The 16th Finance Commission has retained the states’ share in central taxes at 41 percent for the five-year period from 2026–27 to 2030–31, even as it introduced important changes in how this money will be shared among states. The commission’s report, tabled in Parliament on Sunday, also pushes states towards stronger fiscal discipline and fewer grants.
Tax devolution refers to the sharing of central taxes collected by the Union government with states. The “divisible pool” is the portion of these taxes that is shared.
Eighteen of the 28 states had sought an increase in their share of the divisible tax pool to 50 percent from 41 percent. The commission rejected this demand, noting that states already receive more than two-thirds of India’s total non-debt revenues.
Any further increase, it said, would limit the Union government’s fiscal space and affect its ability to fund national priorities such as defence, infrastructure and welfare programmes.
A major change is the inclusion of a state’s contribution to India’s GDP (Gross Domestic Product, or the total value of goods and services produced in the country) as a new criterion in the horizontal devolution formula (which decides how much each state gets from the states’ share).
This GDP contribution has been given a weight of 10 percent. The commission said the idea was to reward efficiency and economic performance, while ensuring that the change remains gradual and does not sharply alter states’ shares.
The commission has also revised other parameters used in the sharing formula:
Removed the 2.5 percent weight given to states’ tax effort (ability to raise their own taxes)
Increased the weight given to population by 2.5 percentage points
Reduced the weight of area, demographic performance and per capita GSDP distance
Per capita GSDP distance measures how far a state’s average income per person falls below a benchmark set by the richest states. Lower-income states typically benefit more under this criterion.
The changes have resulted in higher shares for more industrialised states such as Karnataka, Kerala, Gujarat, Maharashtra, Tamil Nadu and Andhra Pradesh. Karnataka saw the biggest gain, followed by Kerala, Gujarat and Haryana.
In contrast, more populous states such as Uttar Pradesh, Bihar, Rajasthan and Madhya Pradesh have seen a relative decline in their shares.
In a significant departure from earlier finance commissions, the panel has recommended no revenue deficit grants (support given to states whose routine spending exceeds their revenue income). It argued that such grants weaken incentives for fiscal reforms, including subsidy rationalisation and better tax administration.
Instead of state-specific grants, the commission has allocated ₹791 lakh-crore for rural and urban local bodies over five years, with a focus on water, sanitation and urban infrastructure. It has also earmarked ₹204 lakh-crore for state disaster response funds and about ₹79,000 crore for national disaster funds.
The commission has proposed capping states’ fiscal deficits at 3 percent of GSDP (Gross State Domestic Product) and reducing the Union government’s fiscal deficit to 3.5 percent of GDP by the end of the award period. It has also called for ending off-budget borrowings and improving transparency in tax sharing.