Finance Commission of India

The Finance Commission is the constitutional device by which India settles, every five years, the most consequential question a federation can ask itself: who gets the money. It is not a permanent institution, has no enforcement power, and issues recommendations that bind nobody. Yet its award determines the spending capacity of every state government in the country, and in a Union where states deliver most public services but command a minority of tax revenue, the arithmetic it produces is the practical content of Indian federalism.

Article 280 and the Constitutional Charter

• Article 280 requires the President to constitute a Finance Commission within two years of the commencement of the Constitution, and thereafter at the expiration of every fifth year or at such earlier time as the President considers necessary.
  • Each Commission is created, works, reports and dissolves; the quasi-permanence of the office comes from repetition, not tenure. Sixteen Commissions since 1951 have made it the most regular constitutional exercise in Indian public finance.
• Article 280(3) sets out the matters on which the Commission must make recommendations to the President.
  • Clause (a) — the distribution between the Union and the States of the net proceeds of shareable taxes, and the allocation among the States of their respective shares. This single clause contains both vertical devolution and horizontal devolution.
  • Clause (b) — the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India, the constitutional route for which is Article 275.
  • Clause (bb) — measures to augment a State’s Consolidated Fund to supplement Panchayat resources, on the basis of the recommendations of the State’s own Finance Commission. Inserted by the 73rd Amendment.
  • Clause (c) — the identical function for Municipalities, inserted by the 74th Amendment.
  • Clause (d) — any other matter referred to the Commission by the President in the interests of sound finance. This is the open-ended clause through which the Union sets much of the modern agenda.
• Article 281 requires the President to cause every recommendation, together with an explanatory memorandum as to the action taken on it, to be laid before each House of Parliament.
  • This is the accountability mechanism. It does not compel acceptance; it compels disclosure of non-acceptance, forcing a government that rejects an award to say so on the record.
• The Finance Commission (Miscellaneous Provisions) Act, 1951 supplies what Article 280 leaves to Parliament: qualifications, disqualifications, powers, and conditions of service.
  • The Act gives the Commission the powers of a civil court to summon witnesses, require the production of documents and call for records from any office.

Article 280 creates a body that recurs rather than endures, and that difference explains both its independence from any single government and its inability to police what happens after it reports.

The Fiscal Architecture the Commission Works Within

The Commission does not distribute money at large. It works inside a closely drawn scheme in Part XII which decides which taxes are shareable at all, and it is the shrinking of that base — not the headline percentage — that is now the central fiscal grievance of the states.

The tax-sharing scheme

• Article 269 — taxes on the sale or consignment of goods in inter-State trade, levied and collected by the Union but assigned to the States.
• Article 269A, inserted by the 101st Amendment, governs integrated GST on inter-State supply, collected by the Union and apportioned between the Union and the States.
• Article 270 creates the divisible pool: all Union taxes and duties are distributed between the Union and the States in a percentage prescribed by the President on the Finance Commission’s recommendation.
  • Crucially, Article 270(1) excludes from that pool the surcharges of Article 271 and any cess levied for a specific purpose under a law made by Parliament.
• Article 271 allows Parliament to increase any Union tax by a surcharge, and provides that the whole proceeds of such a surcharge form part of the Consolidated Fund of India and are not shared.
• Article 279 defines net proceeds as a tax’s proceeds reduced by the cost of collection, ascertained and certified by the Comptroller and Auditor General, whose certificate is final.
• Article 275 authorises grants-in-aid to States Parliament determines to be in need of assistance, charged on the Consolidated Fund of India — the statutory grants the Commission recommends principles for.
• Article 282 allows either level to make any grant for any public purpose, even outside its legislative competence — the discretionary grants, whose expansion is the oldest structural complaint in Indian fiscal federalism.
• Article 293 requires a State that is indebted to the Union to obtain the Union’s consent before borrowing, a condition that in practice applies to every state permanently.

What changed the architecture

• The 80th Amendment, 2000 implemented the Tenth Commission’s Alternative Method of Devolution, replacing the separate sharing of income tax and Union excise with a single divisible pool of all central taxes.
  • Article 272 was omitted and Article 270 rewritten. The states became entitled to a share of aggregate central tax revenue, which insulated them from the Union’s choice of which tax to raise.
• The 101st Amendment, 2016 pooled the indirect taxing powers of both levels into the GST Council under Article 279A, moving much fiscal-federal decision-making out of the five-yearly cycle into a continuous forum.

Composition, Qualifications and the Independence Question

• The Commission consists of a chairman and four other members appointed by the President. They hold office for the period specified in the President’s order and are eligible for reappointment.
• The Constitution leaves qualifications to Parliament; the 1951 Act prescribes them.
  • The chairman shall be a person having experience in public affairs.
  • The four other members are drawn from four defined categories.
    • A person who is, or is qualified to be appointed as, a Judge of a High Court.
    • A person with special knowledge of the finances and accounts of Government.
    • A person with wide experience in financial matters and in administration.
    • A person with special knowledge of economics.
  • The mix is deliberate, because the award is at once a legal interpretation of Part XII, an audit judgement about proceeds, and an economic judgement about need.
• Disqualifications under the Act cover unsound mind, conviction for an offence involving moral turpitude, and financial interests likely to prejudice the member’s functions.

Where independence is thin

• The Commission is entirely a Union creation. The President — meaning the Union Cabinet — appoints the chairman and every member, and no state has any role in the selection.
• The Terms of Reference are drafted by the Union alone. Because Article 280(3)(d) allows the President to refer “any other matter”, the Union can shape the questions asked and thus constrain the answers available.
• There is no security of tenure and no protected removal procedure, because the body is temporary. The independence architecture that protects the Comptroller and Auditor General or an Election Commissioner simply does not exist here.
• The Commission has no post-award existence. It cannot monitor implementation, cannot revisit an assumption that proves wrong, and cannot respond to a mid-cycle shock such as a pandemic or a tax reform.
• What substitutes for structural independence is professional convention: chairmen have been senior economists, central bankers, finance secretaries or ministers of standing, and their reports are reasoned public documents.

The Finance Commission’s independence rests on the reputations of the people appointed to it rather than on anything the Constitution does to protect them.

Why a Finance Commission Is Necessary: The Theory

The case for the institution is not administrative convenience. It rests on a structural feature of every federation: the level best placed to raise a tax is rarely the level that must spend it, and the gap must be closed by transfer or the federation cannot function.

