Twelfth Finance Commission Guidelines

The Twelfth Finance Commission (TFC), constituted in 2002, made recommendations that significantly shaped the fiscal landscape of India from 2005-2010. Its primary mandate was to recommend the distribution of tax revenues between the Union and the States and among the States themselves. Here are twelve key guidelines arising from its report:

1. Increased Devolution to States: The TFC increased the share of net proceeds of shareable Central taxes to be devolved to the States to 30.5%, up from the 29.5% recommended by the Eleventh Finance Commission. This aimed to provide greater resources directly to the States, fostering greater autonomy in planning and development.
2. Formula for Inter-State Distribution: The commission retained a similar formula to the Eleventh Finance Commission for distributing the States' share of tax revenue, giving weight to factors like population, income distance, area, infrastructure index, tax effort, and fiscal discipline. Population, reflecting needs, and income distance, reflecting backwardness, were heavily weighted.
3. Debt Consolidation and Waiver Facility: Recognizing the heavy debt burden of many States, the TFC proposed a Debt Consolidation and Waiver Facility. States could consolidate their debt owed to the Centre at a lower interest rate, contingent on enacting fiscal responsibility legislation and adhering to a fiscal consolidation path. Furthermore, a debt waiver was offered based on performance in improving their fiscal deficit and debt-to-GSDP ratio.
4. Revenue Deficit Grants: The TFC provided for revenue deficit grants to States that were projected to have revenue deficits even after the devolution of Central taxes. These grants were conditional on States undertaking measures to reduce their revenue deficits and improve their fiscal positions. The goal was to eliminate revenue deficits by 2008-09.
5. Grants for Local Bodies: The commission recommended grants for local bodies, both rural and urban. These grants were intended to support basic services and infrastructure at the grassroots level. The grants were linked to the implementation of reforms, such as the preparation of accounts and the holding of regular elections.
6. Calamity Relief Fund (CRF) and National Calamity Contingency Fund (NCCF): The TFC reviewed the existing scheme for financing disaster relief. It recommended a continuation of the Calamity Relief Fund (CRF) at the State level and the National Calamity Contingency Fund (NCCF) at the Centre, with specific allocations for each.
7. Promotion of Tax Effort: The commission emphasized the importance of States improving their own tax revenue mobilization. While incorporating tax effort as a criterion in the devolution formula, the TFC also stressed the need for administrative reforms to reduce tax evasion and broaden the tax base.
8. Linking Grants to Fiscal Performance: A key theme was linking grants to fiscal performance and reforms. States were incentivized to improve their fiscal management through conditional grants tied to specific targets and reforms in areas like power sector reforms and user charges for public services.
9. Grants for Special Problems: Recognizing specific challenges faced by some States, the TFC recommended grants to address special problems, such as environmental degradation, high incidence of poverty, or infrastructure deficits.
10. Emphasis on Fiscal Responsibility Legislation: The TFC strongly advocated for the enactment of Fiscal Responsibility Legislation (FRL) by both the Centre and the States. These laws aimed to enforce fiscal discipline by setting targets for reducing fiscal deficits and debt.
11. Infrastructure Development: Recognizing the crucial role of infrastructure in economic growth, the TFC recommended increased investment in infrastructure, particularly in sectors like power, roads, and irrigation.
12. Monitoring and Evaluation: The commission emphasized the importance of effective monitoring and evaluation of the implementation of its recommendations, particularly regarding the utilization of grants and the progress in achieving fiscal consolidation targets. This aimed to ensure accountability and transparency in the use of public funds.

In conclusion, the Twelfth Finance Commission's guidelines aimed to enhance fiscal federalism in India by providing greater resources to the States, incentivizing fiscal discipline, and promoting investment in infrastructure and local bodies. Its focus on performance-based incentives and conditional grants significantly influenced the fiscal behavior of both the Union and the State governments during the award period.