Public Finance and Finance Commission: Articles and Deficits

Public finance is the study of how a government raises money, spends it and borrows when the two do not match. In India the subject is examined from two sides: the arithmetic of the Budget, where the deficits are defined, and the constitutional machinery that divides money between the Union and the States, where the Finance Commission sits. This note takes both in turn, keeping to the definitions and the articles, which do not change from year to year.

What public finance covers

The subject has three classical divisions. Public revenue is what the state receives, chiefly from taxes. Public expenditure is what it spends, on salaries, subsidies, interest, defence and capital works. Public debt is what it borrows when expenditure runs ahead of revenue. A fourth concern, financial administration, covers the Budget, audit and the rules under which money is drawn from the treasury.

Receipts of the government

Taxes are classified as direct, where the person who pays also bears the burden, such as income tax and corporation tax, and indirect, where the burden is passed on to the buyer, such as the Goods and Services Tax and customs duty.

The Budget and the constitutional funds

Article 112 of the Constitution requires the President to lay before Parliament, for every financial year, a statement of the estimated receipts and expenditure of the Government of India. That statement is the Annual Financial Statement, which is what the Budget formally is. It separates the Revenue Budget from the Capital Budget, and separately shows expenditure charged on the Consolidated Fund, which is not put to the vote.

• Consolidated Fund of India, Article 266(1): all revenues, loans raised and money received in repayment of loans; nothing can be drawn from it without the authority of Parliament.
• Public Account of India, Article 266(2): money held by the government as a banker, such as provident funds and small savings; withdrawals need no parliamentary appropriation.
• Contingency Fund of India, Article 267: placed at the disposal of the President for unforeseen expenditure, later recouped from the Consolidated Fund.

The four deficits

• Revenue deficit = revenue expenditure minus revenue receipts. It shows that the state is borrowing for its routine running.
• Fiscal deficit = total expenditure minus total receipts other than borrowings. It measures the whole borrowing requirement for the year and is the deficit watched most closely.
• Primary deficit = fiscal deficit minus interest payments. It strips out the cost of past borrowing and shows the current year's own gap.
• Effective revenue deficit = revenue deficit minus grants given to States for the creation of capital assets.

The Fiscal Responsibility and Budget Management Act was passed in 2003 to put statutory limits on these deficits and on government debt, and to require the government to lay fiscal policy statements before Parliament each year. Most States have enacted their own fiscal responsibility legislation on the same pattern.

The Finance Commission under Article 280

India's Constitution gives the Union the more elastic taxes and the States the heavier spending responsibilities, so a mechanism was needed to transfer money downward. Article 280 provides for a Finance Commission, constituted by the President at the expiration of every fifth year or earlier if the President thinks fit. It consists of a Chairman and four other members, whose qualifications and manner of selection Parliament prescribed by the Finance Commission (Miscellaneous Provisions) Act of 1951. The first Finance Commission was set up in 1951 under the chairmanship of K. C. Neogy.

The Commission is a constitutional body, and it is quasi-judicial in nature. It makes recommendations to the President on three matters named in Article 280(3), and on any other matter referred to it in the interests of sound finance.

• The distribution of the net proceeds of taxes between the Union and the States, and the allocation of the States' share among themselves.
• The principles that should govern grants-in-aid to the States out of the Consolidated Fund of India under Article 275.
• Measures needed to augment the Consolidated Fund of a State to supplement the resources of Panchayats and Municipalities, a duty added by the seventy-third and seventy-fourth Constitutional Amendments.

Two points are asked repeatedly. First, the recommendations are advisory: the government is expected to follow them by convention but is not legally bound. Second, under Article 281 the President must cause every recommendation, together with an explanatory memorandum on the action taken on it, to be laid before each House of Parliament. Cesses and surcharges levied under Article 271 are not shared with the States, which is why their size is a matter of dispute in Centre-State finance.

State Finance Commissions

Article 243-I requires the Governor of a State to constitute a Finance Commission at the expiration of every fifth year to review the financial position of the Panchayats, and Article 243-Y extends the same arrangement to Municipalities. Like the central body, a State Finance Commission is a constitutional body, and it recommends how taxes, duties, tolls and fees should be divided between the State and its local bodies. Contrast this with NITI Aayog, which replaced the Planning Commission in 2015: both were created by executive resolution, so neither is a constitutional or even a statutory body.