1. Share of States in Central Taxes
The 16th Finance Commission has recommended that states receive 41% of the divisible pool of central taxes — unchanged from the recommendation made by the 15th Finance Commission. The divisible pool is calculated by excluding the cost of collection, cesses, and surcharges from the gross tax revenue collected by the central government.
2. Criteria for Devolution
The Commission uses a weighted formula across several parameters to determine how central taxes are distributed among states. The table below compares the criteria and their respective weights under the 15th and 16th Finance Commissions:
| Criteria | 15th FC (2021–26) | 16th FC (2026–31) |
|---|---|---|
| Income Distance (Per Capita GSDP) | 45% | 42.5% |
| Population (2011 Census) | 15% | 17.5% |
| Demographic Performance | 12.5% | 10% |
| Area | 15% | 10% |
| Forest | 10% | 10% |
| Tax and Fiscal Efforts | 2.5% | — |
| Contribution to GDP (New) | — | 10% |
| Total | 100% | 100% |
Key Changes in Devolution Criteria
- Income Distance: Defined as the difference between a state’s per capita GSDP and the average per capita GSDP of the top three large states. Per capita GSDP is computed as an average over 2018–19 and 2023–24, excluding the pandemic year 2020–21. States with lower per capita GSDP receive a higher share, promoting equity.
- Population: Devolution share based on a state’s share in the population as per the 2011 Census. The weight has been increased from 15% to 17.5%.
- Demographic Performance: Previously measured by change in Total Fertility Rate (TFR), the 16th FC has redefined this parameter to account for population growth between 1971 and 2011. States with lower population growth over this period receive a higher share.
- Forest: The 16th FC now assigns weight to both a state’s share in overall forest area and its share in the increase in forest area between 2015 and 2023. Crucially, open forests are now also counted — unlike the 15th FC, which considered only dense and moderately dense forests.
- Contribution to GDP (New): This new parameter replaces the earlier “Tax and Fiscal Efforts” metric. A state’s contribution is measured as the square root of its GSDP divided by the sum of the square roots of all states’ GSDPs, using average nominal GSDP from 2018–19 to 2023–24 (excluding 2020–21).
3. Grants-in-Aid (2026–31)
The 16th FC has recommended total grants-in-aid worth ₹9,47,409 crore over the five-year period. These grants cover two broad categories: (i) local body grants and (ii) disaster management grants. Notably, the Commission has discontinued revenue deficit grants, sector-specific grants, and state-specific grants that were recommended by the 15th FC.
| Grant Type | Amount (₹ crore) |
|---|---|
| Local Governments (Total) | 7,91,493 |
| Rural Local Bodies — Basic Grant | 3,48,188 |
| Rural Local Bodies — Performance Grant | 87,048 |
| Urban Local Bodies — Basic Grant | 2,32,125 |
| Urban Local Bodies — Performance Grant | 58,032 |
| Special Infrastructure Component (ULB) | 56,100 |
| Urbanisation Premium (ULB) | 10,000 |
| Disaster Management | 1,55,916 |
| Grand Total | 9,47,409 |
Structure of Local Body Grants
All local body grants come with three mandatory entry-level criteria:
- constitution of local bodies as per the Constitution
- publication of provisional and audited accounts in the public domain
- timely constitution of the State Finance Commission.
Basic Grants: 50% of the basic grant is untied, while the remaining 50% is tied to sanitation and solid waste management, and/or water management.
Performance Grants: Divided into state performance grants (linked to minimum benchmark transfers to local bodies from own resources) and local body performance grants (linked to own source revenue growth).
Special Infrastructure Grants (₹56,100 crore): Tied to development of comprehensive wastewater management systems in cities with populations between 10–40 lakh as per the 2011 Census.
Urbanisation Premium Grants (₹10,000 crore): A one-time grant for merger of peri-urban villages into adjoining urban local body areas, and for formulating a Rural to Urban Transition Policy.
Disaster Management Grants: A corpus of ₹2,04,401 crore has been recommended for State Disaster Relief and Management Funds (SDRF and SDMF). The centre-state cost-sharing ratio is 90:10 for north-eastern and Himalayan states, and 75:25 for all other states. The centre’s share amounts to ₹1,55,916 crore.
4. Fiscal Roadmap
The Commission has recommended that the Centre bring its fiscal deficit down to 3.5% of GDP by 2030–31. For states, the annual fiscal deficit limit has been set at 3% of GSDP. Key fiscal discipline measures include:
- Strict discontinuation of off-budget borrowings by states, with all such borrowings to be brought on-budget.
- Expansion of the definition of fiscal deficit and debt to uniformly include all off-budget borrowings.
