The Finance Commission is a constitutional body in India, established under Article 280 of the Constitution, which defines the financial relations between the Union government and the individual State governments. It is a quasi-judicial body that acts as the "balancing wheel of fiscal federalism". The Commission was created to solve the problem of fiscal imbalance in India's federal structure, where the Centre collects the majority of taxes but the States have significant expenditure responsibilities.
The constitutional provision for the Finance Commission came into existence on November 26, 1949, and the First Finance Commission was formally constituted in 1951 under the chairmanship of K.C. Neogy. Article 280 mandates the President to constitute the Commission every five years or earlier, consisting of a Chairman and four other members.
The Commission's primary mechanism is to make recommendations to the President on three key areas, as outlined in Article 280(3): first, the distribution of the net proceeds of taxes between the Union and the States (vertical devolution) and the allocation of those shares among the States themselves (horizontal devolution); second, the principles that should govern the Grants-in-Aid of the States' revenues out of the Consolidated Fund of India; and third, the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State. This third function was added by the 73rd and 74th Constitutional Amendments in 1992.
The Finance Commission connects directly to the concept of fiscal federalism and its recommendations are laid before both Houses of Parliament under Article 281. A significant recent change is the introduction of the Goods and Services Tax (GST), which has complicated the Commission's work by centralizing certain taxation powers and requiring it to factor in the new tax regime's impact on state finances. Historically, the Commission's role was often contrasted with that of the now-defunct Planning Commission, which handled 'Plan' grants, but the Finance Commission has always focused on the statutory devolution of 'non-Plan' revenue resources. The recommendations of the Finance Commission are advisory and not legally binding on the Centre.