Vertical fiscal imbalance

• Vertical fiscal imbalance is the mismatch between the revenue-raising powers and the expenditure responsibilities assigned to each tier of government.
• The Indian Constitution assigned taxes with a nationwide base to the Union — income tax, corporation tax, customs, union excise, and now the union share of GST.
  • The purpose was to preserve a single common economic space unhindered by internal fiscal barriers. A federation in which each state taxed goods crossing its border would be a customs union at best.
• States were assigned the functions, not the money. Public order, police, public health, agriculture, irrigation, land, local government and most of education sit on the State List or the Concurrent List, and all are expenditure-intensive.
• The result is a persistent structural asymmetry: states raise roughly a third of general government revenue and account for roughly two-thirds of general government expenditure.
• Devolution is therefore not charity. It is the correction of an imbalance the Constitution itself created, made repeatedly and by an arbiter rather than by the party that benefits from it.

Horizontal fiscal imbalance

• Horizontal fiscal imbalance is the inequality among states in the capacity to raise revenue and in the cost of providing a comparable service.
• Its sources are structural rather than behavioural: historical inheritance, differential resource endowment, the level and composition of economic activity, geography, and the age and density of population.
• India’s inter-state differences are exceptionally sharp by federal standards: per capita income in the richest large state is several multiples of the poorest, and the gap has widened since liberalisation.

Musgrave’s three functions and why they sort by level

• Richard Musgrave divided the economic role of government into three branches: allocation, distribution and stabilisation.
  • Allocation — the provision of public goods and services — can and should be decentralised, because preferences differ across places and local governments know them better.
  • Distribution — redistributive taxation and transfers — gravitates to the centre, because factors and people are mobile: a state that redistributes aggressively on its own drives away the taxed and attracts the beneficiaries.
  • Stabilisation — managing aggregate demand, inflation and the business cycle — must be central, because sub-national governments cannot run independent monetary policy and their fiscal multipliers leak across borders.

Oates and the decentralisation theorem

• Wallace Oates‘s decentralisation theorem holds that, absent scale economies and spillovers, it is always at least as efficient for a local government to provide a service at locally preferred levels as for the centre to provide a uniform level.
• The theorem supplies the efficiency case for untied devolution over tied grants: a transfer without conditions lets the state match spending to local preference, which is the point of decentralising the function.
• Oates also supplies the counter-consideration of spillovers: where a service benefits outsiders — disease control, higher education, river management — a matching or conditional grant makes the local government internalise the external benefit.

The equalisation principle and comparative practice

• The equalisation principle holds that every sub-national government should be able to provide a comparable standard of public services at a comparable level of taxation, whatever its own revenue capacity.
• Australia‘s Commonwealth Grants Commission applies the strongest version, equalising both revenue capacity and expenditure need. It is full equalisation, and correspondingly resented by donor states.
• Canada‘s Equalisation Programme, entrenched in section 36(2) of the Constitution Act, 1982, equalises revenue capacity only, not expenditure need, and only upward — no province pays into it directly.
• India’s system is a hybrid: income distance proxies revenue capacity, area, population and forest cover proxy expenditure need, and neither is measured directly, which is why the formula is always contestable.

The soft budget constraint objection

• The strongest theoretical criticism of large transfers is the soft budget constraint, a concept associated with János Kornai: a state expecting a bailout has weaker incentive to tax its own residents or contain spending, and externalises the cost onto the national pool.
• Moral hazard appears in familiar Indian forms: under-taxed agricultural income and property, unrecovered user charges for power and water, off-budget borrowing, and guarantees invisible in the fiscal deficit.
• The counter-argument is that need and imprudence are not the same thing: a formula punishing low own-revenue also punishes a genuinely thin tax base.
  • Commissions separated the two by rewarding tax effort relative to capacity rather than absolute collection — the criterion the Sixteenth Commission has now abandoned.

The Three Heads of Recommendation

Vertical devolution: how much the states get

• Vertical devolution fixes the percentage of the net proceeds of the divisible pool that goes to the states as a whole.
  • Before 2000 the Commission shared income tax and Union excise separately, at different rates, so no single figure describes the award.
  • After the 80th Amendment the figure became comparable across Commissions, and the sequence runs 29% to 29.5% to 30.5% to 32% to 42% to 41%.

Horizontal devolution: how it is divided among states

• Horizontal devolution distributes the states’ aggregate share among individual states through a weighted formula of objective criteria.
• The formula has always combined three families of indicator.
  • Need — population and area, which proxy the number of people to be served and the cost of reaching them.
  • Capacity — income distance, which measures how far a state’s per capita income falls below a benchmark and therefore how weak its own tax base is.
  • Performance and cost disability — tax effort, fiscal discipline, demographic performance, forest cover, and now contribution to GDP.
• Equity and efficiency pull against each other inside the formula. Every point of weight moved to a performance criterion is a point taken from a need or capacity criterion, and therefore from the poorest states.

Grants-in-aid under Article 275

• Grants-in-aid close the gap that remains after devolution. Article 280(3)(b) asks the Commission for the principles governing them; Article 275 is the constitutional vehicle.
• Historically these took several forms.
  • Post-devolution revenue deficit grants — filling the assessed gap between a state’s revenue receipts and its assessed revenue expenditure after devolution.
  • Grants for local bodies under clauses (bb) and (c).
  • Disaster management grants.
  • Sector-specific grants for identified services, and state-specific grants for particular needs.
• Grants-in-aid are the equalising instrument proper. Tax devolution distributes a pool by formula; grants address the residual condition of a named state that the formula cannot reach.
• Their decline as a share of total transfers is a quiet structural change of the last decade, and the Sixteenth Commission’s discontinuation of revenue deficit grants is its sharpest instance.

Augmenting the resources of the third tier

• Clauses (bb) and (c) made the Union Finance Commission an agent of fiscal decentralisation below the state level, which the original Constitution never contemplated.
• The wording is careful and consequential: the Commission recommends measures to augment a State’s Consolidated Fund to supplement the resources of panchayats and municipalities.
  • The money is therefore routed through the state, not paid directly to a local body. The Union Finance Commission cannot bypass a reluctant state government.
  • It must be made on the basis of the State Finance Commission’s report, linking the Union award to a state-level institution it does not control.
• This is the constitutional hinge of third-tier federalism: local bodies received functions under the Eleventh and Twelfth Schedules but no revenue base, and these grants are now their largest predictable source of untied money.

