Editorial 2: A fair share

Context

Keeping the States’ share at 41% would be unjust.

Introduction

The Sixteenth Finance Commission (SFC), effective from April 1, 2026, faces a complex task of redefining fiscal federalism in India. With 22 out of 28 States, including many BJP-ruled ones, demanding an increase in their share of the divisible tax pool from 41% to 50%, the issue has acquired both political and fiscal urgency. These demands arise amid the Centre's growing reliance on non-shareable cesses and surcharges, which has effectively reduced States’ real share in national tax revenue.

Sixteenth Finance Commission (SFC)

• Effective Period: Recommendations of the 16th Finance Commission will apply from April 1, 2026.
• Chairperson: Arvind Panagariya, who recently flagged the fiscal concerns raised by States.
• Central Issue: Balancing vertical devolution (between Centre and States) and horizontal devolution (among States) amid rising fiscal centralisation.

Key Demand by States

• 22 out of 28 States, including many BJP-ruled States, have sought:
  • Increase in States' share of the divisible tax pool from 41% to 50%.
  • This is seen as a legitimate demand in view of eroded fiscal autonomy post-GST.

Shrinking of the Divisible Pool

• Implication:
  • Increase in non-shareable cesses and surcharges has reduced the effective share of States in central tax revenues.

GST and States’ Fiscal Autonomy

• Post-GST Challenges:
  • States have limited avenues to raise their own revenue.
  • GST revenues, although buoyant, have not compensated for the loss of fiscal independence.
  • States are now heavily dependent on transfers from the Centre.

Horizontal Devolution: Formula Concerns

• Southern and progressive States argue that they are penalized for good governance and development.

Challenges Ahead for the Finance Commission

Risks of Status Quo:

• Maintaining the 41% vertical devolution:
  • Undermines cooperative federalism.
  • Misses the chance to revise the federal compact.
• Centre’s Constraints:
  • Rising defence and capital expenditures make the Centre hesitant to reduce its fiscal share.
  • Arvind Panagariya noted that a 9-point jump in devolution would "upset too many carts."

Way Forward

The Sixteenth Finance Commission should consider a modest increase in States’ share of the divisible pool, ideally to 44–45%, to address the fiscal imbalance while respecting the Centre’s spending needs. It must also recommend capping cesses and surcharges and including any surplus in the divisible pool to ensure transparency. Additionally, the horizontal devolution formula should be revised to better balance equity with performance, rewarding efficient governance while supporting less-developed States. This approach would strengthen cooperative federalism and create a fairer fiscal framework.

Conclusion

The Sixteenth Finance Commission must resist the temptation of maintaining fiscal status quo. Instead, it should seize this opportunity to forge a more equitable and cooperative fiscal federalism framework. By responsibly increasing vertical devolution, regulating non-transparent revenue tools, and reforming horizontal distribution, the Commission can strengthen the fiscal foundation of States — the true pillars of Indian democracy.