Syllabus: Issues and challenges pertaining to the federal structure, devolution of powers and finances up to local levels and challenges therein.
Context and Key Recommendations
- Sixteenth Finance Commission recommended retaining States’ share in divisible tax pool at 41%.
- States demanded an increase to 50% citing constrained fiscal space under GST regime.
- Commission acknowledged growing mismatch between State expenditure responsibilities and assured revenue streams.
- States increasingly rely on market borrowings as primary fiscal adjustment mechanism.
Vertical Devolution Assessment
- FC-16 retained status quo on vertical devolution for the 2026–2031 period.
- Suggested approach prioritised stability over expanded discretionary fiscal space for States.
- Commission flagged shrinking effective divisible pool due to cesses and surcharges.
- No recommendation to include cesses and surcharges within the divisible pool.
Horizontal Devolution Formula Changes
- “Tax effort” criterion restructured into “contribution to GDP” performance indicator.
- Weight for this indicator increased sharply from 2.5% under FC-15 to 10%.
- Intended to reward productive and efficient States through outcome-linked transfers.
- Gains for industrialised States like Tamil Nadu and Maharashtra remain incremental.
Demographic and Population Criteria
- Weight for demographic performance reduced to avoid penalising population growth trends.
- Reflects India nearing peak phase of its demographic dividend.
- Weight for population size modestly increased within horizontal devolution formula.
Transfers and Governance Implications
- Total transfers to States budgeted to rise by 12.2% between RE 2025-26 and BE 2026-27.
- About ₹1.2 lakh crore, nearly 42%, routed through Centrally Sponsored Schemes.
- Reinforces model where States primarily implement priorities set by the Centre.
Structural Concerns and Limitations
- Commission recognised financial stress in State budgets without proposing structural corrections.
- No phased roadmap for raising States’ share to 45% or higher by 2031.
- Recommendations reflect cautious reform rather than transformative fiscal federalism rebalancing.