Why in News?
16th Finance Commission Report (2026–31)
- 16th Finance Commission (Chairman: Dr. Arvind Panagariya) submitted report for 2026–31, and Union government accepted devolution recommendations, reviving debates on fiscal federalism, equity, and efficiency.
- Introduced State GDP contribution as a new horizontal devolution criterion, signalling gradual shift toward recognising growth and efficiency alongside equity.
Relevance
GS II — Polity
- Fiscal federalism, Centre–State relations
- Constitutional bodies (Art 280, 270)
- Equity vs efficiency debate
GS III — Economy
- Tax devolution, divisible pool, cess & surcharge issue
- Political economy of resource distribution
Practice Question
- “Finance Commissions must balance equity and efficiency in fiscal transfers.” Discuss in the context of recent Finance Commission recommendations. (250 Words)
Constitutional Basis
Finance Commission — Article 280
- Article 280 mandates a Finance Commission every five years to recommend tax devolution, grants-in-aid, and measures to strengthen fiscal federalism.
- Acts as key constitutional body for Centre–State fiscal balance.
Tax Devolution — Article 270
- Article 270 governs distribution of net tax proceeds between Centre and States through the divisible pool.
- Operationalises fiscal sharing framework.
What Taxes are Shared?
Included in Divisible Pool
- Shared taxes include corporation tax, personal income tax, CGST, and Centre’s share of IGST, forming bulk of sharable revenues. Core revenue-sharing sources.
Excluded Taxes
- Cess and surcharge are excluded from divisible pool; Centre retains full proceeds.
- For 2025–26, divisible pool ~81% of gross tax revenue after such exclusions.
Evolution of Vertical Devolution
Pre-14th FC
- Till 13th FC, vertical share was 32%, with large tied transfers under Centrally Sponsored Schemes (CSS) carrying conditionalities. Limited State autonomy.
14th FC Shift
- 14th FC raised devolution to 42% and reduced CSS conditional transfers, strengthening fiscal autonomy and cooperative federalism. Landmark decentralisation.
Why 41% in 15th FC?
- 15th FC reduced to 41% due to Jammu & Kashmir reorganisation, where Union Territories do not receive State share. Technical adjustment.
Demands by Industrialised States
Efficiency Recognition
- States like Maharashtra, Gujarat, Tamil Nadu, Karnataka, Telangana sought weight for GDP contribution, arguing contribution to national growth deserves fiscal recognition. Push for efficiency.
Income Distance Debate
- Many developed States opposed excessive weight to income distance, claiming it penalises better performers and disincentivises reforms. Equity–efficiency tension.
What 16th FC Recommended?
Vertical Devolution
- Retained 41% share, citing States’ existing tax share, CSS transfers routed to States, and Centre’s needs for defence and infrastructure spending. Status quo maintained.
Cess & Surcharge
- FC held it neither permissible nor desirable to cap or include cess/surcharge in divisible pool under current constitutional scheme. Preserves Union flexibility.
Horizontal Devolution Approach
Guiding Principles
- Emphasised gradual changes in State shares and due recognition to efficiency and growth contribution. Avoids fiscal shocks.
New GDP Criterion
- Added State GDP contribution as criterion with moderate weight, creating directional shift without drastic redistribution. Efficiency signal.
Distribution Impact
- Southern and western States’ shares marginally increased, while big northern/central States saw slight decline. Balanced recalibration.
Key Observations by 16th FC
For the Centre
- Recommended progressive reduction in reliance on cess and surcharge for transparency and fairness. Encourages clean tax sharing.
For States
- Urged targeted subsidies, power-sector reforms, and fiscal discipline to manage deficits and debt sustainably. Promotes fiscal prudence.
PSU Reforms
- Called for public sector enterprise reforms at both Union and State levels to improve efficiency and fiscal health. Structural strengthening.
Governance Significance
Fiscal Federalism
- Reflects balance between equity (redistribution) and efficiency (growth incentives) in India’s cooperative federal framework.
Political Economy
- Devolution debates shape Centre–State relations, regional equity, and development politics.
