Informist, Thursday, Jun. 26, 2025

By Priyasmita Dutta and Sagar Sen

NEW DELHI – The 16th Finance Commission is likely to "broadly" stick to the current 41% vertical tax devolution ratio to balance political considerations and fiscal imperatives, a senior government official said. The commission, chaired by Arvind Panagariya, is, however, likely to overhaul the horizontal devolution structure, the official told Informist Wednesday.

The Centre, which is likely to present a final memorandum of proposals to the finance commission soon, believes that sharply lowering states' share from 41% would be politically risky, especially after Prime Minister Narendra Modi's return to power with a reduced majority last year. "Cutting states' share may be politically difficult," the official said.

As per the terms of reference, the 16th Finance Commission is mandated to determine the formula for states' share of central taxes and the grants-in-aid for five years starting 2026-27 (Apr-Mar). The panel is expected to submit its report by the end of October. The commission has already visited all states and Union territories, and a majority of them, including Bharatiya Janata Party-led state governments, have reportedly sought a 50% share in central taxes.

"That (50% share for states) is not possible," the official said, adding that it would mean huge consequences for the Centre's finances. "The Centre has a narrow scope to tweak the vertical ratio, there will only be 1-2?viation from the current level," the official said. Besides revenue deficit and state-specific grants, finance commissions also recommend social sector grants to improve states' education and health services, grants to local bodies for administrative and governance reforms, and grants tied to infrastructure maintenance.

The 15th Finance Commission had recommended 41% of the divisible pool be devolved to states. The share of states was 1 percentage point lower than the ratio mandated by the 14th Finance Commission to adjust for the reorganisation of Jammu and Kashmir and Ladakh into Union territories. According to the Budget for FY26, the Centre is projected to transfer INR 14.22 trillion to states as their share in taxes, out of the INR 42.70 trillion total tax that the government has projected to collect this fiscal. The devolution of central taxes is much lower than 41% of the total tax collected as the Centre administers a host of cesses and surcharges which are not part of the divisible pool and hence not shared with states.

HORIZONTAL DEVOLUTION

The finance commission determines states' share based on a weighted sum of population, area, forest cover, fiscal effort, income distance and demographic performance. This has, in fact, been a bone of contention between the Centre and states, especially the Opposition-led ones, who argue that they have not been given their due share. Also, the use of population as a metric to decide the devolution has irked many southern states, as they have done a better job in keeping population growth under control.

According to the official cited above, many chief ministers have interacted with the finance ministry and the finance commission over the last few months and have suggested a rethink, particularly on the criterion of income distance, which had a 45% weightage during the 15th Finance Commission's term. Income distance refers to the disparity between a state's per capita income and the per capita income of the state with the highest per capita income, which at the time of the 15th Finance Commission's recommendation, was Haryana.

In a recent meeting with Finance Minister Nirmala Sitharaman, Karnataka Chief Minister Siddaramaiah said that in the last five years, the fiscal capacity and performance of states have changed drastically, the official said. Siddaramaiah argued that the income distance metric has favoured a few states whose fiscal management was weak.

The 15th Finance Commission, headed by N.K. Singh, had given 15% weight to population, 15% to area, 12.5% to demographic performance, 10% to forest cover and ecology and 2.5% to tax and fiscal efforts. "The 16th Finance Commission may give more importance to states' fiscal efforts," the official said. "States that stick to fiscal prudence should be rewarded."

Fiscal prudence has gained much importance in the recent past as the Centre seeks to reduce interest costs and improve its debt sustainability indicators, which are key to India's ambition of a sovereign ratings upgrade. The ratings agencies view India's debt metric at a general level, which takes into account finances of both the Centre and states. End

Edited by Tanima Banejree

For users of real-time market data terminals, Informist news is available exclusively on the NSE Cogencis WorkStation.

Cogencis news is now Informist news. This follows the acquisition of Cogencis Information Services Ltd by NSE Data & Analytics Ltd, a 100% subsidiary of the National Stock Exchange of India Ltd. As a part of the transaction, the news department of Cogencis has been sold to Informist Media Pvt Ltd.

Informist Media Tel +91 (11) 4220-1000

Send comments to feedback@informistmedia.com

© Informist Media Pvt. Ltd. 2025. All rights reserved.