Any other matter in the interests of sound finance

• Clause (d) has grown from a residual provision into the main channel of the Union’s agenda-setting.
• Through it Commissions have examined disaster relief financing, debt sustainability, public enterprise reform, utility pricing, fiscal consolidation and incentives for central schemes.
• It is where the function shifts from arbitration to advice, and where the overreach criticism bites hardest — a body appointed by the Union, answering the Union’s questions, about how states should run their finances.

The Advisory Character of the Award

• The Commission’s recommendations are advisory and not binding on the Government of India. Neither Article 280 nor Article 281 makes them enforceable.
• What makes them effective is a convention of acceptance, sustained since 1951 and stronger for tax devolution than for anything else.
  • Devolution recommendations have been accepted by every government and given effect by Presidential Order under Article 270, which converts a recommendation into a legal entitlement for the award period.
• P. V. Rajamannar, chairman of the Fourth Finance Commission, put the constitutional case for restraint on rejection most clearly.

“Since the Finance Commission is a constitutional body expected to be quasi-judicial, its recommendations should not be turned down by the Government of India unless there are very compelling reasons.” — P. V. Rajamannar

• The quasi-judicial characterisation matters: a body that hears both sides, applies stated principles and gives reasons is closer to adjudication than to advice, and the convention treats it so.
• The limits of the convention are equally clear.
  • Acceptance of the award does not constrain the Union’s tax design. A government can accept 41% and then raise revenue through instruments that never enter the pool.
  • There is no mechanism to review compliance once the Commission has dissolved.
  • No state can enforce the award in court, because the recommendation creates no justiciable right until the Presidential Order is made, and the Order follows the Union’s decision.

Sixteen Commissions: How the Award Evolved

Commission	Chairman	Award period	States’ share
First	K. C. Neogy	1952–57	55% of income tax; 40% of excise on three commodities
Second	K. Santhanam	1957–62	60% of income tax; excise widened to eight commodities
Third	A. K. Chanda	1962–66	66.67% of income tax; excise widened to 35 commodities
Fourth	P. V. Rajamannar	1966–69	75% of income tax
Fifth	Mahavir Tyagi	1969–74	75% of income tax; 20% of excise
Sixth	K. Brahmananda Reddy	1974–79	80% of income tax
Seventh	J. M. Shelat	1979–84	85% of income tax; excise share doubled to 40%
Eighth	Y. B. Chavan	1984–89	85% of income tax; excise raised to 45%
Ninth	N. K. P. Salve	1989–95	85% of income tax; normative approach introduced
Tenth	K. C. Pant	1995–2000	77.5% of income tax; proposed the Alternative Method of Devolution at 29% of all central taxes
Eleventh	A. M. Khusro	2000–05	29.5% of the divisible pool
Twelfth	C. Rangarajan	2005–10	30.5%
Thirteenth	Vijay Kelkar	2010–15	32%
Fourteenth	Y. V. Reddy	2015–20	42%
Fifteenth	N. K. Singh	2020–26	41%
Sixteenth	Arvind Panagariya	2026–31	41%

What the First Commission established

• K. C. Neogy‘s Commission, reporting in 1952, had no precedent and effectively invented the method every successor has used.
  • It fixed the income tax share at 55% on population weighted 80% and collection 20%, establishing that the award would be formula-driven rather than negotiated.
  • It read Article 275 as requiring an assessment of each state’s budgetary need — the origin of the revenue deficit grant.
• Its choice of population as the dominant criterion was uncontroversial in 1952 and is the root of the sharpest federal dispute today.

The shift in criteria

• From collection to need. The First Commission gave 20% weight to where tax was collected, the Second 10%, and the derivation principle then disappeared — until the Sixteenth Commission’s contribution-to-GDP criterion partially revived it.
• From population alone to income distance. The Seventh Commission under J. M. Shelat introduced a four-factor formula — population, the inverse of per capita income, the poverty ratio and revenue equalisation — moving the award toward equalisation.
• From gap-filling to normative assessment. The Ninth Commission under N. K. P. Salve replaced projections of actual deficits with what revenues and expenditures ought to be, removing the incentive by which overspending was rewarded.
• From separate taxes to a single pool. The Tenth Commission under K. C. Pant proposed the Alternative Method of Devolution — a share of all central taxes rather than two named ones — implemented by the 80th Amendment in 2000.
• From consolidation to incentives. The Twelfth Commission under C. Rangarajan restructured state debt through a Debt Consolidation and Relief Facility conditional on FRBM legislation, and the Thirteenth Commission under Vijay Kelkar attached grants to GST implementation, disaster relief and forest cover as an ecological criterion.
• From tied to untied money. The Fourteenth Commission under Y. V. Reddy produced the largest single change in the institution’s history: the vertical share jumped from 32% to 42%.
  • It discontinued sector-specific and state-specific grants, on the reasoning that untied transfers respect state priorities while tied grants substitute the Union’s judgement for the state’s.
  • It abolished the plan/non-plan distinction in its assessment, and introduced forest cover at 7.5% weight alongside 2011 population, both durable and contentious.
• From formula to conditionality. The Fifteenth and Sixteenth Commissions have moved back toward entry conditions, performance components and reform-linked release, which is a partial reversal of the Fourteenth Commission’s untied philosophy.

