Under the Constitution the financial resources of the State are very limited though they have to do many works of social uplift under directive principles. In order to cope with their ever-expanding needs, the Central Government makes grants-in-aid to the States. Grant- in-aid to States , through it Central Government exercises a strict control over the States because grants are granted subject to certain conditions.
The Indian constitution provides for a federal framework with powers divided between the Centre and the states. The Financial powers entrusted by the Constitution reflect a clear asymmetry between the taxation powers and the functional responsibili-ties, with the Centre being assigned taxes with higher revenue potential and States being entrusted with more functional responsibilities. The Constitution provides, under Article 280, the institutional mechanism of Finance Commission and other enabling provisions for the transfer of resources from the Centre.
The Role of the Finance Commission under Indian Constitution are to make recommendation to the President with regard to following matters:
a) To determine the scheme that governs the matters relating to the distribution of net proceeds of taxes which are in the divisible pool, between the Centre and States. 
b) To make recommendations, to determine the principle that would regulate or govern the revenues to the States from the Central Revenue in the form of Grant in Aid to the needy States
c) This function of the Commission is included by the way of 73rd and 74 Constitutional Amendment to strengthen the financial Status of the local bodies by providing the supplement to the resources of the Panchayats and Municipalities in the States on the basis of the recommendation of State Finance Commission from the Consolidated fund of the State.
d) The last function of the Commission as provided by the Constitution under Article 280 3(d) is very vast any matter relating to the Fiscal interest between the intergovernmental bodies can be referred to the Commission by the President, These function or Terms of Reference, which broadly fixed by the Constitution itself; while at the same time an element of flexibility is built into these terms of reference under sub clause (d) of Article 280(3). Under this Clause the President has a power to refer any matter to the Commission ‘in the interests of sound finance.
The 73rd and 74th Constitutional Amendment Acts, 1992, which gave Constitutional status to panchayati raj institutions (PRIs) and urban local bodies (ULBs) respectively, in both letter and spirit in order to bring about greater decentralisation and increase the involvement of the community in planning and implementing schemes and, thus, increase accountability.
The Amendments left important matters such as implementation, service delivery (including local capacity building) and transfer of responsibilities and powers to rural local bodies at the discretion of the state legislatures. Consequently, while expenditure responsibilities of local bodies are extensively enhanced, there is no law to ensure a corresponding assignment of funds to match the additional responsibilities.
The State Finance Commissions are required to recommend financial support from the state and principles for determination of taxes, tolls and fees that could be assigned to or appropriated by the local bodies
Article 243I of the Indian Constitution prescribes that the Governor of a State shall, as soon as may be within one year from the commencement of the Constitution (Seventy-third Amendment) Act, 1992, and thereafter at the expiration of every fifth year, constitute a Finance Commission to review the financial position of the Panchayats and to make recommendations to the Governor as to
The principles which should govern
- The distribution between the State and the Panchayats of the net proceeds of the taxes, duties, tolls and fees leviable by the State, which may be divided between them under this Part and the allocation between the Panchayats at all levels of their respective shares of such proceeds;
- The determination of the taxes, duties, tolls and fees which may be assigned as, or appropriated by, the Panchayats;
- The grants-in-aid to the Panchayats from the Consolidated Fund of the State;