Empowering Local Governance: The Pivotal Role of State Finance Commissions

India’s Panchayati Raj system rests on a simple but powerful idea: governance should reach the last mile. The 73rd Constitutional Amendment Act, 1992 gave that idea a constitutional backbone by recognising Panchayats as the third tier of government. But devolving functions without devolving finances is meaningless. That is precisely why the same amendment introduced State Finance Commissions (SFCs) – a dedicated institutional mechanism to ensure that Panchayats receive their fair share of financial resources. Understanding how SFCs work, what they are mandated to do, and why they often fall short is essential to understanding the state of local self-governance in rural India today.

The constitutional foundation: Article 243I 🔗

Article 243I of the Constitution of India lays down a clear mandate: the Governor of every state must constitute a Finance Commission within one year of the commencement of the 73rd Amendment, and thereafter at the end of every five years. This Commission is tasked with reviewing the financial position of Panchayats and making recommendations to the Governor on how financial resources should flow from the state to local bodies.

The article is modelled closely on Article 280, which establishes the Central Finance Commission. The key difference is jurisdiction – while the Central Finance Commission (CFC) deals with Centre-State fiscal relations, the SFC focuses on State-Panchayat fiscal relations. In this way, Article 243I creates a parallel but subsidiary fiscal architecture at the sub-state level.

Article 243I(4) requires the Governor to place the SFC’s recommendations before the State Legislature, along with an explanatory memorandum stating what action has been taken on those recommendations. This provision is meant to ensure transparency and public accountability in how state governments respond to the SFC’s findings.

What exactly does an SFC recommend? 🔗

The scope of an SFC’s mandate is broad and multi-dimensional. As outlined under Article 243I, the Commission makes recommendations to the Governor on the following areas:

Distribution of tax proceeds: The SFC recommends the principles governing how the net proceeds of taxes, duties, tolls, and fees levied by the state should be divided between the state government and Panchayats at all three levels – village, intermediate (block), and district.

Assignment of revenue sources: It identifies which specific taxes, duties, tolls, or fees may be directly assigned to or appropriated by Panchayats to generate their own source revenue.

Grants-in-aid: The SFC recommends the quantum and principles of grants-in-aid to be provided to Panchayats from the Consolidated Fund of the State.

Measures to improve financial health: Beyond transfers, the SFC is also empowered to suggest structural measures to strengthen the overall fiscal capacity of Panchayats – covering everything from better accounting practices to revenue mobilisation.

Any other matter referred by the Governor: The Governor can refer additional matters to the SFC, giving the Commission a degree of flexibility to address emerging local fiscal challenges.

These recommendations are intended to be comprehensive – addressing both the flow of state funds downward to Panchayats and the capacity of Panchayats to generate resources on their own.

Composition and procedure 🔗

Article 243I(2) gives the State Legislature the authority to determine the composition, qualifications, and manner of selection of SFC members through law. This means there is no single uniform model across states – different states have constituted SFCs with varying compositions. Some states include retired civil servants, economists, or legal experts; others have appointed serving officers. Article 243I(3) further provides that the SFC shall determine its own procedure and shall have such powers as the State Legislature may confer on it by law.

This flexibility, while accommodating state-level diversity, has also led to significant variation in the quality, independence, and resources available to different SFCs across India – a point that has drawn sustained criticism from experts and parliamentary committees alike.

The SFC-Central Finance Commission link 🔗

One of the most important but often overlooked dimensions of the SFC framework is its relationship with the Central Finance Commission. Article 280(3)(bb) of the Constitution mandates that the Central Finance Commission recommend measures to augment the Consolidated Fund of each state on the basis of the recommendations made by the State Finance Commission. This creates a sequenced fiscal chain: SFC assessment → state legislative action → CFC augmentation.

In practical terms, this means SFC reports are not just internal state documents. They are supposed to serve as the baseline for what the Central Finance Commission decides to recommend in terms of additional grants to states specifically for strengthening Panchayat finances. Under the 15th Finance Commission, grants of approximately ₹2,36,805 crore were allocated for Panchayats across 28 states for the period 2021-26, with both tied and untied components. But the effective use of these grants depends heavily on how well the SFC framework has functioned in each state.

The constitutional design thus envisions SFCs as the foundational building block of the entire fiscal decentralisation architecture. When SFCs fail to function properly, the entire chain is weakened – affecting how accurately the Central Finance Commission can assess and respond to ground-level fiscal needs of Panchayats.

Challenges: where the system is falling short 🔗

Despite a constitutionally sound design, SFCs across India have struggled to deliver on their mandate. The challenges are structural, institutional, and political.

Delayed and irregular constitution 🔗

The most basic requirement – constituting an SFC every five years – has been routinely violated. A 2025 report of the Standing Committee on Rural Development and Panchayati Raj noted that only 25 out of 28 states had constituted State Finance Commissions at all. According to a Lok Sabha committee report cited by Mongabay India, out of 26 states surveyed, only nine had constituted their 6th SFC, and of those, only two were active. States like Gujarat, Jharkhand, and Goa had constituted merely three SFCs over the entire period since 1993, while Arunachal Pradesh had constituted just two. This pattern of delay directly undermines the objective of periodic, evidence-based financial reviews.