The Fifteenth Finance Commission’s Award

• The Fifteenth Commission under N. K. Singh, constituted in 2017, is the only Commission to have submitted two reports — an interim award for 2020-21 and a final award for 2021-26.
• Vertical devolution was set at 41%, down from the Fourteenth Commission’s 42%.
  • The one percentage point adjustment funded the newly created Union Territories of Jammu and Kashmir and Ladakh from the Union’s resources after the reorganisation of 2019.
  • The reduction was not a withdrawal of the Fourteenth Commission’s generosity but an accounting consequence of a state ceasing to be a state.
• The horizontal criteria were: income distance 45%, population (2011) 15%, area 15%, demographic performance 12.5%, forest and ecology 10%, and tax and fiscal effort 2.5%.
  • Income distance measured the gap from the highest-income state on per capita GSDP over 2015-18; demographic performance used the reciprocal of the total fertility rate scaled by 1971 population; forest and ecology used each state’s share of dense forest; tax effort used own tax revenue relative to state GDP.
• Grants totalled about Rs 10.33 lakh crore.
  • Revenue deficit grants of about Rs 2.9 lakh crore to 17 states, tapering to six north-eastern and hill states.
  • Local body grants of about Rs 2.4 lakh crore rural and Rs 1.2 lakh crore urban, plus Rs 70,051 crore for health grants through local governments — with no release after March 2024 to a state that had not constituted its State Finance Commission and acted on its report.
  • Sector-specific grants of about Rs 1.3 lakh crore across eight sectors from health and education to the judiciary and aspirational districts, and state-specific grants of Rs 49,599 crore monitored by a high-level state committee.
  • Disaster risk management with a state fund corpus of about Rs 1.6 lakh crore, the Union contributing about Rs 1.2 lakh crore on the existing 90:10 and 75:25 pattern.
• On the fiscal roadmap it recommended that both levels comply with their own FRBM legislation and pursue debt consolidation, holding a firm debt trajectory impossible to specify amid uncertainty.
  • It observed that off-budget borrowing defeats FRBM compliance, and asked for full disclosure of extra-budgetary borrowings and their elimination in a time-bound manner.
  • It also proposed a statutory framework for public financial management covering budgeting, accounting and audit standards at all levels, and an independent Fiscal Council.
• On defence it recommended a non-lapsable Modernisation Fund for Defence and Internal Security of about Rs 2.4 lakh crore, financed from the Consolidated Fund of India, defence disinvestment and land monetisation — deliberately not from the divisible pool.

The Terms of Reference controversy

• The Fifteenth Commission’s Terms of Reference produced the most serious federal objection in the institution’s history: several states petitioned the President and southern finance ministers met to coordinate opposition.
• The 2011 population base. The ToR directed use of 2011 population data where earlier Commissions had used 1971 data, and states that had reduced fertility fastest argued they were being penalised for complying with national policy.
• The defence and internal security fund. States read the proposal for a separate funding mechanism as a plan to carve defence spending out of the divisible pool before their share was computed, reducing devolution without touching the headline percentage.
• Examining populist measures. The ToR asked for performance-based incentives, including on expenditure on populist measures.
  • States objected that what counts as populist is a political judgement, that welfare spending is a legitimate state competence, and that conditioning devolution on it converts an entitlement into a reward for obedience.
• Flagship scheme performance. Linking incentives to centrally sponsored flagship schemes drew the objection that devolution is compensation for a constitutional imbalance, not payment for delivering the Union’s programmes.
• The answers were partly reassuring — the demographic performance criterion offset the 2011 base, and the defence fund drew on the Union’s own resources — but the episode established that whoever writes the Terms of Reference shapes the outcome.

The award can be neutral only if the question is neutral, and the question is written by one of the two parties to the dispute.

The Sixteenth Finance Commission

• The Sixteenth Finance Commission was constituted on 31 December 2023 under the chairmanship of Arvind Panagariya, economist and former Vice-Chairman of NITI Aayog.
  • Members: Ajay Narayan Jha, Annie George Mathew and Manoj Panda, with Soumya Kanti Ghosh as part-time member.
  • It reported to the President on 17 November 2025 and was tabled in the Lok Sabha on 1 February 2026 with the Union Budget, alongside the explanatory memorandum as to action taken required by Article 281.
  • The award covers 2026-27 to 2030-31.
• Its Terms of Reference were narrower and attracted less protest: the three constitutional heads under Article 280(3), plus a review of disaster management financing under the Disaster Management Act, 2005.
  • The absence of a “populist measures” clause was widely read as a deliberate de-escalation after the previous round.
  • States nonetheless objected to what the ToR omitted — there was no reference to examining cesses and surcharges, which was the states’ single largest demand.

Vertical devolution held at 41%

• The Commission retained the states’ share at 41% of the net proceeds of the divisible pool, rejecting the demand of eighteen states for an increase to 50%.
• Its reasoning was that the Union’s own obligations — defence, internal security, interest and national infrastructure — leave no room for a higher share.
• Tamil Nadu’s submission put the counter-case most sharply: because of the growth of non-shareable levies, the effective share reaching states falls below 30%, so that holding the headline at 41% conceded nothing.
• The Commission declined to recommend bringing cesses and surcharges into the pool, which is the decision that has drawn the heaviest criticism from state governments and from fiscal-federalism scholars.

The Article 279 disclosure recommendation

• The Commission recommended that the Union disclose annually the net proceeds of taxes, as certified by the Comptroller and Auditor General under Article 279.
• Article 279 already makes the CAG’s certificate final, but that figure has never been published in a form letting states verify the base on which their 41% is computed.
• States have no independent means of checking the gross tax figure, the collection cost deducted, or the amount classified as cess and surcharge. Disclosure converts a matter of trust into a matter of record.
• The Union accepted this recommendation, which makes it one of the few genuinely new transparency obligations to emerge from a Finance Commission award.

The six horizontal criteria

Criterion	15th FC	16th FC	What it measures
Income distance	45%	42.5%	Gap between a state’s per capita GSDP and the average of the top three large states
Population (2011)	15%	17.5%	Scale of the population to be served
Demographic performance	12.5%	10%	Redefined as population growth between 1971 and 2011; lower growth scores higher
Area	15%	10%	Cost of administering and reaching a dispersed population
Forest and ecology	10%	10%	Now includes open forest alongside dense forest, and increase in forest area 2015–2023
Tax and fiscal effort	2.5%	removed	Own tax revenue relative to GSDP
Contribution to GDP	—	10% (new)	State’s share in all-state GSDP, taken as the square root to moderate the advantage of large economies

