Sixteenth Finance Commission Recommendations: Fiscal Federalism and Structural Deferrals

The Hindu - News · 11 Mar 2026 · 2 min read
Prelims · Economy Mains · GS2 Governance High relevance

The Union government accepted the Sixteenth Finance Commission's recommendation to retain States' share in the divisible pool at 41%, but deferred structural reforms, highlighting growing fiscal asymmetry and centralization.

Key points

Sixteenth Finance Commission (FC16) recommended retaining States' share in the divisible pool at 41%, but the actual share is shrinking due to rising cesses and surcharges excluded from the pool.

The divisible pool as a proportion of gross tax revenues fell from 89.2% (FC13) to 78.3% (FC15), exacerbating fiscal asymmetry between the Centre and States.

Revenue deficit grants, sector-specific grants, and State-specific grants were discontinued, removing targeted fiscal relief mechanisms for States.

Fiscal Responsibility Legislation (FRL) amendments to control off-budget borrowings were deferred, allowing States to continue opaque fiscal practices.

[GS2-Governance] The shift from tax & fiscal effort (2.5% weight) to contribution to GDP (10% weight) in the horizontal devolution formula benefits high-GSDP States like Maharashtra and Gujarat, disadvantaging poorer States like Bihar and Uttar Pradesh.

Local body grants of ₹7,91,493 crore are tied to performance conditions, disproportionately affecting States with weaker governance infrastructure.

The end of GST compensation in 2022 left States without a structural replacement, with Tamil Nadu alone facing a ₹20,000 crore shortfall in 2024-25.

[GS3-Economy] States like Punjab (debt-to-GSDP ratio of 42.9%) and Rajasthan (37.9%) face unsustainable fiscal trajectories due to revenue deficits and unenforced fiscal rules.

Way Forward: India should amend the FRL to enforce fiscal discipline, reintroduce targeted grants for fiscally stressed States, and integrate cesses/surcharges into the divisible pool to restore fiscal federalism.

Key terms

GST Compensation

Constitutional guarantee (Article 279A) ensuring 14% annual SGST growth for States until June 2022. Its discontinuation without replacement has created structural revenue gaps, particularly for manufacturing States like Tamil Nadu.

Divisible Pool

The portion of central tax revenues shared with States under Article 270 of the Constitution. It excludes cesses and surcharges, which have grown from 10.8% to 21.7% of gross tax revenues since FC13, undermining fiscal federalism.

Fiscal Responsibility Legislation (FRL)

A legal framework to enforce fiscal discipline by limiting deficits and debt. The 2003 FRBM Act mandates fiscal targets but lacks enforcement mechanisms, allowing States to bypass rules through off-budget borrowings.

Horizontal Devolution Formula

The methodology to distribute States' share of central taxes. FC16 replaced the tax effort criterion (rewarding fiscal efficiency) with a GDP contribution criterion (10% weight), favoring economically stronger States over those with greater need.