16th Finance Commission Advocates Fiscal Discipline While Retaining States' Tax Share at 41%
The 16th Finance Commission, a constitutional body established under Article 280, has submitted its recommendations for the period spanning April 2026 to March 2031. Chaired by Dr. Arvind Panagariya, the Commission was tasked with reviewing the framework for sharing Union government tax revenues with states and structuring fiscal transfers. In a significant move, the panel has proposed retaining the states' share in the divisible pool of central taxes at the current level of 41 percent.
Key Recommendations for Enhanced Fiscal Management
The Commission's report underscores the necessity for greater efficiency in public expenditure and the strengthening of fiscal accountability mechanisms across all states. It has called for a rationalization of centrally sponsored schemes by linking their implementation to measurable, real-time output indicators. To ensure productive use of resources, the Commission suggested that the Union government appoint a high-powered committee to reassess these schemes and recommend the closure of those that fail to utilize funds effectively.
In a bid to enhance transparency, the Commission recommended that the Union government annually disclose data on net tax proceeds, as certified by the Comptroller and Auditor General under Article 279. This measure aims to bring more clarity regarding the divisible pool and the actual devolution process, addressing longstanding concerns about opacity in tax sharing.
Finance Minister Accepts Vertical Devolution Recommendation
Finance Minister Nirmala Sitharaman has announced the government's acceptance of the Commission's recommendation to maintain the vertical share of devolution at 41 percent. For the fiscal year 2026-27, the government has allocated Rs 1.4 lakh crore to states as Finance Commission Grants. These funds encompass Rural and Urban Local Body Grants as well as Disaster Management Grants, reflecting a comprehensive approach to supporting state-level initiatives.
New GDP Contribution Criterion for Horizontal Devolution
For horizontal devolution, which involves the distribution of resources among states, the Commission has introduced a novel criterion: contribution to Gross Domestic Product, assigned a weight of 10 percent. This addition complements traditional parameters such as population, demographic performance, area, forest cover, and per-capita income distance. The GDP contribution serves as a proxy for efficiency-linked indicators like tax effort and fiscal discipline, while per-capita income distance continues to capture equity-linked indicators, ensuring a balanced approach to resource allocation.
Discontinuation of Revenue Deficit Grants and Emphasis on Fiscal Reforms
The Commission has decided not to recommend revenue deficit grants during its award period, continuing the trend set by the 15th Finance Commission, which had reduced such grants to near-zero by FY26. The panel observed that state revenue deficits primarily arise from committed and discretionary expenditures, and there is substantial scope for states to enhance revenues and rationalize spending. It warned that the expectation of revenue deficit grants could weaken incentives for essential fiscal reforms, such as rationalizing subsidies, improving tax administration, and curbing revenue expenditures.
Performance-Linked Funding for Local Bodies and Disaster Management
In a move to bolster local governance, the Commission has recommended grants totaling Rs 7,91,493 crore for rural and urban local bodies from FY27 to FY31. These grants are proposed to be classified into basic and performance-linked components, with an emphasis on states improving local revenue systems. The Commission advocated for the development of citizen-friendly, GIS-based property tax IT systems to enhance enumeration, assessment, and collection of property taxes.
Additionally, the Commission stressed the need for stronger audit and reporting frameworks for local bodies, suggesting that existing arrangements for technical guidance and supervision by the CAG should be continued and strengthened to improve the quality of audit and accounts.
For disaster management, the Commission recommended a total corpus of Rs 2,04,401 crore for states from FY27 to FY31. It also pushed for the transformation of the National Disaster Management Information System into a real-time transaction-level disaster data platform and proposed adding heatwave and lightning to the list of notified national disasters.
Tightened Fiscal Consolidation and Borrowing Discipline
The Commission has called for stringent fiscal discipline, recommending that states' fiscal deficit remain capped at 3 percent of Gross State Domestic Product. Simultaneously, it urged the Union government to reduce its fiscal deficit to 3.5 percent of GDP by the end of the award period. The panel also advised states to completely discontinue the practice of incurring off-budget borrowings and to bring all such borrowings onto their budgets, ensuring greater fiscal transparency and accountability.
Push for Subsidy Rationalization and Public Sector Enterprise Reforms
Highlighting the rising burden of subsidies, the Commission cautioned that borrowing for expenditure on subsidy and transfer schemes is not sound fiscal policy. It urged states to rationalize such schemes and introduce sunset clauses to ensure fiscal sustainability.
Regarding public sector enterprises, the Commission recommended evaluating their performance and considering the immediate closure of inactive PSUs to reduce fiscal strain. It also encouraged states to explore state-level privatization policies as a means to enhance efficiency and reduce financial burdens.
Overall, the recommendations of the 16th Finance Commission signal a significant shift towards performance-linked fiscal transfers, tighter borrowing discipline, and greater transparency in Centre-state fiscal relations. These measures aim to foster a more accountable and efficient fiscal environment during the award period, ultimately contributing to sustainable economic growth and development across the nation.
