16th Finance Commission (2026–31)

The 16th Finance Commission (FC) has retained the States’ share of tax devolution at 41%, giving it a form of “semi-permanence”, while introducing performance-based horizontal distribution and proposing a ‘grand bargain’ to merge cesses and surcharges into the divisible pool.

Highlight: The Commission seeks to balance fiscal consolidation with cooperative federalism, but some recommendations have sparked debate over equity and state autonomy.

Key Recommendations

1. Vertical Devolution and the ‘Grand Bargain’

• States’ share of the divisible tax pool remains at 41%, unchanged from the 15th FC.

• To address concerns over rising cesses and surcharges (outside the divisible pool), the FC proposed a ‘grand bargain’: states accept a smaller share of a larger divisible pool if the Centre merges most levies into shareable taxes.

Highlight: This is a major step toward rationalising non-shareable levies while maintaining fiscal space for states.

2. Horizontal Devolution

The Commission shifted focus toward rewarding economic performance with the following revised formula:

Highlight: Introduction of GDP contribution rewards richer states, shifting some weight away from equity-oriented criteria.

3. Grants-in-Aid (Rs 9.47 Lakh Crore)

• Local Bodies (Rs 8 Lakh Cr): Rural Rs 4.4 Lakh Cr, Urban Rs 3.6 Lakh Cr.

  • Includes Urbanisation Premium Grant (Rs 10,000 Cr) for rural-urban transition.

  • Special Infrastructure Grants (Rs 56,100 Cr) for wastewater management.

• Disaster Management (Rs 2.04 Lakh Cr): Cost-sharing 90:10 for northeastern/Himalayan states, 75:25 for others.

Highlight: Grants are conditional on proper local governance, audited accounts, and functioning State Finance Commissions.

4. Fiscal Roadmap and Reforms

• Fiscal Deficit: Centre target 3.5% of GDP by 2030–31; States 3% of GSDP.

• Off-Budget Borrowings: Recommended end of off-budget liabilities in fiscal deficit calculations.

• Power Sector: Encouraged privatisation of DISCOMs.

• Subsidies: Rationalise unconditional cash transfers (now 20.2% of total subsidy).

• Public Sector Enterprises (PSEs): Closure of 308 inactive state PSEs recommended.

• Transparency: Annual disclosure of CAG-certified net tax proceeds to clarify divisible pool size.

Highlight: Strong focus on fiscal discipline, efficiency, and transparency.

Key Issues and Criticisms

1. Status Quo vs. Growing Imbalances: States’ share retained at 41%, ignoring calls to raise it (~50%), potentially limiting untied revenues for states.

2. Unchecked Cesses & Surcharges: No curbs on non-shareable levies, shrinking the effective divisible pool.

3. Rewarding Rich States: ‘Contribution to GDP’ favors industrialized states, reducing equity for poorer or geographically constrained states.

4. Discontinuation of Revenue Deficit Grants: Particularly affects hill, northeastern, and structurally deficit states.

5. Conditional Fiscal Discipline: Caps on state deficits, DISCOM privatization, and subsidy rationalisation limit state flexibility.

6. Equity Gap: Major losing states include UP, Bihar, West Bengal, MP, Odisha, and several northeastern states, while richer states gain.

Highlight: Populous and economically weaker states risk being trapped in fiscal constraints, widening regional disparities.

Suggested Steps to Strengthen Fiscal Federalism

1. Enhance Vertical Transfers: Increase states’ share above 41% and cap cesses/surcharges to restore predictability.

2. Phased Transition: Introduce a Floor Guarantee to prevent absolute declines below 15th FC levels.

3. Balance Equity with Efficiency: Retain progressive criteria (income distance, forest cover) while rewarding social and revenue performance.

4. Empower Local Bodies: Strengthen PRIs/ULBs through matching grants and real taxation powers.

5. Strengthen Federal Dialogue: Reactivate Inter-State Council (Article 263) meetings for resolving fiscal disputes.

Conclusion

The 16th Finance Commission navigated a complex federal landscape by retaining the 41% vertical share and introducing performance incentives.
However, failure to curb cesses, discontinuation of revenue deficit grants, and tilt toward richer states have raised concerns over fiscal equity.
Balancing performance-based incentives with equalisation and state autonomy remains the core challenge for India’s fiscal federalism.