Non-binding nature of recommendations 🔗

A fundamental structural weakness is that SFC recommendations are advisory, not binding on state governments. While the Constitution requires the Governor to table the recommendations and an Action Taken Report (ATR) before the State Legislature, it does not compel the government to accept or implement them. In practice, many state governments have selectively implemented recommendations or rejected them without adequate justification. As the Mongabay India investigation found, there are several instances where states have simply failed to present the ATR before the assembly at all. This defeats the transparency objective of Article 243I(4).

Data deficits and weak institutional support 🔗

The quality of an SFC’s recommendations depends directly on the quality of data it works with. Across many states, there is a significant lack of reliable, timely data on the fiscal position of Panchayats – their revenues, expenditures, liabilities, and service delivery outcomes. As experts noted in the Mongabay India report, the absence of this data severely hampers the quality of SFC work. SFCs in many states also lack dedicated secretariats, trained staff, and adequate funding to conduct independent analysis, making them dependent on state government data and personnel.

The synchronisation problem 🔗

A technical but critical issue is the lack of temporal synchronisation between SFCs and the Central Finance Commission. Ideally, SFC reports should be available before the CFC begins its work, so that the latter can base its augmentation recommendations on actual SFC findings. In reality, delays in SFC constitution and reporting mean that the CFC often has to work without current SFC data. As scholars have observed, when this sequenced conditional chain is repeatedly bypassed, the deviation becomes institutionalised – and the constitutional design loses its operational force. The recommendations of the CFC then become decoupled from ground-level assessments, making fiscal transfers less targeted and less effective.

Unfunded mandates and asymmetric devolution 🔗

The 73rd Amendment devolved 29 subjects from the Eleventh Schedule to Panchayats, but the transfer of corresponding finances has remained deeply uneven. Many Panchayats are expected to discharge responsibilities – from primary health to rural roads – without being given the money to do so. This “unfunded mandate” problem is a direct consequence of weak SFC functioning. As fiscal experts have noted, the asymmetry between functions and finance at the local level creates structural imbalances that no amount of Central Finance Commission grants can fully offset without a well-functioning SFC framework at the state level.

What good SFC functioning looks like: lessons from Karnataka and Kerala 🔗

Not all states have performed poorly. Karnataka and Kerala consistently rank at the top of India’s Devolution Index, and a key contributing factor in both cases is the effective functioning of their SFCs. In Karnataka, SFC recommendations have resulted in the timely release of funds to Panchayats, while in Kerala, the SFC has emerged as a credible and effective institution that supports transparent financial transfers. These examples demonstrate that the constitutional framework is sound – the gap lies in political will and institutional capacity.

From 2024-25 onwards, the central government has made the constitution of a functioning SFC a mandatory condition for states to access certain central grants, a significant policy shift that could finally create a concrete incentive for states to take SFC obligations seriously.

The path forward 🔗

To realise the original constitutional vision, several reforms are necessary. Experts and parliamentary committees have recommended that a formal “charter” be developed for SFC constitution – specifying timelines, minimum composition standards, and reporting requirements. The mandatory Action Taken Report must be enforced with consequences for non-compliance. States must invest in building Panchayat-level fiscal databases so that SFCs have the data they need to make meaningful recommendations. And the temporal coordination between SFC reports and CFC deliberations must be built into the planning calendar of both bodies. The Standing Committee on Panchayati Raj has also recommended linking financial incentives under central grants and schemes directly to actual progress in devolution – a step that, if implemented rigorously, could transform SFCs from dormant constitutional bodies into active engines of fiscal federalism.

At its core, the SFC framework is not just a financial mechanism. It is the institutional expression of a democratic commitment – that rural communities, through their elected Panchayats, should have real control over resources that affect their daily lives.

What do you think? Given that SFC recommendations are currently non-binding, should the Constitution be amended to make their implementation mandatory on state governments – and if so, what safeguards should accompany such a change? With states constituting SFCs irregularly and selectively implementing their findings, is the current framework capable of achieving genuine fiscal decentralisation, or does it require a more fundamental redesign?

References

1. https://www.constitutionofindia.net/articles/article-243i-constitution-of-finance-commission-to-review-financial-position/
2. https://www.sfc.sikkim.gov.in/visitor/aboutfincomm
3. https://www.pib.gov.in/PressReleaseIframePage.aspx?PRID=1911562
4. https://prsindia.org/policy/report-summaries/devolution-of-funds-under-panchayati-raj-system
5. https://india.mongabay.com/2023/03/state-finance-commissions-in-poor-shape/
6. https://theiashub.com/free-resources/mains-marks-booster/devolution-of-powers-and-finances-up-to-local-levels-and-challenges-therein
7. https://fvbb.com/ns/why-delinking-the-finance-commission-s/308587
8. https://decentralization.net/2025/02/the-status-of-devolution-to-panchayats-in-india/