16th Finance Commission Recommendations – Explained Pointwise

The Finance Commission (FC) is a Constitutional body constituted by the President every five years to make recommendations on centre-state fiscal relations. The Report of the 16th Finance Commission (Chairman: Dr. Arvind Panagariya) was tabled in Parliament on February 1, 2026 for the five-year period between 2026-27 and 2030-31.

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What are some of the key recommendations of the Finance Commission? What are the positive aspects of the 16th Finance Commission’s recommendations? What are the criticisms against the recommendations of 16th finance commission?

What are some of the key recommendations of the Finance Commission?

1. Vertical Devolution: The share of states in the divisible pool of central taxes has been recommended at 41%. This is same as the share recommended by the 15th Finance Commission.
2. Horizontal Devolution: To provide for the distribution of central taxes among states, Finance Commissions define a formula with weightage for certain parameters – which include:
   1. Income distance 
   2. Population (2011)
   3. Demographic performance 
   4. Area 
   5. Forest 
   6. Contribution to GDP = The 16th FC has introduced this parameter to account for the contribution to national GDP. This replaces the Tax and Fiscal Efforts parameter used by the 15th FC which rewarded states with a higher tax collection efficiency. 
3. Grants-in-Aid:
   • The 16th FC has recommended grants worth Rs 9.47 lakh crore over the five-year period. These comprise grants for:
     1. Urban & Rural Local Bodies
     2. Disaster Management
   • The 16th FC has discontinued the following grants recommended by the 15th FC:
     1. Revenue Deficit Grants
     2. Sector-specific Grants
     3. State-specific Grants
4. Grants for Local Bodies: 
   • The 16th FC has recommended grants worth Rs 4.4 lakh crore and Rs 3.6 lakh crore for rural and urban local bodies, respectively.
   • These grants are divided into basic (80%) and performance-based (20%) components:
     • Basic grants: 50% of the basic grant will be untied and the rest 50% will be tied to: (i) sanitation and solid waste management, and/or (ii) water management.
     • Performance grants: These grants for local bodies are further divided into state performance grants and local body performance grants. State performance grants will be made available upon meeting a minimum benchmark for transfers to local bodies from their own resources. Local body performance grants are linked to achievement of minimum targets specified by the Commission for own source revenue growth.
   • Special Infrastructure Grants and Urbanisation Premium Grants have also been recommended for urban local bodies.
   • All local body grants will be made available upon fulfilment of three entry-level criteria:
     1. Constitution of the local bodies as per the Constitution.
     2. Publication of provisional and audited accounts of the local bodies in the public domain.
     3. Timely constitution of the State Finance Commission.
5. Disaster Management Grants:
   • The Commission has recommended disaster management corpus of Rs 2,04,401 crore for State Disaster Relief and Management Funds (SDRF and SDMF).
   • The cost-sharing pattern between the centre and states is recommended to be: (i) 90:10 for north-eastern and Himalayan states, and (ii) 75:25 for all other states.
6. Fiscal roadmap:
   • The Commission has recommended that the Centre should bring down fiscal deficit to 3.5% of GDP by 2030-31. It recommended the annual fiscal deficit limit for states to be 3% of GSDP.
   • It also recommended strictly discontinuing the practice of off-budget borrowings for
     states and bringing all such borrowings onto their budgets. The definition of fiscal deficit and debt should be expanded to uniformly include all off‑budget borrowings.
7. Power-sector Reforms:
   • The Commission recommended that states should actively pursue privatisation of electricity distribution companies (DISCOMs).  To shield the private investor from debt burden after discom takeover, a special purpose vehicle may be created to warehouse the debt.
   • Pre-payment or eventual repayment of this debt may be allowed using the funds from the Special Assistance Scheme for Capital Investment. It also recommended that states should be allowed to utilise this assistance only after the privatisation process is complete.
8. Subsidy Expenditure:
   • The Commission recommended states to review and rationalise their subsidy expenditure. It noted that schemes providing unconditional cash transfers tend to have large and untargeted beneficiaries.
   • It recommended setting clear exclusion criteria and a rigorous review process to ensure effective targeting. In addition, it recommended discontinuing financing of subsidies through off budget borrowings.
9. Public Sector Enterprise (PSE) Reforms:
   • The Commission recommended a review and closure of 308 inactive State Public Sector Enterprises (SPSEs). It recommended formulation of a state-level PSEs disinvestment policy to target inactive and underperforming SPSEs.
   • State or union PSEs, which incur losses for three out of four consecutive years, should be placed for the respective Cabinet’s consideration. The Cabinet may decide closure, privatisation, or continuation depending on the strategic importance of the enterprise.

