In its award for the sharing of tax resources for the 2026-31 period, the 16th Finance Commission has managed to strike a fair balance between rewarding equity and efficiency. It sought to address a longstanding grievance of the ‘better performing’ southern and western States by carving out a slightly larger share of the resource pie for them as a reward. So, in the ‘horizontal devolution’ formula, equity parameters such as ‘income distance’ from the richer States and area have been pared, while contribution to GDP, introduced for the first time, has been accorded generous emphasis.
As for ‘vertical devolution’ the 15th finance panel’s formula of 41 per cent share of the divisible tax pool has been retained, but revenue deficit grants have been done away with, to boost fiscal rectitude. Grants to local bodies have been raised sharply. Arguing that the needs of States can be met by rationalising expenditure, the panel has said that unconditional cash transfers as well as financing of subsidies through off budget borrowings should stop. Therefore, the nearly ₹3 lakh crore grants awarded by the 15th finance panel to eliminate revenue deficit have been done away with. But grants to urban local bodies have nearly doubled to ₹9.47 lakh crore. Ideally, the ratio of finance-panel transfers to discretionary non-finance panel transfers should rise. An approach that pushes rights-based transfers with enforcement of fiscal discipline is the best one.
Southern States have been griping over successive finance panel awards. Their grouse is valid, but overstated. In their success, the labour from northern States has had a role to play. Nevertheless, the latest award does well to reward their governance without going overboard. In the horizontal sharing formula, the distance of the per capita income of a State from the average of the per capita incomes of the three richest States or ‘income distance’ has been accorded a weight of 42.5 per cent, against 45 per cent in the 15th panel award. In a notable perspective shift, the weight given to demographic performance has been reduced from 12.5 per cent to 10 per cent, taking into account the rising share of elderly population. This is a realistic course correction. As a result of these shifts, Karnataka, Kerala, Gujarat, Andhra Pradesh, Punjab and Haryana are the dominant gainers, while Bihar, Uttar Pradesh, West Bengal, Odisha and Madhya Pradesh have lost out. However, UP, Bihar, West Bengal, Madhya Pradesh get to keep the major chunk on account of poverty, area and population.
The latest award does not come down as harshly on cesses and surcharges as the previous ones. While urging the States to exercise fiscal discipline, the award should also have argued for a Central limit to cesses and surcharges, that erode the divisible pool. That would have seemed even-handed. But in all, the 16th finance panel formula does well to promote cooperative federalism.
Published on February 3, 2026