Third Union Finance

The third Union Finance Commission of India, constituted in December 1960 under the chairmanship of Ashok Kumar Chanda, held significant responsibilities in shaping the financial landscape of the country. Its primary mandate, as with previous finance commissions, was to recommend principles governing the distribution of tax revenues between the Union (Central) government and the states for the period covering 1962-63 to 1966-67. This encompassed a crucial period in India’s development planning, marked by the Third Five-Year Plan, and necessitated careful consideration of the states’ financial needs to facilitate their contribution to national progress.

The commission’s recommendations centered on the divisible pool of taxes, primarily income tax and Union excise duties. Regarding income tax, the commission retained the existing formula where 66 2/3% of the net proceeds were allocated to the states. However, a crucial change was introduced in the distribution formula. Instead of relying solely on population, the commission incorporated a factor for assessing collection, allotting 20% weightage to the state’s contribution to income tax revenue. This was intended to incentivize states to improve tax collection efficiency.

For Union excise duties, the commission significantly expanded the scope of distribution. Previously, only a select group of commodities were included in the divisible pool. The third Finance Commission proposed that 20% of the net proceeds from all Union excise duties (excluding those specifically earmarked) be distributed among the states. This broadening of the divisible pool was a progressive step, providing states with a more substantial share of central excise revenue and greater financial autonomy.

The commission also addressed the thorny issue of grants-in-aid under Article 275 of the Constitution. These grants are provided to states in need of financial assistance. The commission recommended both statutory and discretionary grants, keeping in mind the revenue gap of the states after taking into account their share of tax revenues. A significant recommendation was the inclusion of development schemes in determining the grant amounts. This acknowledged the growing importance of developmental activities at the state level and provided a mechanism for the center to support these efforts.

A key challenge faced by the commission was balancing the fiscal needs of the states with the overall financial stability of the Union government. India was at a critical juncture, investing heavily in planned development, defense (especially in light of the 1962 Sino-Indian War), and infrastructure. Reconciling these competing demands required a delicate balancing act.

The recommendations of the third Finance Commission, while generally accepted, were not without criticism. Some argued that the weightage given to collection in income tax distribution could disincentivize poorer states with limited industrial activity. Others felt that the grants-in-aid criteria were still somewhat subjective. Nevertheless, the commission’s report marked a significant step forward in federal finance in India, particularly in broadening the divisible pool of excise duties and recognizing the importance of development schemes in determining grants to states. Its recommendations helped shape the financial relationship between the Union and states, contributing to the ongoing process of fiscal decentralization and cooperative federalism in India.