State Finance Commission

Also called: Article 243I, Article 243Y · Topic: Panchayati Raj: Rural Local Government · NCERT: Class 11, Ch 8 "Local Governments"

Meaning

A State Finance Commission (SFC) is a body that the Governor of a state must set up every five years (Article 243I). It reviews the money position of panchayats, and of municipalities under Article 243Y. It then recommends how state taxes, duties, tolls, fees and grants should be shared with them.

It matters because panchayats raise very little money of their own. The SFC is meant to make the state's sharing of money follow fixed rules. That way, sharing does not depend on political favours.

Explanation

How it is set up and when

• Who sets it up: the Governor of the state. The President does not.
• The word used is "shall". This means setting up an SFC is mandatory (compulsory).
• Article 243G on giving powers to panchayats says "may", so it is optional.

• Article 243H on panchayat taxes and grants also says "may", so it is optional.

• Timing:

• The first SFC had to be set up within one year of the 73rd Amendment coming into force on 24 April 1993.

• After that, a new SFC must be set up at the end of every fifth year.

• Members and procedure:

• The state legislature may make a law on how many members the SFC has. The law may also set their qualifications and how they are chosen.
• The SFC decides its own procedure. It has the powers that state law gives it.

What it recommends

• Vertical sharing (how money is split between the state and its local bodies):

• It covers how the net proceeds (money left after collection costs) of state taxes, duties, tolls and fees are divided between the state and panchayats.

• Horizontal sharing (how money is split among local bodies):

• It covers how the panchayats' share is divided among the tiers. These are the village (gram panchayat), block (panchayat samiti) and district (zila parishad).

• NCERT adds that money is also divided between rural and urban bodies.

• Taxes and fees: which taxes, duties, tolls and fees panchayats may levy themselves, or may be given by the state.

• Grants-in-aid (money given to support a body) from the Consolidated Fund of the State, which is the state's main account.
• Steps to improve the money position of panchayats.
• Under Article 243Y, the same work is done for municipalities.

From report to action: the steps

1. The Governor sets up the SFC (Article 243I(1)).
2. The SFC studies local body finances and gives its report to the Governor.
3. The Governor places the report before the state legislature. An action-taken note goes with it. This note says what the state has done on each recommendation (Article 243I(4)).
4. The state decides whether to accept the recommendations. They are advisory. The state is not bound to follow them.
5. The SFC's advice also feeds the Union Finance Commission. Under Article 280(3)(bb), the Union Finance Commission suggests ways to add to the state's Consolidated Fund so the state can support its panchayats.

Limits and gaps

• SFCs are often set up late.
• Reports are often not tabled (placed before the legislature). Some are tabled but never acted on.
• States are short of money themselves.
• A state that has little money cannot give much to its local bodies.
• An NCERT cartoon asks this very question.
• This is the core weakness: panchayats depend on states that are themselves short of funds.

In the Constitution and practice

• Article 243I (panchayats) was added by the 73rd Amendment Act, 1992, in force from 24 April 1993.
• Article 243Y (municipalities) was added by the 74th Amendment Act, 1992. It gives the same SFC the job of reviewing municipal finances.
• Article 280(3)(bb) was added by the 73rd Amendment. It links the Union Finance Commission to the SFC for panchayats. Clause (c) was added for municipalities by the 74th Amendment.
• Related money articles:
• 243H says the state may give panchayats taxes and grants.
• 243J says the state may provide for audit of panchayat accounts.

• The SFC is the only mandatory part of this set.

• Why NCERT values it: NCERT says the SFC keeps the sharing of money from becoming "a political matter". A fixed formula replaces favours.

• Record in practice:
• The Standing Committee on Rural Development and Panchayati Raj presented its report on 29 July 2025. It noted that only 25 of 28 states had set up SFCs [3].

• It said this was so even though, from 2024-25, setting up an SFC is a condition for getting central grants [3].

• Union grants now depend on SFCs:

• 15th Finance Commission: details of the SFC became a mandatory condition for releasing grants after March 2024 [3].
• 16th Finance Commission (2026-31): "timely constitution of the State Finance Commission" is one of three entry-level conditions (conditions that must be met before any grant is given) for all local body grants [4].

• The other two conditions are:

  • local bodies must be set up as the Constitution requires;
  • provisional and audited accounts must be published [4].

• Why the money matters:

• The RBI study of January 2024 found that panchayats' own revenue was only 1.1% of their total revenue [2].
• Grants made up over 95% of their receipts [2].
• So the sharing formula that the SFC recommends decides most of what panchayats can spend.

Don't confuse with

• Union Finance Commission (Article 280): set up by the President. It recommends how Union taxes are shared between the Union and the states. The SFC is set up by the Governor and shares state money with local bodies.
• State Election Commission (Article 243K): another body the 73rd Amendment made mandatory. It conducts panchayat elections. The SFC deals only with finances.
• Article 243H: says the state may give panchayats taxes and grants, so it is optional. Article 243I says the Governor shall set up an SFC, so it is mandatory.
• Article 243Y: the same SFC idea applied to municipalities (74th Amendment). Article 243I covers panchayats (73rd Amendment).

Prelims Hooks

• Article 243I: SFC for panchayats. Article 243Y: SFC for municipalities. Both are set up by the Governor, not the President.
• Timing: the first SFC within 1 year of 24 April 1993. After that, a new one at the end of every fifth year.
• Article 280(3)(bb): the Union Finance Commission recommends ways to augment (add to) a state's Consolidated Fund for its panchayats, based on that state's SFC's advice. It was added by the 73rd Amendment.
• Trap: among Articles 243G, 243H, 243I and 243J, only 243I (SFC) uses "shall". The others use "may".
• Article 243I(4): the Governor places the SFC report, with an action-taken note, before the state legislature, not before Parliament.
• 16th FC (2026-31): a timely SFC is one of three entry-level conditions for local body grants [4]. Only 25 of 28 states had set up SFCs, as noted in July 2025 [3].

Mains Points

• SFCs exist on paper but are weak in practice.
• They are set up late, and their reports are not tabled or acted on. By 2025, only 25 of 28 states had set one up [3].
• So panchayats get money through state discretion rather than a formula, which is the opposite of what NCERT says the SFC was meant to achieve.

• Reform: set a legal deadline for tabling SFC reports with an action-taken report. Give SFCs permanent staff.

• Tying Union grants to SFCs is a useful lever.

• The 15th and 16th FCs made a timely SFC a condition for local body grants [3][4]. This pushes states that ignored Article 243I.

• But the condition only ensures the SFC is set up. It does not ensure its advice is followed.

• The SFC alone cannot solve panchayats' dependence on grants.

• Own revenue is only 1.1% of panchayat revenue [2], and states are short of money themselves.
• So the SFC should also recommend stronger tax powers for panchayats, such as property tax.
• Bolivia's 1994 Popular Participation Law shows another model. It automatically shares 20% of national taxes per head among 314 municipalities, set by national law. In India, sharing depends on state choice.

Related concepts

• Eleventh Schedule
• Devolution of powers to panchayats
• Activity mapping
• Own source revenue of local bodies
• Tied and untied grants to local bodies

Read more

• Functions and finances: Eleventh Schedule, SFCs and own revenue