.