• Income distance remains dominant and is the engine of equalisation, but the benchmark changed: from the single highest-income state to the average of the top three, which compresses the range and reduces the transfer to the poorest states.
• Population was raised to 17.5%, the highest weight given to raw 2011 population by any recent Commission, and this is the change that most directly cuts against the demographically successful states.
• Demographic performance was redefined from the reciprocal of the total fertility rate to population growth over 1971–2011. The redefinition matters because it measures a historical outcome rather than a current rate, freezing the reward at the 2011 census.
  • Southern and western states argue early transition carries its own bill — ageing populations, rising pension and old-age care costs, a shrinking working-age share — arriving before high incomes do, so a criterion rewarding only past restraint understates the present cost.
• Area was cut from 15% to 10%, which reduces the transfer to large, sparsely populated states.
• Forest and ecology is the ecological federalism criterion: a state keeping land under forest forgoes the revenue that land would yield under industry or agriculture, bearing that cost for a national and global public good.
  • The addition of open forest to the dense-forest measure widens the criterion considerably, since open forest covers far more of India’s land than dense forest.
  • Including the increase in forest area between 2015 and 2023 converts a stock measure into a partly flow measure, rewarding afforestation rather than only inherited cover.
  • The criticism mirrors the case for it: measuring area rather than quality or carbon value rewards having forest, not protecting it, and open forest includes badly degraded land.
• Contribution to GDP is the genuinely new criterion, and it replaces tax and fiscal effort.
  • It measures a state’s share of all-state GSDP, with the square root applied so that a state with four times the output receives twice the weight rather than four times.
  • The rationale is that states generating more national output bear the congestion and infrastructure costs of growth — a partial return of the derivation principle abandoned after the Second Commission.
  • The objection is that it is regressive by construction, moving weight from poor states to rich through a criterion of outcome rather than effort: a state cannot lift its GSDP share within one award period, but it can lift its tax effort.

Who gained and who lost

State	15th FC share	16th FC share	Change
Uttar Pradesh	17.94%	17.62%	−0.32
Bihar	10.06%	9.95%	−0.11
Madhya Pradesh	7.85%	7.35%	−0.50
West Bengal	7.52%	7.22%	−0.31
Karnataka	3.65%	4.13%	+0.48
Kerala	1.93%	2.38%	+0.46
Gujarat	3.48%	3.76%	+0.28
Tamil Nadu	4.08%	4.10%	+0.02

• The pattern is consistent: the new GDP-contribution criterion and the lower income-distance weight moved money from the populous northern and eastern states to the southern and western ones, by fractions of a percentage point.
• Tamil Nadu, whose government campaigned hardest on devolution, gained almost nothing — the fact most cited by critics who call the new criterion symbolic.

Grants: a smaller and narrower envelope

• Total grants recommended come to Rs 9.47 lakh crore, against the Fifteenth Commission’s Rs 10.33 lakh crore — a reduction in nominal terms across a five-year gap, and a substantial reduction in real terms.
• The composition changed more than the total.

Grant	15th FC	16th FC
Revenue deficit grants	Rs 2.9 lakh crore to 17 states	Discontinued entirely
Sector-specific grants	About Rs 1.3 lakh crore	Discontinued
State-specific grants	Rs 49,599 crore	Discontinued
Local body grants	About Rs 4.36 lakh crore	Rs 7,91,493 crore
Disaster management (Union share)	About Rs 1.2 lakh crore	Rs 1,55,916 crore

• The Commission has made a decisive choice: almost the whole of grants-in-aid now goes to the third tier and to disaster management, and almost nothing goes to state governments as such.

Local body grants and third-tier federalism

• Rs 7,91,493 crore for local bodies over five years is the largest sum any Finance Commission has directed to the third tier, and it is roughly five-sixths of the entire grants envelope.
  • Rural local bodies: Rs 4,35,236 crore — basic grants Rs 3,48,188 crore and performance grants Rs 87,048 crore.
  • Urban local bodies: Rs 3,56,257 crore — basic grants Rs 2,32,125 crore, performance grants Rs 58,032 crore, a special infrastructure component of Rs 56,100 crore, and an urbanisation premium of Rs 10,000 crore.
• The basic-to-performance split is 80:20. Within the basic grant, half is untied and half is tied to sanitation and solid waste management or to water management.
  • Performance grants are split between a state performance component, which tests whether the state has actually transferred the money and devolved functions, and a local body performance component, which tests growth in the local body’s own source revenue.
  • The design attempts to break the dependence trap: panchayats draw over ninety per cent of revenue from grants and municipal borrowing is under 0.05% of GDP, so a grant that does not reward own revenue entrenches dependence.
• Entry-level conditions apply to all local body grants: a state qualifies only if it has constituted its local bodies as the Constitution requires, published provisional and audited local accounts publicly, and constituted its State Finance Commission in time.
• The special infrastructure component of Rs 56,100 crore is confined to wastewater management in 23 cities with populations between 10 and 40 lakh as recorded in the 2011 census.
  • The reasoning is that the largest corporations can borrow in the market and the smallest towns lack absorptive capacity, while mid-sized cities are where urban growth is concentrated and where sewerage was never built.
• The urbanisation premium of Rs 10,000 crore is an incentive payment.
  • It rewards states that merge peri-urban villages into adjoining urban local bodies so as to create municipal units above one lakh population, and that adopt a Rural-to-Urban Transition Policy.
  • It addresses a real distortion: census towns that are urban in every economic sense are still administered as panchayats, because states gain from calling settlements rural, leaving urban India under-governed and under-taxed.
• Most controversially, it recommended that Articles 280(3)(bb) and (c) be amended to remove the requirement that local body recommendations be made “on the basis of” State Finance Commission reports.
  • The justification is practical: State Finance Commissions are constituted late, report late and are frequently not acted upon, so a Union body building on them is building on nothing.
  • The objection is constitutional: the linkage was inserted deliberately by the 73rd and 74th Amendments, and severing it removes the only external pressure that has ever induced states to constitute them.
  • The report is internally in tension — timely constitution remains an entry condition for the grants, yet reliance on the report is to end, which reduces the institution to a box to tick.

Disaster management financing

• Total corpus for the State Disaster Response Fund and State Disaster Mitigation Fund: Rs 2,04,401 crore, of which the Union’s share is Rs 1,55,916 crore.
• The sharing pattern is retained at 90:10 for north-eastern and Himalayan states and 75:25 for all others, reflecting both their exposure and their weaker fiscal capacity.
• The shift of emphasis from response to mitigation continues a direction set by the Fifteenth Commission, and reflects the fact that climate-related disaster costs are now a recurring item in state budgets.
• The unresolved question is whether a five-yearly fixed corpus can absorb a risk distribution fattening at the tail: one bad flood season exhausts a state’s fund, after which relief becomes a discretionary Union decision again.