- The combined debt of the central and state governments is projected to decline from 77.3% of GDP in 2026–27 to 73.1% of GDP by 2030–31.
5. Power Sector Reforms
The Commission has recommended that states actively pursue the privatisation of electricity distribution companies (DISCOMs). To protect private investors from the debt burden upon DISCOM takeover, a Special Purpose Vehicle (SPV) may be created to warehouse the debt. States will be permitted to use funds from the Special Assistance Scheme for Capital Investment only after the privatisation process is complete.
6. Subsidy Expenditure Rationalisation
The Commission has called on states to review and rationalise their subsidy expenditure, noting that schemes offering unconditional cash transfers tend to have large and untargeted beneficiary bases. Key recommendations include:
- Setting clear exclusion criteria and a rigorous review process to improve targeting of subsidies.
- Discontinuing financing of subsidies through off-budget borrowings.
- Adoption of a uniform approach for accounting and disclosure of subsidies and transfers across states, addressing the current misclassification of subsidies as assistance, grants, or other expenditure.
7. Public Sector Enterprise (PSE) Reforms
The Commission recommended a review and closure of 308 inactive State Public Sector Enterprises (SPSEs). Further recommendations include:
- Formulation of a state-level PSE disinvestment policy targeting inactive and underperforming enterprises.
- Any state or union PSE incurring losses for three out of four consecutive years must be placed before the respective Cabinet, which may decide on closure, privatisation, or continuation based on strategic importance.
Top Individual State Shares (out of 100):
- Uttar Pradesh: 17.62
- Bihar: 9.95
- Madhya Pradesh: 7.35
- West Bengal: 7.22
- Maharashtra: 6.44
State-wise Data
Individual Share of States in Devolved Taxes (out of 100)
| State | 14th FC (2015–20) | 15th FC (2021–26) | 16th FC (2026–31) |
|---|---|---|---|
| Andhra Pradesh | 4.31 | 4.05 | 4.22 |
| Arunachal Pradesh | 1.37 | 1.76 | 1.35 |
| Assam | 3.31 | 3.13 | 3.26 |
| Bihar | 9.67 | 10.06 | 9.95 |
| Chhattisgarh | 3.08 | 3.41 | 3.30 |
| Goa | 0.38 | 0.39 | 0.37 |
| Gujarat | 3.08 | 3.48 | 3.76 |
| Haryana | 1.08 | 1.09 | 1.36 |
| Himachal Pradesh | 0.71 | 0.83 | 0.91 |
| Jharkhand | 3.14 | 3.31 | 3.36 |
| Karnataka | 4.71 | 3.65 | 4.13 |
| Kerala | 2.50 | 1.93 | 2.38 |
| Madhya Pradesh | 7.55 | 7.85 | 7.35 |
| Maharashtra | 5.52 | 6.32 | 6.44 |
| Manipur | 0.62 | 0.72 | 0.63 |
| Meghalaya | 0.64 | 0.77 | 0.63 |
| Mizoram | 0.46 | 0.50 | 0.56 |
| Nagaland | 0.50 | 0.57 | 0.48 |
| Odisha | 4.64 | 4.53 | 4.42 |
| Punjab | 1.58 | 1.81 | 2.00 |
| Rajasthan | 5.50 | 6.03 | 5.93 |
| Sikkim | 0.37 | 0.39 | 0.34 |
| Tamil Nadu | 4.02 | 4.08 | 4.10 |
| Telangana | 2.44 | 2.10 | 2.17 |
| Tripura | 0.64 | 0.71 | 0.64 |
| Uttar Pradesh | 17.96 | 17.94 | 17.62 |
| Uttarakhand | 1.05 | 1.12 | 1.14 |
| West Bengal | 7.32 | 7.52 | 7.22 |
Cities Eligible for Special Infrastructure Component (ULB Grants)
The following cities with populations between 10–40 lakh (2011 Census) are eligible for the Special Infrastructure Component under urban local body grants:
Pune (Maharashtra), Jaipur (Rajasthan), Lucknow (Uttar Pradesh), Kanpur (Uttar Pradesh), Nagpur (Maharashtra), Indore (Madhya Pradesh), Bhopal (Madhya Pradesh), Visakhapatnam (Andhra Pradesh), Patna (Bihar), Vadodara (Gujarat), Ludhiana (Punjab), Faridabad (Haryana), Rajkot (Gujarat), Dhanbad (Jharkhand), Amritsar (Punjab), Howrah (West Bengal), Ranchi (Jharkhand), Coimbatore (Tamil Nadu), Vijayawada (Andhra Pradesh), Jodhpur (Rajasthan), Madurai (Tamil Nadu), Raipur (Chhattisgarh).
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.