Why in News
The 16th Finance Commission, chaired by Arvind Panagariya, has submitted its recommendations for the award period 2026–31. The report was tabled in Parliament alongside the Union Budget 2026–27 and signals a shift from entitlement-based fiscal transfers toward a framework driven by performance, compliance, and fiscal discipline.
Overview of the 16th Finance Commission Report
- The share of states in the divisible pool of central taxes has been retained at 41%, continuing the arrangement under the 15th Finance Commission.
- Fiscal transfers are increasingly linked to performance benchmarks and compliance norms.
- A new indicator—contribution to GDP—has been introduced in the horizontal devolution formula.
- The report places strong emphasis on:
- Fiscal consolidation
- Transparency in public finances
- Phasing out off-budget borrowings
- Rationalisation of subsidies
At the same time, concerns have been raised regarding declining untied transfers, equity in inter-state distribution, and erosion of fiscal autonomy, particularly for southern and economically weaker states.
Key Recommendations
1. Tax Devolution
Vertical Devolution
- The proportion of the Union’s divisible tax pool devolved to states remains at 41%.
- The divisible pool continues to exclude cesses, surcharges, and collection charges.
- States had sought an increase to 50%, citing expanded expenditure responsibilities, making the status quo a contentious issue.
Horizontal Devolution
The 41% share is distributed among states using revised criteria and weightage:
| Criterion | Weight |
|---|---|
| Income Distance | 42.5% |
| Population (2011 Census) | 17.5% |
| Demographic Performance | 10% |
| Area | 10% |
| Forest & Ecology | 10% |
| Contribution to GDP | 10% |
A major change is the removal of the tax and fiscal effort parameter, replaced by direct recognition of economic output.
Rationale Behind Devolution Criteria
- Income Distance: Measures the gap between a state’s per capita GSDP and that of the top three high-income states, favouring poorer states.
- Population (2011): Reflects expenditure needs linked to population size.
- Demographic Performance: Based on population growth between 1971–2011, rewarding population stabilisation.
- Forest & Ecology: Considers share of forest cover and increase in forest area (2015–2023), including open forests.
- Contribution to GDP: A new parameter recognising states’ role in national economic output.
Grants-in-Aid
Total Grants: ₹9.47 lakh crore
Local Body Grants: ₹8 lakh crore
- Rural local bodies: ₹4.4 lakh crore
- Urban local bodies: ₹3.6 lakh crore
Entry Conditions:
- Constitutionally compliant local bodies
- Public disclosure of audited accounts
- Timely constitution of State Finance Commissions
Structure:
- 80% Basic Grants
- 50% untied
- 50% tied to sanitation, waste management, and water services
- 20% Performance Grants linked to outcomes and reforms
Urban-Specific Measures:
- One-time Urbanisation Premium of ₹10,000 crore for peri-urban integration
- ₹56,100 crore for wastewater infrastructure in cities with populations of 10–40 lakh
Disaster Management Grants
- Total allocation: ₹2,04,401 crore
- Cost-sharing formula:
- 90:10 for North-Eastern and Himalayan states
- 75:25 for other states
- Centre’s share: ₹1,55,916 crore
Discontinued Grants
The Commission has discontinued:
- Revenue deficit grants
- Sector-specific grants
- State-specific grants
This marks a departure from earlier redistributive mechanisms.
Other Major Recommendations
Fiscal Consolidation Roadmap
- Centre’s fiscal deficit to decline to 3.5% of GDP by 2030–31.
- States’ deficit capped at 3% of GSDP.
- Off-budget borrowings to be fully integrated into official debt.
- Combined public debt projected to fall from 77.3% (2026–27) to 73.1% (2030–31).
Power Sector Reforms
- Encouragement of DISCOM privatisation.
- Transfer of legacy debt to a Special Purpose Vehicle.
- Repayment through the Special Assistance Scheme for Capital Investment post-privatisation.
Subsidy Rationalisation
- Introduction of exclusion criteria.
- Elimination of off-budget subsidy financing.
- Uniform disclosure norms.
Trends indicate that cash transfer schemes now account for 20.2% of subsidy spending (2025–26), up from 3% in 2018–19, driven by JAM-enabled delivery.
Public Sector Enterprise Reform
- Closure of 308 inactive State Public Sector Enterprises (SPSEs).
- Review of loss-making SPSEs for closure, privatisation, or strategic retention.
Transparency in Tax Data
- Annual publication of CAG-certified net tax proceeds under Article 279 to clarify the size of the divisible pool.
Key Concerns
- Unchanged Vertical Devolution: Rising reliance on cesses and surcharges constrains states’ fiscal space.
- Horizontal Formula Shifts: Reduced redistributive emphasis and greater weight to GDP and population benefit industrialised states.
- Weakening Demographic Incentives: Gradual dilution of rewards for population control raises equity concerns.
- Removal of Revenue Deficit Grants: Hill and special-category states argue that structural deficits persist.
- Tighter Fiscal Limits: Risk of crowding out infrastructure and welfare expenditure.
- Over-Centralisation: Expansion of tied grants may reduce states to implementing agencies.
Measures to Reinforce Fiscal Federalism
- Introduce elasticity-linked transfers tied to revenue buoyancy.
- Provide a floor guarantee to prevent decline in nominal state shares.
- Strengthen State Finance Commissions through matching grants.
- Impose a cap on cesses and surcharges, potentially around 10% of Gross Tax Revenue.
- Revitalise the Inter-State Council (Article 263) for continuous fiscal dialogue.
Conclusion
The 16th Finance Commission marks a decisive move toward a compliance-driven and performance-oriented fiscal architecture. While it prioritises efficiency, productivity, and fiscal discipline, its success will depend on safeguarding equity, preserving state autonomy, and ensuring that vulnerable regions are not disadvantaged in India’s evolving federal framework.