First Finance Commission

The First Finance Commission of India

The First Finance Commission, constituted in 1951 under the chairmanship of K.C. Neogy, marked a crucial step in shaping the fiscal federalism of newly independent India. Established under Article 280 of the Constitution, the Commission’s primary mandate was to recommend principles governing the distribution of tax revenues between the Union and the States, and the principles that should govern the grants-in-aid to the States out of the Consolidated Fund of India.

Facing the daunting task of establishing a fair and equitable system amidst diverse economic realities and limited data, the Commission focused on creating a framework that would address the revenue needs of the States while maintaining the financial stability of the Union. Their recommendations, submitted in 1952, became the bedrock for future Finance Commissions.

A key recommendation of the First Finance Commission was the distribution of income tax. Recognizing the States’ need for greater financial resources, the Commission suggested that 55% of the net proceeds of income tax (excluding taxes on Union emoluments) be distributed among the States. This marked a significant increase in the States’ share of income tax revenue compared to the pre-independence arrangements. The Commission also introduced a formula for distributing this share amongst the States, based on population (80%) and collection (20%). This formula, though simplistic, aimed to balance the needs of larger, more populous states with the contributions made by states with higher income tax collection.

Regarding the distribution of Union excise duties, the Commission recommended a more cautious approach. Considering the relatively nascent stage of industrial development and the potential impact on Union finances, they initially recommended sharing excise duties only on three commodities: tobacco, matches, and vegetable products. They suggested that 40% of the net proceeds from these duties be distributed among the States, based on population. This cautious approach reflected the Commission’s awareness of the need to protect the Union’s revenue base while gradually expanding the States’ share in central taxes.

Furthermore, the Commission provided guidelines for grants-in-aid under Article 275 of the Constitution. They emphasized the principle of “fiscal need” and advocated for providing grants to States facing budgetary deficits after accounting for their share of central taxes. They also recognized the importance of equalizing grants to address disparities in the levels of development and essential services across the States. While specific criteria for determining fiscal need were not explicitly defined, the Commission laid the foundation for a system of needs-based grants that has been refined by subsequent Finance Commissions.

The First Finance Commission’s report was instrumental in establishing a framework for fiscal federalism in India. Its recommendations, though subject to adjustments by subsequent Commissions, established key principles such as revenue sharing based on need and contribution, and the provision of grants-in-aid to address fiscal imbalances. The Commission’s work provided a vital starting point for navigating the complex challenges of resource allocation between the Union and the States, contributing significantly to the overall stability and development of the Indian economy.