16th Finance Commission

The Finance Commission is a constitutional body under Article 280 that strengthens India’s fiscal federalism. Constituted every five years, it recommends tax devolution, grants-in-aid, and fiscal reforms to address vertical and horizontal imbalances between the Union and the States.

The 16th Finance Commission, chaired by Shri Arvind Panagariya, covers the period 2026–27 to 2030–31. It represents a clear shift towards performance, transparency and long-term fiscal sustainability. The 16th Finance Commission’s recommendations span tax devolution, local body financing, disaster management, fiscal consolidation, power-sector reforms, subsidy rationalisation, and public sector enterprise restructuring. Together, these measures aim to promote inter-state equity, strengthen fiscal discipline, enhance local governance, and align public finances with India’s developmental priorities.

 

Finance Commission Meaning

• The Finance Commission is a constitutional commission under Article 280 that ensures fiscal federalism in India

Constitution: The Finance Commission is constituted by the President of India every five years.

Composition:

• One Chairman

• Four Members with expertise in finance, economics, or public administration

Core Function: 

• The Finance Commission recommends the sharing of net tax proceeds between the Union and States.

• Taxes Covered: Includes Income Tax, GST, and other central taxes as examined by the Finance Commission.

• Inter-State Distribution: The Finance Commission decides the criteria for distribution among states (horizontal devolution).

• Grants-in-Aid: The Finance Commission recommends grants to revenue-deficient states under Article 275.

• Local Bodies: The Finance Commission suggests measures to strengthen the finances of Panchayats and Municipalities.

• Fiscal Discipline: The Finance Commission advises on expenditure control, debt, and fiscal reforms.

• Advisory Role: The Finance Commission examines financial matters referred by the President.

• Significance: The Finance Commission is the key commission ensuring equitable resource distribution and cooperative federalism in India.

• 16th Finance Commission Members

16th Finance Commission Chairman: Shri Arvind Panagariya, former Vice-Chairman, NITI Aayog.

 

16th Finance Commission Recommendations

• The Report of the 16th Finance Commission was tabled in Parliament on February 1, 2026, covering the period of five years from 2026-27 to 2030-31.  Key recommendations of the Commission include:

Share of States in Central Taxes

• The 16th Finance Commission has recommended a 41% share for states in the divisible pool of central taxes, unchanged from the 15th Finance Commission.

• The divisible pool is calculated by excluding the cost of collection, cesses, and surcharges from the gross tax revenue of the central government.

• Criteria for Devolution

• Finance Commissions use a formula-based approach with assigned weights to specific criteria to distribute central taxes among states.

 

The table below presents the criteria and weightages adopted by the 16th Finance Commission for determining each state’s share.

 

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%

 

Per Capita GSDP Distance (Income Distance)  

• The 16th Finance Commission defines income distance as the gap between a state’s per capita GSDP and the average per capita GSDP of the top three large, high-income states.

• Per capita GSDP is calculated as an average for 2018–19 to 2023–24, excluding the pandemic year 2020–21.

• States with lower per capita GSDP receive a higher share under this criterion, ensuring equity in inter-state fiscal transfers.

• Demographic Performance

• The 15th Finance Commission introduced the demographic performance parameter to reward states for population control, using the Total Fertility Rate (TFR) as the basis.

• The 16th Finance Commission has redefined this criterion to measure population growth between 1971 and 2011, replacing the TFR-based assessment.

• States with lower population growth during this period receive a higher share, reinforcing incentives for long-term demographic management. 

• Forest

• The 16th Finance Commission assigns weightage to both a state’s share in total forest area and its contribution to the increase in forest cover (2015–2023).

• It also includes open forests while calculating the total forest area.

• In contrast, the 15th Finance Commission considered only dense and moderately dense forests and assessed states solely on their share in the overall forest area.

• Contribution to GDP

• The 16th Finance Commission has introduced “contribution to national GDP” as a new parameter.

• This replaces the “tax and fiscal efforts” criterion of the 15th Finance Commission, which rewarded higher tax collection efficiency.

• A state’s contribution to GDP is computed as the square root of its GSDP divided by the sum of the square roots of GSDP of all states.

• GSDP values are taken as the average nominal GSDP for 2018–19 to 2023–24, excluding the pandemic year 2020–21.

• Grants-in-Aid

The 16th Finance Commission has recommended grants totalling ₹9.47 lakh crore for the five years. 

These grants are limited to:

• Urban and rural local bodies, and

• Disaster management.