What are the positive aspects of the 16th Finance Commission’s recommendations?

1. Rewarding Economic Performance (The GDP Parameter): By replacing the narrow “Tax and Fiscal Effort” metric with “Contribution to GDP”, the 16th FC rewards states that drive national economic growth. This addresses long-standing grievances from industrialized states (like Karnataka, Tamil Nadu, and Maharashtra) that felt penalized for their economic success under previous formulas.
2. Strategic Urbanisation Focus: The 16th FC acknowledged that India’s future growth lies in its cities, introducing two innovative grants:
   1. Urbanization Premium: A one-time incentive for states to merge “peri-urban” (semi-urban) villages into larger Urban Local Bodies (ULBs). This encourages planned urban expansion rather than chaotic sprawl.
   2. Special Infrastructure Component: Dedicated funding for wastewater management in mid-sized cities (population 10–40 lakh) which often lack the financial muscle of mega-metros.
3. Enforcing Fiscal Discipline:
   1. End of Off-Budget Borrowings: 16th FC called for a strict discontinuation of off-budget borrowings, requiring all such liabilities to be disclosed in the main budget. This provides a truer picture of public debt.
   2. Rationalizing Subsidies: It advised states to move away from “unconditional cash transfers” and implement clear exclusion criteria, ensuring welfare spending reaches the most vulnerable rather than becoming a general populist tool.
4. Empowerment of Local Bodies: While the 15th FC started the trend, the 16th FC has solidified the push for grassroots accountability by recommending Performance-linked grants. In fact, to even access basic grants, states must ensure timely constitution of State Finance Commissions and the public disclosure of audited accounts for all panchayats and municipalities.
5. Transparency in “Net Proceeds”: The commission recommended that the Centre annually disclose tax data as certified by the CAG to ensure states have full visibility into the “divisible pool.”

What are the criticisms against the recommendations of 16th finance commission?

1. Vertical Devolution Stagnation: A major point of contention is the decision to retain the states’ share at 41%. 18 out of 28 states had formally requested an increase to 50%. 41% is insufficient given that states now bear the majority of “ground-level” expenditure responsibilities in health, education, and social welfare, while their power to raise independent revenue has been curtailed post-GST. 
2. The “Cess & Surcharge” Loophole: The commission has been criticized for not addressing the growing “leakage” of the divisible pool through cesses and surcharges. Cess & surcharge are collected by the Centre but are not shared with states. Between 2013-2019, for every Rs100 collected by the Centre, about Rs 93-95 was collected as taxes & duties that form the divisible pool & the remaining Rs 5-7 was collected as cess & surcharge. For 2025-26, the Centre is expected to collect Rs 89 as taxes & duties & Rs 11 as cesses & surcharges.   
3. Impact on Poorer States: States like Bihar and Uttar Pradesh have seen a marginal decline in their share because to accommodate the GDP parameter, the weight of “Income Distance” was reduced from 45% to 42.5%. Critics argue that this parameter benefits already industrialized states (the “richer” states), potentially widening the developmental gap and violating the principle of “Economic Convergence.”
4. Discontinuation of Revenue Deficit Grants: Complete scrapping of RDGs will impact the Hill & Special Category States like NE States, Himachal Pradesh, Uttarakhand etc. Revenue deficit of these states is due to lack of favourable geography & industrialization. Removing these grants without a transition plan could cripple their public services.
5. “Freebie” Criticism: The commission’s warning against “unconditional cash transfers” (like Majhi Ladki Bahin or Gruha Lakshmi) is viewed as an ideological intervention into state welfare politics.
6. Power Sector Privatization: Linking capital assistance to the privatization of DISCOMs is criticized as a “one-size-fits-all” approach that ignores the specific political and social realities of different states.

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