16th Finance Commission Report

16th Finance Commission Report

The role of the Finance Commission in India's fiscal federalism is extremely important. The report of the 16th Finance Commission was presented to Parliament on February 1, 2026, and will be applicable for a five-year period from 2026-27 to 2030-31. This report sets out a new framework for the distribution of resources between the Centre and the States.The Finance Commission is constituted under Article 280 of the Indian Constitution, with the primary objective of ensuring a fair distribution of tax revenues between the Centre and the States. The 16th Finance Commission was chaired by [Chairman's name, if necessary, can be added], and included expert members from the fields of economics, public finance, and administration.

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¨     The President of India had constituted the 16th Finance Commission on 31 December 2023 under the chairmanship of Dr. Arvind Panagariya.

As per the Terms of Reference (TOR), the XVIFC was mandated to submit a report covering a five-year period, making recommendations on:

¨     Distribution of the net proceeds of taxes between the Union and the States.

¨     Allocation among the States of their respective shares of such proceeds.

¨     Grants-in-aid to States.

¨     Review of arrangements for financing Disaster Management initiatives, among other matters.

Key Recommendations of the 16th Finance Commission

¨     Share of States in Central Taxes: The Commission retained the previous share vertical devolution, keeping states’ share in the divisible pool of central taxes at 41%.

¨     However, the horizontal devolution has been revised through changes in the previous six criteria to balance equity and efficiency across states.

¨     Fiscal Roadmap: The Commission has recommended that the Centre should bring down the fiscal deficit to 3.5% of GDP by 2030-31.

¨     For States, it recommended the annual fiscal deficit limit for states to be 3% of GSDP. It also recommended strictly discontinuing the practice of off-budget borrowings for states and bringing all such borrowings onto their budgets.

¨     The Commission has projected the combined debt of the central and state governments to decline from 77.3% in 2026-27 to 73.1% of the GDP in 2030-31.

¨     Subsidy Expenditure: To address fiscal populism, it suggested rationalising subsidy schemes and introducing sunset clauses for non-merit subsidies.

¨     Power-Sector Reforms: The Commission recommended that states should actively pursue the privatisation of electricity distribution companies (DISCOMs).

¨     It proposed the creation of Special Purpose Vehicles to absorb the legacy debt of distribution utilities and protect private investors.

¨     Public Sector Enterprise Reforms: The Commission recommended a review and closure of 308 inactive State Public Sector Enterprises (SPSEs).

¨     It recommended the formulation of a state-level PSEs disinvestment policy to target inactive and underperforming SPSEs.

Criteria for Devolution

Explanation of Devolution Criteria and Recent Changes

¨     Per Capita GSDP Distance (Income Distance): The 16th FC has defined income distance as the 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.Per capita GSDP has been computed as the average over the period 2018-19 and 2023-24, excluding the pandemic year of 2020-21.Lower-income states receive higher shares to promote equity.

¨     Population (2011 Census): Distribution is based on each state’s population share as per the 2011 Census.

¨     Demographic Performance: The 15th FC had introduced this parameter to award states for controlling population on the basis of Total Fertility Rate (TFR). The 16th FC has redefined the criteria to measure population growth between 1971 and 2011 instead of the TFR.States with lower population growth will have a higher share under this parameter.

¨     Area: It relates to devolution based on the geographical size of a State. The 16th FC has reduced its weightage, thus limiting the advantage earlier given to geographically large states.

¨     Forest and Ecology: While the weight remains the same, the 16th Finance Commission has introduced two new parameters while keeping the earlier parameters of the 15th FC.The 15th FC had considered only dense and moderately dense forests, and defined the parameter only in terms of share in the overall forest area.The 16th FC adds the state’s share in the increase in forest cover between 2015 and 2023, and also adds open forests in arriving at the total forest area.

¨     Contribution to GDP: The 16th FC has introduced this 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.GSDP of each state has been measured as the average nominal GSDP between 2018-19 and 2023-24 (excluding the pandemic year of 2020-21).

¨     Removal of Tax and Fiscal Efforts: The earlier parameter that rewarded higher tax collection efficiency was dropped to simplify the formula and reduce overlap with GDP contribution.

Grants-in-aid

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: The 16th FC has recommended grants worth Rs 4.4 lakh crore and Rs 3.6 lakh crore for rural and urban local bodies, respectively

¨     Disaster Management: The Commission has recommended a disaster management corpus of Rs 2,04,401 crore for State Disaster Risk Management Funds (SDRF and SDMF). The cost-sharing pattern between the centre and states is recommended to be: (i) 90:10 for north-eastern and Himalayan states, (ii) 75:25 for all other states.