The 16th Finance Commission has discontinued the following grants provided by the 15th Finance Commission:

• Revenue deficit grants

• Sector-specific grants

• State-specific grants

Grants for Local Bodies 

• The 16th Finance Commission has recommended ₹4.4 lakh crore for rural local bodies and ₹3.6 lakh crore for urban local bodies over five years.

Local body grants are split into:

• Basic grants (80%)

• Performance-based grants (20%)

For urban local bodies, the Commission has also proposed:

• Special Infrastructure Grants, and

• Urbanisation Premium Grants

Entry-Level Conditions for all local body grants: Grants are released only upon fulfilment of:

• Constitution of local bodies as per the Constitution

• Public disclosure of provisional and audited accounts

• Timely constitution of the State Finance Commission

Grant Components

• Basic Grants:50% untied

• 50% tied to: Sanitation & solid waste management, and/or Water management

Special Infrastructure Grants (Urban): 

• For comprehensive wastewater management systems

• Applicable to cities with a population of 10–40 lakh (Census 2011)

• ₹56,100 crore recommended over five years

Urbanisation Premium Grants: 

• One-time grants for Merger of peri-urban villages into urban areas

• Preparation of Rural-to-Urban Transition Policy

• ₹10,000 crore allocated

Disaster Management Grants

• Total disaster management corpus: ₹2,04,401 crore for SDRF and SDMF

• Cost-sharing pattern:

• 90:10 for North-Eastern and Himalayan states

• 75:25 for other states

• Centre’s share: ₹1,55,916 crore

Fiscal Roadmap

• The 16th Finance Commission has recommended reducing the Centre’s fiscal deficit to 3.5% of GDP by 2030–31.

• The 16th Finance Commission has fixed the annual fiscal deficit ceiling for states at 3% of GSDP.

• The 16th Finance Commission has called for the strict discontinuation of off-budget borrowings by states and their full inclusion in state budgets.

• It has recommended expanding the definition of fiscal deficit and public debt to uniformly cover all off-budget borrowings.

• The combined debt of the Centre and States is projected to decline from 77.3% of GDP in 2026–27 to 73.1% of GDP by 2030–31.

Power-sector Reforms

• The 16th Finance Commission has advised states to actively pursue the privatisation of electricity DISCOMs.

• To protect private investors from legacy liabilities, it recommended creating a Special Purpose Vehicle (SPV) to warehouse existing DISCOM debt.

• The repayment or pre-payment of this debt may be supported through the Special Assistance Scheme for Capital Investment.

• States should be allowed to access this assistance only after completion of the privatisation process.

Subsidy Expenditure

• The 16th Finance Commission recommended that states review and rationalise subsidy expenditure to improve efficiency.

• It observed that unconditional cash transfer schemes often have large, untargeted beneficiary bases.

• The Commission advised clear exclusion criteria and a rigorous review mechanism to ensure better targeting.

• It also recommended ending subsidy financing through off-budget borrowings.

• The Commission flagged the lack of standardisation in how subsidies and transfers are defined, classified, and accounted for across states.

• It noted frequent misclassification of subsidies as assistance, grants, or other expenditures.

• To address this, it recommended a uniform framework for accounting and transparent disclosure of subsidies and transfers.

Public Sector Enterprise Reforms

• The 16th Finance Commission has recommended review and closure of 308 inactive State Public Sector Enterprises (SPSEs).

• It advised states to frame a state-level PSE disinvestment policy focusing on inactive and underperforming SPSEs.

• State or Union PSEs incurring losses in three out of four consecutive years should be placed before the respective Cabinet.

• The Cabinet may decide on closure, privatisation, or continuation, based on the strategic importance of the enterprise.

 16th Finance Commission Impact

The impact of the recommendations of the 16th Finance Commission can be attributed to its devolution of taxes.​​​​​​​

Impact on Southern States

Under the revised devolution formula of the 16th Finance Commission, all five Southern States have witnessed an increase in their share of tax devolution.

• Andhra Pradesh: Share increased from 4.047% → 4.217%.

• Karnataka: Share increased from 3.647% → 4.131%.

• Kerala: Share increased from 1.925% → 2.382%.

• Tamil Nadu: Share marginally increased from 4.079% → 4.097%.

• Telangana: Share increased from 2.102% → 2.174%.

Contrasting Trend in Large Northern States

• Uttar Pradesh: Share declined from 17.939% → 17.619%.

• Bihar: Share declined from 10.058% → 9.948%

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Subject: Economics

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