The 16th Finance Commission’s tough balancing act

The world is experiencing significant geopolitical changes, which would lead to economic hardships for many countries, including India. In this volatile situation, the challenges before the Sixteenth Finance Commission (FC16) are considerable. The primary agenda before the FC16 is to address the North-South debate in India over inequity in allocating Central funds to the states. Along with that, rising cess and surcharges is another important issue. In finding a solution to all these, we need to look at which states have been gaining and which are losing their share over time; and what can be done to reverse this trend.
Presently, the FC16 will make its recommendations by October 31, 2025, covering a period of five years commencing from April 1, 2026. This time, while forecasting the revenues and expenditures, the challenge before FC16 will be to assess the impact of global economic uncertainty due to ongoing wars, Covid-19-related fiscal shocks, etc. Under Article 280 of the Constitution, the FCs recommend transferring resources from the Centre to the states to address vertical and horizontal fiscal imbalances. Gradually, successive FCs have made increments in the devolution ratio and have successfully enhanced the size of the divisible pool and the share of states therein.
The Central government has greater revenue-raising scopes, because of their nationwide tax collection base while the development responsibilities lie on the states. The Union government collects 60-68% of combined revenue receipts whereas the revenue expenditure of the state ranges between 50-60%. Additionally, prudent fiscal management is expected from states but they are financially hamstrung because of limited fiscal space to meet their committed liabilities.
Every FC has aimed to bridge this gap through vertical and horizontal approaches. For vertical equity, the FC recommends transfers under two heads: (i) tax devolutions as a percentage of sharable tax revenue, and (ii) specific purpose grants. For horizontal devolution across states, altogether twelve criteria have been adopted by different FCs. The FC, while deciding horizontal criteria, looks into several issues for the balanced development of all states. Hence, this article proposes a few criteria for consideration by FC16 to have an equitable regional development:
Every FC had new challenges to address and each commission has done their work meticulously. Designing proper and balanced recommendations in such a stressed fiscal situation is a tough task. Moreover, incentivising the states for prudent fiscal behaviour would be the foremost challenge. FC16’s recommendations are even more crucial because the award period matches with the final phase of SDG 2030, which will lay a foundation for Viksit Bharat@2047.
Dr Barna Ganguli is a faculty member at the Bihar Institute of Public Finance and Policy, and Manoj Narayan is a development professional. The views expressed are personal