Context: Aside from presenting Union Budget 2021-22, Finance Minister Nirmala Sitharaman also tabled the 15th Finance Commission (XVFC) report in Lok Sabha.

• The Fifteenth Finance Commission's ToR(Terms of Reference) was unique and wide-ranging in many ways. 
• The Commission highlight its report on vertical and horizontal tax devolution, local government grants, disaster management grant, incentives for States in many areas such as power sector, adoption of DBT, solid waste management etc.
• The Commission also highlight on whether a separate mechanism for funding of defence and internal security ought to be set up and if so how such a mechanism could be operationalized.
• The Commission was asked to recommend performance incentives for States in many areas like power sector, adoption of DBT, solid waste management etc.

About the Report

• This report has been organised in four volumes. Volume I and II, as in the past, contain the main report and the accompanying annexes. 
• Volume III is devoted to the Union Government and examines key departments in greater depth, with the medium-term challenges and the road map ahead. 
• Volume IV is entirely devoted to states.

Vertical devolution

• In order to maintain predictability and stability of resources, especially during the pandemic, XVFC has recommended maintaining the vertical devolution at 41 per cent – the same as in our report for 2020-21. 
• It is at the same level of 42 per cent of the divisible pool as recommended by FC-XIV. 
• However, it has made the required adjustment of about 1 per cent due to the changed status of the erstwhile State of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir.
• In XVFC’s assessment, gross tax revenues for 5-year period is expected to be 135.2 lakh crore. Out of that, Divisible pool (after deducting cesses and surcharges & cost of collection) is estimated to be 103 lakh crore.
• States’ share at 41 per cent of divisible pool comes to 42.2 lakh crore for 2021-26 period.
• Including total grants of Rs. 10.33 lakh crore (details later) and tax devolution of Rs. 42.2 lakh crore, aggregate transfers to States is estimated to remain at around 50.9 per cent of the divisible pool during 2021-26 period.
• Total XVFC transfers (devolution + grants) constitutes about 34 per cent of estimated Gross Revenue Receipts of the Union leaving adequate fiscal space for the Union to meet its resource requirements and spending obligations on national development priorities.

Horizontal devolution
On horizontal devolution, while XVFC agreed that the Census 2011 population data better represents the present need of States, to be fair to, as well as reward, the States which have done better on the demographic front, XVFC has assigned a 12.5 per cent weight to the demographic performance criterion.
XVFC has re-introduced tax effort criterion to reward fiscal performance.

Local Governments

• Urban local bodies have been categorised into two groups, based on population, and different norms have been used for flow of grants to each, based on their specific needs and aspirations. Basic grants are proposed only for cities/towns having a population of less than a million. For Million-Plus cities, 100 per cent of the grants are performance-linked through the Million-Plus Cities Challenge Fund (MCF).

Health

• XVFC has recommend that health spending by States should be increased to more than 8 per cent of their budget by 2022.
• Given the inter-State disparity in the availability of medical doctors, it is essential to constitute an All India Medical and Health Service as is envisaged under Section 2A of the All-India Services Act, 1951.

Performance incentives and grants

• XVFC has recommended grants of Rs. 4,800 crore (Rs. 1,200 crore each year) from 2022-23 to 2025-26 for incentivising the States to enhance educational outcomes.
• XVFC has recommended Rs. 6,143 crore for online learning and development of professional courses (medical and engineering) in regional languages (matribhasha) for higher education in India.

XVFC has recommended that Rs. 45,000 crore be kept as performance-based incentive for all the States for carrying out agricultural reforms

• for amending their land-related laws on the lines of NITI Aayog’s model law
• incentive-based grants to States that maintain and augment groundwater stock.
• growth in agricultural exports
• production of oilseeds, pulses and wood and wood-based products

Defence and Internal Security

• Keeping in view the extant strategic requirements for national defence in the global context, XVFC has, in its approach, re-calibrated the relative shares of Union and States in gross revenue receipts. This will enable the Union to set aside resources for the special funding mechanism that XVFC has proposed.
• The Union Government may constitute in the Public Account of India, a dedicated non-lapsable fund, Modernisation Fund for Defence and Internal Security (MFDIS).

Disaster Risk Management

• Mitigation Funds should be set up at both the national and State levels, in line with the provisions of the Disaster Management Act. 
• The Mitigation Fund should be used for those local level and community-based interventions which reduce risks and promote environment-friendly settlements and livelihood practices.
• XVFC has recommended six earmarked allocations for certain priority areas, namely, two under the NDRF (Expansion and Modernisation of Fire Services and Resettlement of Displaced People affected by Erosion) and four under the NDMF (Catalytic Assistance to Twelve Most Drought-prone States, Managing Seismic and Landslide Risks in Ten Hill States, Reducing the Risk of Urban Flooding in Seven Most Populous Cities and Mitigation Measures to Prevent Erosion).

Fiscal consolidation

• Provided range for fiscal deficit and debt path of both the Union and States.
• Additional borrowing room to States based on performance in power sector reforms.
• A threshold amount of annual appropriation should be fixed below which the funding for a CSS may be stopped. Below the stipulated threshold, the administrating department should justify the need for the continuation of the scheme. As the life cycle of ongoing schemes has been made co-terminus with the cycle of Finance Commissions, the third-party evaluation of all CSSs should be completed within a stipulated timeframe. The flow of monitoring information should be regular and should include credible information on output and outcome indicators.
• In view of the uncertainty that prevails at the stage that XVFC have done its analysis, as well as the contemporary realities and challenges, we recognise that the FRBM Act needs a major restructuring and recommend that the time-table for defining and achieving debt sustainability may be examined by a High-powered Inter-governmental Group. 
• This High-powered Group can craft the new FRBM framework and oversee its implementation. It is important that the Union and State Governments amend their FRBM Acts, based on the recommendations of the Group, so as to ensure that their legislations are consistent with the fiscal sustainability framework put in place. 
• This High-powered Inter-Governmental Group could also be tasked to oversee the implementation of the 15th Finance Commission’s diverse recommendations.
• State Governments may explore formation of independent public debt management cells which will chart their borrowing programme efficiently.