The fiscal roadmap and off-budget borrowing

• The Commission recommended the Union reduce its fiscal deficit to 3.5% of GDP by 2030-31, with states capped at 3% of GSDP annually.
• Combined general government debt is projected to fall from 77.3% of GDP in 2026-27 to 73.1% by 2030-31.
• Off-budget borrowings should be strictly discontinued and all such liabilities brought onto the state budget.
  • Off-budget borrowing routes debt through state enterprises, special purpose vehicles or corporations — serviced from the state budget but invisible in the fiscal deficit, and the principal means by which the FRBM ceiling is evaded.
  • The Commission also recommended amending fiscal responsibility legislation to bring uniformity across states in definitions, disclosure and debt paths.
• Critics note that the projections assume nominal GDP growth of around 11%, widely regarded as optimistic, and that a uniform deficit cap ignores differing state debt positions.

Power sector, subsidies and public enterprises

• Electricity distribution. States should actively pursue privatisation of DISCOMs, with a special purpose vehicle to warehouse existing DISCOM debt so a private acquirer takes the operating business without the accumulated liability.
  • Central capital investment assistance is to be released only after privatisation is complete, making reform a condition of the money rather than an exhortation.
  • This is the most ideologically contested recommendation in the report: electricity distribution is a State List subject, and several states read a conditional transfer tied to privatisation as imposing a choice the Constitution assigns to them.
• Subsidies and transfers. The Commission found that cash transfer schemes are frequently untargeted and that states classify subsidies inconsistently, making comparison impossible.
  • It recommended clear exclusion criteria identifying who should not receive a transfer, rigorous periodic review, sunset clauses so that schemes lapse unless renewed on evidence, uniform accounting standards for subsidies across states, and the discontinuation of off-budget financing of subsidies.
  • The objection echoes the Fifteenth Commission’s ToR row: welfare spending is a state legislative competence, and a constitutional body recommending its curtailment strays from arbitration into policy.
• State public sector enterprises. It recommended review and closure of 308 inactive State PSEs, which carry establishment costs, unpaid statutory dues and accumulated arrears while conducting no business.
  • A PSE at either level incurring losses in three of four consecutive years should go to the relevant Cabinet for a decision on closure, privatisation or strategic continuation.
  • States should formulate explicit disinvestment policies; the report also flags the contingent liabilities of state guarantees, invisible in the fiscal deficit but liable to crystallise into it.

What the Union accepted

• The explanatory memorandum tabled with the report records the following.
  • Accepted: the 41% vertical share; the Article 279 CAG-certified disclosure; and the horizontal devolution formula in full.
  • Also accepted: the entirety of the local body grant package — total, classification, entry conditions, tied and untied provisions, urbanisation premium and special infrastructure component — and the disaster management package with its Rs 2,04,401 crore corpus and sharing ratios.
  • Accepted in principle: the 3% of GSDP fiscal deficit cap on states, with SASCI capital investment loans excluded from the computation.
  • Deferred or under examination: the discontinuation of off-budget borrowings, the amendment of fiscal responsibility legislation, the Union’s own 3.5% fiscal deficit target, the rationalisation of centrally sponsored schemes, the power sector recommendations, the subsidy recommendations, and the public enterprise reforms.
• The pattern is consistent with the institution’s history.
  • The states’ 3% cap was accepted in principle; the Union’s own 3.5% target was not.
  • The rationalisation of centrally sponsored schemes, which is the states’ second-largest grievance after cesses, was placed under examination rather than acted on.

A Finance Commission can command the Union’s compliance on what it must pay and not on what it must do, and every award since 1951 has revealed the same asymmetry.

Cesses and Surcharges: The Shrinking Divisible Pool

• The single largest fiscal-federal grievance in India today is not the 41% but the base to which it is applied.
• The exclusions of Article 270(1) and Article 271 are constitutional, and both were designed for exceptional and temporary use.
• Their use is no longer exceptional. Cesses and surcharges rose from roughly 9.5% of gross tax revenue in 2010-11 to over 20% at their peak around 2020-21, and have remained in the region of a fifth of gross tax revenue since.
• The consequence is arithmetical. The divisible pool has fallen from about 87% of gross tax revenue in the early 2010s to about 78%. Applying 41% to 78% yields roughly 32% of gross tax revenue, not 41%.
• The Sixteenth Commission’s own projections imply an effective transfer of around 32.7% of gross tax revenue in 2026-27, and the gap between recommended and effective share has widened with every award since the Thirteenth.
• The instruments are legally unimpeachable and fiscally decisive.
  • A cess must be levied for a specified purpose, yet the Comptroller and Auditor General has repeatedly found cess proceeds not transferred to the dedicated funds — the GST Compensation Cess among them — which undercuts the justification for excluding them.
  • A surcharge requires no stated purpose at all.
• The Sixteenth Commission declined to recommend any change, citing the Union’s defence and infrastructure obligations.
  • The political economist Rathin Roy has called this an abdication: the Union keeps 59% of a pool it has itself been shrinking, while states carry rising matching obligations in health, education, sanitation and employment.
• The remedies canvassed are three, in ascending order of difficulty.
  • Disclosure, which the Sixteenth Commission recommended and the Union accepted.
  • A ceiling on cesses and surcharges as a proportion of gross tax revenue, self-imposed or recommended.
  • A constitutional amendment to bring them into the divisible pool after a defined period, which no Commission has recommended and no Union government has entertained.

A percentage of a pool means nothing until someone fixes the pool, and the Constitution gives that power to only one of the two parties.

