What can local bodies expect from the 16th FC?

For Preliminary Examination:  Current events of national and international Significance

For Mains Examination: GS III - Economy

Context:

On November 17, the 16th Finance Commission (FC) submitted its report to the President of India.

Read about:

16th Finance Commission (FC)

Panchayats, municipalities

Key takeaways:

On November 17, the 16th Finance Commission (FC) presented its report to the President of India.

What about panchayats and municipalities?

• A key expectation from the Commission is that it would propose ways to strengthen the financial position of panchayats and municipalities, as required under Article 280(3)(bb) and (c) of the Constitution.
• In most federal systems, local governments deliver crucial public services such as drinking water supply, sanitation, public health, rural roads, and upkeep of community infrastructure.
• To fund these functions, they are authorised to levy certain taxes—like property tax, advertisement tax—and collect non-tax revenues such as market fees or tolls. Yet, across States and Union Territories, their revenue sources are insufficient compared to their spending responsibilities, resulting in a sizeable fiscal gap.
• Following the 73rd and 74th Constitutional Amendments, State governments have the authority to allocate revenue powers and expenditure duties to various levels of rural and urban local bodies. Because each State exercises this power differently, the fiscal autonomy of panchayats and municipalities varies widely across the country.
• Ideally, the functions assigned to local governments should match the financial powers given to them. However, there is no dedicated list specifying the exact functions or revenue instruments for these bodies.
• The 11th and 12th Schedules list 29 subjects for panchayats and 18 for municipalities, but these lists are indicative rather than mandatory. Moreover, Union and State governments continue to design most schemes related to economic development and social justice, leaving local governments mainly in the role of implementers.
• States often transfer responsibilities to local bodies without offering adequate revenue powers or staffing support. Consequently, panchayats and municipalities suffer financial strain, which affects both their developmental role and day-to-day functioning.

What does the State Finance Commission (SFC) do?

• Every five years, each State sets up a State Finance Commission, which recommends how State revenues should be shared with local governments.
• SFCs may propose assigning revenue sources to local bodies, granting them a share of State revenues, providing conditional or unconditional grants, delegating civic functions and staff, and improving administrative systems.
• Although more than a hundred SFC reports have been produced, very few have been implemented effectively.
• Because of this, local governments remain heavily dependent on fiscal transfers from the Union government. The Constitution therefore directs the Union Finance Commission (UFC) to recommend how State finances should be supplemented to support local bodies.

What have earlier UFCs done?

• Six UFCs have so far had their recommendations implemented. Most were unable to estimate the real financial needs of local governments and instead provided lump-sum grants on an ad hoc basis.
• The 13th Finance Commission broke this trend by recommending that grants for local governments be fixed as a percentage of the divisible pool of Union taxes, ensuring protection against inflation and allowing local bodies to benefit from rising tax revenues.
• However, later Commissions reversed this approach and again recommended lump-sum grants. The 15th FC also continued this pattern.
• Another inconsistency relates to conditional grants. To promote administrative reforms in local bodies, the 13th, 14th and 15th UFCs split grants into basic (unconditional) and performance-based (conditional) components.
• But each Commission introduced a completely new set of conditions, disregarding the previous one.
• For example, the 13th FC prescribed six conditions, very few of which States could meet. The 14th FC discarded them and proposed new criteria, and the 15th FC introduced yet another set of requirements