Why in News?
The 16th Finance Commission Report, chaired by Arvind Panagariya, has submitted its report for the award period 2026–31. The report was tabled in Parliament along with the Union Budget 2026–27.
It signals a shift from an “entitlement-based” transfer system to a more “compliance-driven” fiscal federalism, linking transfers to performance, discipline, and transparency.
Key Recommendations of the 16th Finance Commission
1. Tax Devolution
(A) Vertical Devolution
States’ share retained at 41% of the divisible pool of central taxes (same as the Fifteenth Finance Commission of India).
- The divisible pool excludes cesses, surcharges, and cost of collection.
- Although states had demanded an increase to 50%, the share remains unchanged.
(B) Horizontal Devolution (Distribution Among States)
The 16th FC has revised the formula, placing greater emphasis on economic performance.
Criteria and Weightage:
| Criteria | Weight (%) |
| Income Distance (Per Capita GSDP) | 42.5 |
| Population (2011 Census) | 17.5 |
| Demographic Performance | 10 |
| Area | 10 |
| Forest & Ecology | 10 |
| Contribution to GDP (New) | 10 |
Notably, the earlier tax and fiscal effort parameter has been removed and replaced with a 10% weight for contribution to GDP, rewarding economically stronger states.
Explanation of Key Criteria
1. Income Distance (42.5%)
- Measures the gap between a state’s per capita GSDP and the average of the top three highest-income large states.
- Poorer states receive a higher share to ensure inter-state equity.
2. Population (2011 Census) – 17.5%
- Reflects expenditure needs based on population size.
3. Demographic Performance – 10%
- Based on population growth (1971–2011).
- States that controlled population growth are rewarded.
4. Forest & Ecology – 10%
- Based on forest area share and increase in forest cover (2015–2023).
- Unlike the 15th FC, open forests are also included.
5. Contribution to GDP – 10% (New)
- Rewards states contributing more to national GDP.
- Marks a shift toward performance-based transfers.
Grants-in-Aid (2026–31)
Total recommended grants: ₹9.47 lakh crore
1. Local Body Grants – ₹8 lakh crore
- Rural: ₹4.4 lakh crore
- Urban: ₹3.6 lakh crore
Conditions:
- Constitutionally mandated local bodies
- Audited account disclosure
- Timely State Finance Commissions
Break-up:
- 80% Basic Grants (50% untied; 50% tied to sanitation/water)
- 20% Performance Grants
Additional provisions:
- ₹10,000 crore urbanisation premium (one-time)
- ₹56,100 crore for wastewater management in cities (10–40 lakh population)
2. Disaster Management Grants
- ₹2,04,401 crore for SDRF/SDMF
Cost sharing:
- 90:10 (NE & Himalayan states)
- 75:25 (Others)
Discontinued Grants
- Revenue deficit, sector-specific, and state-specific grants (given by the 15th FC) have been discontinued.
Fiscal Discipline Measures
- Centre’s fiscal deficit to reduce to 3.5% of GDP by 2030–31
- States’ fiscal deficit capped at 3% of GSDP
- End of off-budget borrowings
- Combined debt projected to decline from 77.3% to 73.1% of GDP
Structural Reform Recommendations
1. Power Sector
- Encouragement for DISCOM privatisation
- Legacy debt restructuring through SPV
2. Subsidy Rationalisation
- Caution against unconditional cash transfers
- Clear exclusion criteria recommended
- Uniform accounting of subsidies
- Cash transfer schemes now account for a major share of state subsidy spending, partly due to the success of the JAM Trinity.
3. Public Sector Enterprises
- Closure of 308 inactive SPSEs
- Loss-making PSEs to be reviewed for closure/privatisation
4. Transparency
- Annual disclosure of CAG-certified net tax proceeds under Article 279.
Concerns Raised
1. No Increase in Vertical Devolution
- States demanded 50%, retained at 41%.
- Heavy reliance on cesses and surcharges reduces untied funds.
2. Equity Concerns
- Reduced weight to income distance
- New GDP contribution criterion may favour industrialised states.
- Southern states argue that population control efforts are insufficiently rewarded.
3. Discontinuation of Revenue Deficit Grants
- Hill and special category states fear structural disadvantages.
4. 3% Fiscal Deficit Cap
- May restrict capital expenditure and welfare spending.
5. Increasing Tied Grants
Limits states’ fiscal flexibility and autonomy.
The 16th Finance Commission marks a transition toward compliance-based fiscal federalism, emphasising fiscal discipline, performance, and transparency.
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