The Twelfth Finance Commission (2005-2010)

The Twelfth Finance Commission (TFC), constituted under the chairmanship of Dr. C. Rangarajan, was a pivotal body responsible for recommending principles governing the distribution of tax revenues between the Union and the States of India for the period spanning 2005-2010. Its recommendations significantly impacted the fiscal federalism landscape of the nation.

Key Recommendations and Their Impact

Vertical Devolution: A central recommendation was to increase the States’ share in the net proceeds of Union taxes to 30.5%. This aimed to provide States with greater fiscal autonomy and resources for development. This marked a notable, though not dramatic, increase from the previous commission’s recommendation.

Horizontal Devolution: The TFC adopted a modified Gadgil-Mukherjee formula for distributing the States’ share amongst themselves. The formula gave weightage to various factors, including population, income distance (the gap between a state’s per capita income and the highest per capita income among all states), area, infrastructure index, and tax effort. A crucial addition was the inclusion of fiscal discipline as a criterion, incentivizing states to manage their finances prudently.

Debt Relief: A major emphasis was placed on debt consolidation and relief for States. The TFC recommended a debt waiver scheme linked to States adhering to fiscal responsibility legislation and undertaking fiscal reforms. This was a significant step towards addressing the unsustainable debt burden of several States, enabling them to free up resources for developmental activities.

Grants-in-Aid: The Commission also recommended grants-in-aid to States under Article 275 of the Constitution. These grants were intended to address specific needs, such as promoting education, improving healthcare infrastructure, and maintaining infrastructure. Special consideration was given to States with special category status.

Local Bodies: Recognizing the importance of local governance, the TFC recommended substantial grants to local bodies (Panchayats and Municipalities) to improve their financial capacity and enable them to undertake development activities at the grassroots level. These grants were linked to the implementation of local government reforms.

Significance and Criticism

The Twelfth Finance Commission played a crucial role in strengthening fiscal federalism in India. Its recommendations helped to improve the financial position of States, incentivize fiscal prudence, and promote equitable development. The debt relief measures were particularly significant in addressing the fiscal challenges faced by many States.

However, the TFC’s recommendations also faced criticism. Some argued that the horizontal devolution formula still favored some States over others. The emphasis on fiscal discipline was seen by some as potentially penalizing States that were already struggling financially. Others criticized the adequacy of the grants-in-aid provided for specific sectors.

Overall, the Twelfth Finance Commission’s report was a landmark document that had a significant impact on the financial relations between the Union and the States in India. Its recommendations laid the foundation for further reforms in fiscal federalism.