16th Finance panel formula awards ‘efficient’ States

Source: The post “16th Finance panel formula awards ‘efficient’ States” has been created, based on “16th Finance panel formula awards ‘efficient’ States” published in “Business line ” on 05th February 2026.

UPSC Syllabus: GS Paper-3- Indian Economy

Context: The 16th Finance Commission’s award for the period 2026–31 seeks to balance equity and efficiency in Centre–State financial relations. It aims to reward better-performing States while ensuring fiscal discipline and strengthening cooperative federalism.

Key Features

1. Changes in Horizontal Devolution

1. The Commission has reduced the weight of income distance from 45% to 42.5% to limit excessive redistribution.
2. It has introduced the contribution to GDP as a new criterion to reward economically productive States.
3. It has reduced the weight given to demographic performance from 12.5% to 10% in view of the ageing population.
4. It has slightly reduced the weight assigned to area and other equity parameters.

Impact:

1. States such as Karnataka, Kerala, Gujarat, Andhra Pradesh, Punjab, and Haryana have emerged as major gainers.
2. States such as Bihar, Uttar Pradesh, West Bengal, Odisha, and Madhya Pradesh have relatively lost share.
3. However, poorer States continue to receive significant transfers due to population and poverty-related criteria.

2. Changes in Vertical Devolution

1. The Commission has retained the 41% share of States in the divisible tax pool.
2. It has abolished revenue deficit grants to promote fiscal discipline.
3. It has ended nearly ₹3 lakh crore worth of deficit grants provided by the 15th Finance Commission.
4. It has substantially increased grants to urban local bodies to ₹9.47 lakh crore.
5. It has encouraged States to meet their needs by rationalising expenditure.

3. Promotion of Fiscal Discipline

1. The Commission has discouraged unconditional cash transfers to States.
2. It has recommended stopping off-budget borrowings for financing subsidies.
3. It has emphasised the need for responsible budgeting and fiscal rectitude.
4. It has supported increasing the share of rule-based Finance Commission transfers over discretionary transfers.

4. Addressing Regional Imbalances

1. The Commission has recognised the concerns of southern and western States regarding declining shares.
2. It has rewarded them for better governance and economic performance.
3. It has acknowledged that their growth has been supported by migrant labour from northern States.
4. It has ensured that poorer States are not completely deprived of resources.

5. Approach Towards Cesses and Surcharges

1. The Commission has been less critical of cesses and surcharges compared to earlier panels.
2. It has urged States to maintain fiscal discipline.
3. However, it has not strongly recommended a limit on cesses and surcharges.
4. This weakens the divisible pool available for States.

Limitations of the 16th Finance Commission Award

1. The Commission has failed to impose strict limits on cesses and surcharges, which reduce States’ fiscal autonomy.
2. The abolition of revenue deficit grants may hurt fiscally weaker States.
3. Performance-based criteria may disadvantage structurally backward States.
4. Rising responsibilities of States have not been fully matched with resources.
5. The formula still relies heavily on past data, limiting responsiveness to current realities.

Way Forward

1. The Centre should impose reasonable limits on cesses and surcharges to protect the divisible pool.
2. Special transitional support should be provided to fiscally weak States.
3. Capacity-building measures should be strengthened in backward regions.
4. Fiscal responsibility frameworks should be linked with incentives.
5. Periodic review of devolution criteria should be undertaken to reflect economic and demographic changes.
6. Greater transparency in Centre–State transfers should be ensured.

Conclusion: The 16th Finance Commission’s award represents a balanced attempt to combine equity with efficiency in fiscal federalism. Despite certain limitations, it promotes responsible governance and cooperative federalism. With suitable reforms and safeguards, it can contribute to more balanced and sustainable development.

Question: What are the key features and limitations of the 16th Finance Commission (2026–31) award? Suggest a way forward.

Source: Business Line