No reduction in States’ share in tax devolution
Context:
The Union Finance Minister confirmed that the Centre was transferring the mandated 41% of the divisible pool of taxes to States as per the 15th and 16th Finance Commission recommendations (2026-31).
The Centre clarified that cesses and surcharges (health, road cess) are not part of the divisible pool but are utilized for specific developmental purposes (building schools, roads) that ultimately benefit States.
Budget 2026-27 marks the start of the 16th FC cycle and includes long-term infrastructure goals (roads, waterways) targeting 2047.
16th Finance Commission (2026-31) Criteria and recommendations:
The Finance Commission (FC) is a Constitutional body constituted by the President every five years to make recommendations on centre-state fiscal relations.
The recommendations of FCs are advisory in nature and not binding on the Union government. However, they are usually accepted with minor modifications or deviations.
The 16th FC, chaired by Dr. Arvind Panagariya, introduced a new efficiency criterion ("State's contribution to GDP") while reducing the weightage of "Income Distance."
Criteria
15th FC (2021-26)
16th FC (2026-31)
Income Distance
45%
42.5%
Population (2011)
15%
17.5%
Demographic Performance
12.5%
10%
Area
15%
10%
Forest
10%
10%
Tax and Fiscal Efforts
2.5%
Contribution to GDP
10%
Total
100%
100%
Recommendations:
Income Distance of a state = Difference between the Per capita GSDP of a state and the average of the per capita GSDP of the top three large states with the highest per capita GSDP.
States with a lower per capita GSDP will receive a higher share on this parameter.
The 16th FC has redefined this to account for population growth between 1971 and 2011 instead of relying on change in Total Fertility Rate (TFR).
The 16th FC has introduced Contribution to GDP parameter to account for the contribution to national GDP.
Contribution to GDP by a state is calculated as the squared root of its GSDP to the sum of squared root of GSDP of all states
The 16th FC has recommended grants worth Rs 9.47 lakh crore over the five-year period. These comprise grants for:
urban and rural local bodies
disaster management.
The 16th FC has discontinued the following grants recommended by the 15th FC: (i) revenue deficit grants, (ii) sector-specific grants, and (iii) state-specific grants.
The Commission has recommended that the Centre should bring down fiscal deficit to 3.5% of GDP by 2030-31.
recommended annual fiscal deficit limit for states to be 3% of GSDP
Recommended that states should actively pursue privatisation of electricity distribution companies (DISCOMs).