Latest Finance Commission Recommendations Explained
The 16th Finance Commission, chaired by Dr. Arvind Panagariya, lays down the framework for Centre–State fiscal relations for the five years from 2026 to 2031.
Vertical Devolution: The States' share in the divisible pool of central taxes has been maintained at 41%, the same level recommended by the 15th Finance Commission.
Horizontal Devolution: The distribution of the States’ share is based on the following criteria:
Income Distance: 42.5%, reduced from the earlier 45%.
2011 Population: 17.5%.
Demographic Performance: 10%, with the criterion revised to assess population growth between 1971 and 2011.
Area: 10%.
Forest Cover: 10%, taking into account both open forests and changes in forest cover.
Contribution to GDP: 10%. This is a new criterion that replaces the earlier consideration of tax and fiscal efforts.
Grants-in-Aid (Total: ₹9.47 Lakh Crore)
Local Bodies: A total grant of ₹8 lakh crore has been proposed for local bodies, including ₹4.4 lakh crore for rural and ₹3.6 lakh crore for urban local bodies. Of this amount, 80% will be provided as basic grants, while the remaining 20% will be linked to performance.
Disaster Management: States have been allocated ₹2.04 lakh crore to strengthen their disaster management and response funds.
Grants Discontinued: The Commission has done away with revenue deficit grants, sector-specific grants, and state-specific grants under its recommendations.
Fiscal Discipline & Structural Reforms
Fiscal Deficit Goals: The Commission has suggested bringing the Centre’s fiscal deficit down to 3.5% of GDP by 2030–31. For States, the fiscal deficit limit has been retained at 3% of GSDP.
Off-Budget Borrowings: States have been advised to discontinue off-budget borrowing and reflect all such liabilities transparently within their respective budgets.
Power Sector & Subsidies: The recommendations support the privatisation of power distribution companies (DISCOMs) and call for States to undertake a careful review and rationalisation of subsidies.
Vertical Devolution
Share of States: The share of States in the divisible pool has been kept at 41%, continuing the recommendation of the 15th Finance Commission. This was lower than the 42% share suggested by the 14th Finance Commission.
Cesses and Surcharges: The 41% devolution does not cover cesses and surcharges imposed by the Centre.
States’ Concern: States have raised concerns over the growing reliance on cesses and surcharges, as the revenue collected through these channels is not included in the divisible pool available for devolution to States.
Rising Share: In 2021–22, cesses and surcharges, including the associated cost of collection, amounted to ₹13.5 for every ₹100 collected by the Centre in taxes. This represented the highest proportion recorded in more than a decade.
Criteria for Horizontal Devolution
Income Distance: This criterion measures the gap between a State’s per capita GSDP and the average per capita GSDP of the three highest-income large States. States with relatively lower GSDP receive a greater share, helping promote greater fiscal equity.
Population: The allocation is calculated using population figures from the 2011 Census.
Demographic Performance: The criterion has been revised to consider population growth during 1971–2011, replacing the change in Total Fertility Rate (TFR) used by the 15th Finance Commission.
Purpose: The revised approach gives greater weight to States that have successfully controlled population growth. As a result, States with lower population growth, particularly several southern States, are expected to receive a relatively larger share under this criterion.
Forest Cover: The forest criterion now considers both a State’s share in the overall forest area and the increase in its forest cover between 2015 and 2023. Unlike the 15th Finance Commission, which focused only on dense and moderately dense forests, the revised approach also takes open forests into account.
Contribution to GDP: The earlier parameter based on tax and fiscal effort has been replaced with a criterion linked to a State’s contribution to national GDP. The calculation uses the square root of each State’s GSDP in relation to the combined square roots of the GSDPs of all States. The assessment is based on average nominal GSDP for 2018–19 to 2023–24, with the pandemic-affected 2020–21 year excluded from the calculation.
The Finance Commission (FC) is a constitutional authority appointed by the President once every five years. Its primary role is to recommend measures concerning the distribution of financial resources and fiscal responsibilities between the Centre and the States.
The 16th Finance Commission, headed by Dr. Arvind Panagariya, submitted its report for the 2026–27 to 2030–31 period, and the report was presented before Parliament on February 1, 2026.
