Reference Article: Editorial | The Hindu – A cautious nudge: On the 16th Finance Commission’s recommendations
UPSC Relevance:
GS Paper II – Polity and Governance (Fiscal Federalism, Centre–State relations), GS Paper III – Indian Economy (Public finance, tax devolution, GST)
The Sixteenth Finance Commission (FC-16) has retained the States’ share in the divisible pool of Central taxes at 41% for 2026–31, despite States demanding a rise to 50%. This decision comes even as the Commission acknowledges that GST has constrained States’ fiscal autonomy and pushed them towards higher market borrowings to meet expenditure needs.
Vertical Devolution
- States’ share of Central taxes remains unchanged at 41%
- States face tightening fiscal space due to GST and limited revenue-raising powers
- No roadmap to gradually increase vertical devolution, despite clear fiscal stress
- Shrinking effective divisible pool due to cesses and surcharges is acknowledged but not corrected
Horizontal Devolution Changes
- “Tax effort” criterion replaced with a broader “contribution to GDP”
- Weight for this criterion raised sharply from 2.5% (FC-15) to 10%
- Intended to reward productive and economically efficient States
- Demographic performance weight reduced, recognising India’s nearing demographic peak
- Population size weight modestly increased to avoid penalising high-population States
Impact on States
- Industrialised and fiscally stronger States such as Tamil Nadu and Maharashtra gain only marginally
- Redistributive balance remains largely intact to avoid shocks to transfer-dependent States
- Reform is cautious and incremental rather than transformative
Transfers and Governance Concerns
- Total transfers to States projected to rise by 12.2% between 2025–26 (RE) and 2026–27 (BE)
- About 42% of this increase comes via Centrally Sponsored Schemes
- Reinforces a model where States act mainly as implementers of centrally designed priorities
- Limits genuine fiscal autonomy and flexibility at the State level
Assessment
The FC-16 recognises the fiscal stress faced by States and introduces modest improvements in horizontal devolution. However, by retaining the 41% vertical devolution ratio and avoiding structural reforms such as including cesses and surcharges in the divisible pool, it stops short of restoring balance in fiscal federalism.
Sample UPSC Mains Question
Critically examine the recommendations of the Sixteenth Finance Commission with respect to vertical and horizontal devolution. Do they adequately address the challenges faced by States under India’s evolving framework of fiscal federalism?