Why delinking the Finance Commission’s devolution from state FC reports is a flawed idea

In his book Increasing Returns and Path Dependence in the Economy, economist W. Brian Arthur explains how institutional outcomes often persist not because they are efficient, but because early deviations alter the payoff structure of future choices. Once a sub-optimal equilibrium is reached, coordination effects and adaptive expectations lock it in.

Fiscal federalism exhibits similar dynamics. When a constitutionally sequenced mechanism is repeatedly bypassed, actors internalize the bypass as the new norm. Procedural deviation then becomes institutional practice.

India’s 73rd and 74th constitutional amendments inserted Articles 243-I and 243-Y, mandating quinquennial state finance commissions (SFCs) to recommend the vertical distribution of state revenues to panchayats and municipalities. Simultaneously, Article 280(3)(bb) and (c) oblige the Union finance commission (FC) to recommend “measures needed to augment the Consolidated Fund of a State to supplement the resources of panchayats and municipalities on the basis of the recommendations made by the SFCs.” The phrase establishes a conditional chain starting with SFC assessment followed by state legislative action and then FCs augmentation. The FC’s role is supplementary and derivative.

It is not a primary allocator to local bodies. Constitutionally, in the absence of SFC reports, the informational predicate for Article 280(3)(bb) and (c) is formally incomplete. Successive FCs have acknowledged this.

SFCs fail first on timing and cycle design, which breaks the constitutional chain under Articles 280(3)(bb)/(c) that Union augmentation must be “on the basis of” SFC recommendations. In practice, SFC award periods rarely align with the Union FC award window. So, even where