Share of States in Central Taxes
The Commission has proposed that States should continue to receive 41% of the divisible pool of central taxes, keeping the share unchanged from the recommendation of the 15th Finance Commission.
The divisible pool refers to the portion of the Centre’s gross tax revenue available for sharing with the States after accounting for the cost of tax collection and excluding cesses and surcharges.
Per Capita GSDP Distance (Income Distance)
The 16th Finance Commission measures income distance by comparing a State’s per capita GSDP with the average per capita GSDP of the three highest-income large States. For this calculation, per capita GSDP is taken as an average for 2018–19 to 2023–24, while 2020–21 has been left out because of the pandemic. States with comparatively lower per capita GSDP are assigned a greater share under this criterion, with the objective of promoting greater fiscal equity.
Population
The population component is based on each State’s proportion of the total population according to the 2011 Census. This proportion determines the State’s share under the population criterion.
Demographic Performance
The 15th Finance Commission used demographic performance to recognise States that had made progress in controlling population growth, using changes in the Total Fertility Rate (TFR) as the basis. The 16th Finance Commission has modified this approach and instead considers population growth between 1971 and 2011. Consequently, States that recorded relatively lower population growth are expected to receive a larger share under this criterion.
Forest
The 16th Finance Commission has broadened the forest-related criterion by considering two aspects: a State’s share of the country’s total forest area and its contribution to the increase in overall forest cover between 2015 and 2023. The assessment also includes open forests when determining the total forest area. This marks a departure from the 15th Finance Commission, which considered only dense and moderately dense forests and focused solely on each State’s share of the total forest area.
Contribution to GDP
The 16th Finance Commission has added contribution to national GDP as a new criterion for horizontal devolution. It replaces the tax and fiscal effort criterion followed by the 15th Finance Commission, which was intended to recognise States with better tax-collection performance.
A State’s contribution is determined using the square root of its GSDP relative to the combined square roots of the GSDPs of all States. For this calculation, the Commission uses each State’s average nominal GSDP for 2018–19 to 2023–24, while excluding the pandemic-affected year 2020–21.
Frequently Asked Questions (FAQs)
1. What is the Finance Commission of India?
The Finance Commission is a constitutional body established under Article 280 of the Indian Constitution. It is constituted by the President every five years to recommend how financial resources should be shared between the Centre and the States.
2. Who is the Chairman of the 16th Finance Commission?
The 16th Finance Commission is chaired by Dr. Arvind Panagariya, former Vice Chairman of NITI Aayog.
3. What is the period covered by the 16th Finance Commission?
The recommendations of the 16th Finance Commission cover the five years from 2026–27 to 2030–31.
4. What share of central taxes has been recommended for States?
The Commission has retained the States’ share in the divisible pool of central taxes at 41%. This is the same percentage recommended by the 15th Finance Commission.
5. What is horizontal devolution?
Horizontal devolution refers to the distribution of the States’ share of central tax revenues among different States. The Finance Commission uses specific criteria and weightages to determine each State’s share.
6. What are the major criteria for horizontal devolution?
The key criteria include income distance, population, demographic performance, area, forest cover, and contribution to GDP. These parameters are intended to balance equity, population needs, geographical factors and economic contribution.
7. How has the demographic performance criterion changed?
The 16th Finance Commission has shifted from the change in Total Fertility Rate (TFR) used by the 15th Finance Commission to population growth between 1971 and 2011. States with relatively lower population growth receive greater consideration under this criterion.
8. What is the income-distance criterion?
Income distance measures the gap between a State’s per capita GSDP and the average per capita GSDP of the three highest-income large States. States with lower per capita GSDP receive a greater share under this criterion to promote fiscal equity.
9. What is new about the forest criterion?
The forest criterion considers both a State’s share of the total forest area and its share in the increase in forest area between 2015 and 2023. Unlike the previous approach, it also takes open forests into account.
10. What is the new contribution-to-GDP criterion?
The 16th Finance Commission has introduced contribution to GDP as a criterion for horizontal devolution. It replaces the tax and fiscal effort criterion used by the 15th Finance Commission and recognises States based on their contribution to national economic output.