The Southern States’ Grievance

• The objection comes most persistently from the southern states — Kerala, Tamil Nadu and Karnataka above all — though Maharashtra, Gujarat, Punjab and Haryana share versions of it.
• The population argument. Earlier Commissions used 1971 population in deference to the population-stabilisation policy and the parallel freeze on Lok Sabha seats; the move to 2011 population at 17.5% weight transfers resources toward higher-fertility states.
  • The claim is not that population is an illegitimate criterion but that states which delivered a national policy objective are now being charged for having delivered it.
• The contribution argument. Southern states contribute far more to central taxes than they receive back.
  • Karnataka receives about 47 paise for every rupee it contributes; Tamil Nadu about 29 paise; Telangana about 43 paise; Andhra Pradesh about 49 paise.
  • Uttar Pradesh receives about Rs 1.79 and Bihar about Rs 7.06 for every rupee contributed.
  • These figures drove the “Chalo Delhi” and “My Tax, My Right” protests of February 2024, in which the Karnataka and Kerala governments took the dispute to the national capital.
• The equalisation counter-argument is the strongest reply, and it is the reason the exercise exists.
  • The point of a general-purpose transfer is comparable public services at comparable tax rates, and on that aim stale population data is indefensible: a child born in 1990 needs a school whether or not her state met a fertility target.
  • Using 1971 data never functioned as a lever for family planning. Fertility fell because of income, female education and health systems, not because of a devolution formula.
  • Penalising residents of poorer states for outcomes they did not choose — being born in a district with weak schools and hospitals — is difficult to reconcile with a common citizenship.
  • Population is only one criterion among six. Income distance at 42.5% remains dominant, and area, forest, demographic performance and now GDP contribution all cut in other directions.
• Both sides describe the same instrument correctly. A system designed to equalise must move money from richer jurisdictions to poorer; what has changed is that the redistributive burden has grown while the pool has shrunk, and that combination, not equalisation itself, made the grievance combustible.

Delimitation, the 2027 Census and a Shared Logic

• The devolution grievance and the delimitation grievance are the same argument applied to two different currencies — money and seats.
• Lok Sabha seat allocation has been frozen on 1971 population since the 42nd Amendment (1976), extended by the 84th Amendment (2001) to the first census taken after 2026.
• The next census is scheduled for 2027 and will enumerate caste, making it the first census capable of ending the freeze.
• If seats are reallocated on current population, states that reduced fertility fastest lose parliamentary weight in proportion to their success, exactly as they lose fiscal weight under a 2011-population criterion.
  • Projections placed before Parliament in 2026 with proposed delimitation legislation showed the scale: on a 2011 basis Uttar Pradesh gains seats and Tamil Nadu loses several, in a larger House.
• The 106th Amendment (2023) compounds the linkage, because women’s reservation in the Lok Sabha takes effect only after a census and a delimitation, tying a rights question to the same demographic arithmetic.
  • Hence proposals for a permanent cap on total seats, or reallocation only of added seats, are debated alongside reweighting the devolution formula — both attempts to decouple representation and revenue from raw population.

The Finance Commission and the Planning Commission

• For six decades the Commission shared the field with a body the Constitution never mentioned. The Planning Commission, created by a Cabinet resolution in 1950, distributed plan assistance on a scale that repeatedly exceeded the Finance Commission’s award.
• The division that emerged — Finance Commission for non-plan revenue expenditure, Planning Commission for plan expenditure — is found nowhere in Article 280 and bore progressively less relation to how governments actually spend.
• P. V. Rajamannar — chairman of the Fourth Finance Commission and later of the Tamil Nadu committee on centre-state relations — was the earliest and most persistent critic of the arrangement.
  • He argued that the overlap of functions between the two bodies made coherent fiscal federalism impossible, and that the constitutional body had been displaced by the executive one.
• The Article 282 route was the mechanism.
  • Article 282 permits any grant for any public purpose, and was intended as a residual power for exceptional expenditure.
  • Plan transfers, and later centrally sponsored schemes, were routed through it, which meant they escaped Article 280(3)(b) altogether: the Finance Commission never recommended principles for them, and no formula constrained them.
  • The Gadgil formula, later the Gadgil-Mukherjee formula, gave plan assistance an appearance of objectivity from 1969, but it was adopted by the National Development Council, not recommended by a constitutional body, and discretionary components survived alongside it.
• The structural criticism is the distinction between statutory and discretionary transfers.

	Statutory transfers	Discretionary transfers
Constitutional basis	Articles 270, 275	Article 282
Determined by	Finance Commission, a constitutional body	Executive decision of the Union
Character	Formula-bound, published, reasoned	Scheme-bound, negotiated, conditional
Predictability	Fixed for five years by Presidential Order	Revisable annually in the Budget
State autonomy	Largely untied	Tied, with matching contributions

• NITI Aayog replaced the Planning Commission in 2015, and it holds no resource-transfer power at all. It advises, evaluates, convenes and publishes indices; it does not allocate money to states.
• Whether this strengthened the Finance Commission is genuinely contested.
  • The case that it did: the plan/non-plan distinction was abolished, removing the basis for a parallel transfer system; the Commission became the only body recommending general-purpose transfers; and the jump to 42% came the same year.
  • The case that it did not: discretionary transfers migrated to the Finance Ministry. Centrally sponsored schemes continue under Article 282 with matching contributions that pre-commit state budgets, designed between line ministries and the Finance Ministry with no forum for collective state bargaining.
  • The Planning Commission had the National Development Council, in which every chief minister sat; its abolition removed a negotiating venue without replacing it, leaving the Finance Commission as the only occasion on which states are formally heard on money.

GST and the Limits of a Five-Yearly Body

• The 101st Amendment (2016) is the most significant change to Indian fiscal federalism since 1950, and it reshaped the ground on which the Finance Commission stands.
• States surrendered their most important independent tax handle — value added tax on goods — into a pooled system governed by the GST Council under Article 279A.
  • The Union holds one-third of the weighted votes and all states together two-thirds, with decisions requiring a three-quarters majority, so the Union has an effective veto and no group of states can carry a measure without it.
• Mohit Minerals (2022) held the Council’s recommendations persuasive and not binding, with Parliament and state legislatures holding simultaneous power over GST — restoring state autonomy in principle while changing little in practice.
• GST compensation, guaranteeing 14% annual growth in protected revenue, ran five years and ended in June 2022. The compensation cess continued only to service pandemic borrowing, not to compensate states, and was discontinued from 22 September 2025.
• The rate rationalisation of September 2025 collapsed the structure into principal slabs of 5% and 18%, with a 40% rate for demerit and luxury goods, moving large categories of goods down from 12% and 28%.
  • It is a genuine simplification, but it also reduces revenue, and because GST is a shared tax states bear much of that loss with no compensation mechanism left.
  • The Sixteenth Commission’s projections were finalised in the same months, and are criticised for not adequately pricing in the revenue effect of those rate cuts.
• This exposes a structural mismatch. The Finance Commission fixes shares for five years; the GST Council can change the size of what is being shared at any meeting.
  • A Commission’s award rests on revenue projections that a subsequent Council decision can invalidate within months, and the Commission has dissolved by then and cannot revise anything.
  • There is no institutional link between the two bodies: the Council does not consult the Commission, and the Commission has no standing to be heard in the Council.

