How is the Finance Commission of India constituted? What do you know about the terms of reference of the recently constituted Finance Commission? Discuss. (UPSC 2018)

The Finance Commission is a constitutional body that acts as the key arbiter of fiscal relations between the Union and the States. It is meant to ensure fair sharing of resources and to strengthen cooperative federalism.

• Constitution and composition: Under Article 280, the President constitutes a Finance Commission every five years, or earlier if needed. It has a Chairman and four other members appointed by the President.
• Qualifications: The Chairman is chosen from persons of public affairs. Members are selected from persons who are or have been High Court judges, or who have special knowledge of government finance and accounts, wide experience in financial matters and administration, or special knowledge of economics.
• Functions: It recommends the distribution of net tax proceeds between the Union and States, principles for grants-in-aid, measures to augment State funds for Panchayats and Municipalities, and other matters referred by the President.

Terms of reference of the recently constituted Finance Commission included:

• recommendation of the share of States in the divisible pool of central taxes and their inter-se distribution;
• principles governing grants-in-aid to States under Article 275;
• ways to strengthen the resources of local bodies;
• review of arrangements relating to disaster management financing.

These terms are important because they go beyond tax devolution and link fiscal transfers with local governance and disaster resilience. However, the Commission has to balance equity, efficiency, fiscal discipline and incentives for performance. A well-designed ToR can improve trust between the Union and States, but an overly narrow approach may weaken the spirit of federalism.