State Finance Commissions and the Third Tier

• Article 243-I requires the Governor to constitute a State Finance Commission every five years to review panchayat finances and recommend the distribution of state taxes between the state and its local bodies, the grants-in-aid to them, and measures to improve their finances; Article 243-Y extends it to municipalities.
• It is the exact analogue of the Union Finance Commission one tier down, and the 73rd and 74th Amendments deliberately linked the two.
• In practice the institution has largely failed.
  • Constitution is chronically delayed. The Fifteenth Commission found that only nine states had constituted their sixth State Finance Commission by the time it was due, and many states remain on their second or third.
  • Reports are submitted late, often after the period they were meant to cover has begun.
  • Action Taken Reports are frequently not tabled in the state legislature, which is the only mechanism by which a state government must explain a rejection.
  • Composition is weak: appointments often go to serving or retired bureaucrats and politicians rather than to public finance specialists, and secretariats lack the data to make a defensible assessment.
  • Recommendations are routinely ignored, because unlike the Union award there is no convention of acceptance and no political cost to disregarding them.
• The consequence is the well-documented fiscal condition of Indian local government: panchayats drawing over ninety per cent of revenue from grants, municipal own revenue stagnant, property tax collection well below potential, and municipal borrowing below 0.05% of GDP.
• Union Commissions have responded by making local body grants conditional on State Finance Commission compliance — the March 2024 deadline, and now the entry-level condition of timely constitution.
• Against that background the Sixteenth Commission’s proposal to amend Article 280(3)(bb) and (c) is a considered but risky judgement.
  • It accepts the failure of State Finance Commissions as a fact to be worked around rather than a defect to be cured.
  • It frees the Union Commission to make its own assessment of local body needs, which will almost certainly produce a better-reasoned award.
  • But it removes the constitutional dependence that gave states a reason to take the state-level institution seriously, at the very moment the largest sum in the institution’s history is placed in local body hands.

The Design-versus-Practice Gap

• On the narrowest measure it is India’s most successful constitutional body: every award since 1951 has been accepted on tax devolution and given effect by Presidential Order. The gap between design and control is nonetheless wide, and widening.

Design	Practice
Arbiter between two levels of government	Appointed, staffed and instructed by one of them
Recommends the division of the divisible pool	Has no say in how large the pool is
Recommends principles for grants-in-aid under Article 275	The largest transfers flow through Article 282, outside its purview
Recommendations are quasi-judicial	Legally advisory and unenforceable by any state
Links to the third tier through State Finance Commissions	Those bodies are irregular, and the link is now to be severed
Five-yearly cycle suited to a stable tax system	GST rates and cess design change continuously between awards
Dissolves after reporting	No institution monitors compliance or revises assumptions

• What it possesses is reasoned public argument: every award is published with its assumptions, data and logic, which is why states contest the formula rather than the institution. That evidentiary authority is real power in a federation with no upper chamber able to defend state finances.

The Reform Debate

• Constitutionalise the divisible pool. An amendment could cap cesses and surcharges as a share of gross tax revenue, or bring them into the pool after a defined period. Without it, every other reform is arithmetic on a shrinking base.
• Give states a role in appointment and in the Terms of Reference — from consulting the Inter-State Council under Article 263 before notification to letting states nominate a member. The Punchhi Commission urged a stronger, regularly convened Council for exactly this class of dispute.
• A permanent secretariat or standing fiscal council. The Commission reassembles from nothing every five years; a permanent body would supply continuity of data, monitoring and mid-cycle reassessment when a shock invalidates the projections. The Fifteenth Commission’s proposal for an independent Fiscal Council was not acted on.
• Bring Article 282 transfers within Article 280(3)(b), so that the discretionary channel is constrained by the same public reasoning as the statutory one.
• Rationalise centrally sponsored schemes. States have asked for fewer schemes, lower matching ratios and more flexibility in design. The Sixteenth Commission recommended rationalisation; the Union placed it under examination.
• Restore a needs-based equalisation grant. The objection to discontinuing revenue deficit grants is not that they were well designed but that nothing replaced them.
  • Ajay Narayan Jha, a member of both the Fifteenth and Sixteenth Commissions, has argued that abandoning grants-in-aid without a state-wise normative assessment of need leaves the Article 280(3)(b) mandate unperformed.
• Strengthen State Finance Commissions rather than bypass them: a standard composition requirement, a timetable synchronised with the Union cycle, and a statutory obligation to table an Action Taken Report.
• Make disclosure routine. The Article 279 recommendation now accepted should extend to cess and surcharge collections, their utilisation against stated purposes, and off-budget liabilities at both levels.

Conclusion

The Finance Commission was designed to solve a problem the Constitution deliberately created. By assigning broad-based taxes to the Union and expenditure-heavy functions to the states, the framers guaranteed a permanent vertical imbalance and then built an institution to correct it every five years. Seventy-five years on, that correction still works: the award is made, published, argued over and implemented.

• What has changed is that the Commission’s authority now covers a smaller proportion of the money that actually moves between the Union and the states.
  • Cesses and surcharges have taken a fifth of gross tax revenue outside its reach.
  • Article 282 schemes carry large transfers on which it recommends nothing.
  • The GST Council can alter the size of the shared pool between awards.
• The Sixteenth Commission’s award captures that position exactly: it held the vertical share, moved weights at the margin, placed an unprecedented sum with local bodies and won a real transparency gain — while declining to touch the divisible pool and discontinuing the grants that reached the states in most difficulty.
• The acceptance pattern is the sharpest evidence of all: everything obliging the Union to transfer was accepted, everything obliging it to discipline itself was deferred.
• Its durability rests on something the Constitution never supplied. Article 280 gives no tenure, no enforcement power and no independence architecture; it gives a public, reasoned, recurring occasion on which the fiscal claims of states must be heard.
  • That has been enough to make every government accept every award, and never enough to stop one changing the base on which the award is computed.
• The reform agenda therefore points one way. The Commission does not need more power over the division; it needs purchase on the size of what is divided. Until the pool itself is protected, a higher percentage will keep buying the states less than it appears to.

The Commission has always been able to say how the pool should be shared and never able to say how much of the country’s revenue should be in it, and that is the whole of the modern fiscal-federal argument.