Jun 23, 2025
8
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The 16th Finance Commission of India was constituted on December 31, 2023 (Article 280), to make recommendations for the five-year period starting April 1, 2026 Its primary mandate is to determine how the “net proceeds of taxes” are shared between the Union and the States. In short, the Commission evaluates the central and state fiscal positions and recommends the division of tax revenues.
Finance Commission of India
The Finance Commission is a constitutional body in India established under Article 280 of the Constitution, tasked with maintaining fiscal federalism by recommending the distribution of tax revenues between the central and state governments. Constituted every five years by the President, it comprises a Chairman and four members with expertise in finance, economics, or public administration.
It recommends the sharing of net tax proceeds (e.g., income tax, GST) between the Union and states, grants-in-aid for revenue-deficient states, and measures to enhance local body resources for grassroots governance.
It also advises on fiscal discipline, public expenditure, and other financial matters referred by the President.
Constitution and Members
The 16th Finance Commission is chaired by Dr. Arvind Panagariya (former NITI Aayog vice-chairman). Other members appointed (by Gazette Notifications) include Ajay Narayan Jha (former 15th FC member and Expenditure Secretary), Annie George Mathew (former Special Secretary, Expenditure), Dr. Niranjan Rajadhyaksha (economic expert), and Dr. Soumya Kanti Ghosh (SBI Group Chief Economic Advisor, part-time). Ritvik Ranjanam Pandey (Joint Secretary, Finance Ministry) serves as the Commission’s Secretary.
Terms of Reference
The Terms of Reference (ToR) set by the Union Cabinet (Nov 2023) outline the Commission’s scope. Article 280(1) mandates that the Commission recommend:
(a) the distribution of net tax proceeds between the Centre and states;
(b) grants-in-aid to states from the Consolidated Fund; and
(c) measures to augment state finances for Panchayats and Municipalities. Accordingly, the 16th FC must define the principles for tax-sharing (Article 270)
(d)state grants (Article 275), and also suggest ways to strengthen local bodies’ budgets.
The official ToR specifically includes reviewing the financing of disaster management (Disaster Management Act, 2005) and suggesting improvements. The Commission’s report is due by October 31, 2025, covering FY2026–27 to FY2030–31
Table of content
Tax Devolution: Recommending how to share Union tax revenues (e.g. income tax, GST) with the states. This is often called vertical devolution.
Horizontal Distribution: Allocating each state’s share of the tax pool based on criteria like population, income distance, etc. (horizontal devolution).
Grants-in-Aid: Proposing grants from the Consolidated Fund of India to states under Article 275, particularly to help revenue-deficient states stabilize their finances.
Local Bodies Support: Suggesting measures to augment the financial resources of Panchayats and Municipalities by enhancing state Consolidated Funds.
Disaster Management: Evaluating and improving the funding arrangements for disaster response, as set out under the Disaster Management Act, 2005.
Fiscal Roadmap: Advising on fiscal targets (deficits and debt) for the Centre and states to ensure fiscal sustainability.
These responsibilities align with the constitutional mandate of the Finance Commission. In essence, the 16th FC must assess and recommend the distribution of financial resources between the Union and states, considering factors such as changing demographics, economic growth, and fiscal needs.
Tax Revenue Distribution under the 16th Finance Commission of India
Understanding this section is crucial for UPSC aspirants preparing for questions on fiscal federalism and tax devolution:
What is Tax Revenue Distribution?
Legal basis: Article 270 mandates the Finance Commission to determine how “net proceeds of taxes” collected by the Union Government are shared with the states.
Structure: Two-tier sharing:
Vertical Devolution: How much of the total divisible pool goes to states vs. the Centre.
Horizontal Devolution: How each state’s share then gets divided among the states.
Under the 15th Finance Commission UPSC, this was fixed at 41% of the central divisible pool. The 16th Finance Commission UPSC, covering FY 2026–27 to 2030–31, will re-evaluate this share based on current fiscal needs.
What the 16th Finance Commission of India Must Reassess?
Areas for review by the 16th FC include:
Vertical Percentage (41%): Should it remain or change—especially demands from states to raise it to 50%
Treatment of Cesses and Surcharges: States want these included in the divisible pool if they exceed a specific threshold
New Devolution Formula: Update horizontal weights (e.g., more emphasis on tax effort, demographic, or economic performance) to reflect current realities
In addition to tax-sharing, the 16th Finance Commission UPSC outlines principles for grants-in-aid under Article 275, focusing on revenue-deficit relief and targeted support. Here's a clear breakdown for UPSC aspirants:
What Are Grants-in-Aid?
Definition: Funds provided by the Centre to States to meet fiscal shortfalls or specific developmental objectives.
Legal Basis: Article 275 empowers the Centre to allocate these grants from the Consolidated Fund of India.
Relevance: Grants are essential to ensure balanced development across states, even beyond what tax devolution offers.
Grants-in-Aid Under the 16th Finance Commission UPSC
The 16th Finance Commission of India will recommend the amount and conditions for
Revenue-deficit grants – to bridge fiscal gaps post tax-devolution
Sector‑specific/state‑specific grants – for areas like health, education, and infrastructure
Local-body grants – to support Panchayats and Municipalities
The 16th Finance Commission UPSC has been explicitly tasked—under its Terms of Reference—to review and enhance disaster management financing. This mandate reflects India's increasing vulnerability to natural disasters and the need for robust fiscal support systems.
Legal Mandate for Disaster Funding
Terms of Reference: Article 280 mandates the Commission to “review the present arrangements on financing Disaster Management initiatives, with reference to the funds constituted under the Disaster Management Act, 2005, and make appropriate recommendations”.
1. Pandemic & Geopolitical Disruptions
The 16th Finance Commission UPSC inherits a volatile fiscal backdrop: slow economic growth post-COVID, disrupted supply chains, and global tensions.
These factors have slashed state revenues (e.g., GST collections) while increasing expenditures in health, social security, and welfare.
2. Declining State Share in Union Taxes
According to DrishtiIAS, states’ share in gross Union tax revenue fell from 35% in 2015–16 to just 30% in 2023–24—a divergence from the 15th Finance Commission UPSC’s recommended 41%
This weakening of state finances is concerning, since it curtails their ability to manage expenditures independently.
3. Growth of Cesses & Surcharges
A growing share of Union revenue now comes from cesses and surcharges—about 25% as of 2022–23—funds that are outside the divisible pool
This drains resources from the tax pot that should be shared with states, creating a structural gap that the 16th Finance Commission of India must address.
4. GST-Related Shortfalls
The withdrawal of GST compensation after 2022 left states with revenue shortfalls of 19% to 33%, according to PRS data
Although the GST Council provided back-to-back loans (₹1.1 lakh crore in 2020–21, ₹1.59 lakh crore in 2021–22) these were loans, not grants—and often resulted in increased state liabilities.
5. Restricted Fiscal Space
The FRBM Act limits states' borrowing to 3% of GSDP—including off-budget and public account borrowings
Coupled with rising deficits and limited resource mobilization, states have little room for counter-cyclical fiscal policies or large development projects.
6. Overdependence on Centrally Sponsored Schemes (CSS)
Spending via Centrally Sponsored Schemes rose from ₹5.2 lakh crore in 2015–16 to ₹14.7 lakh crore by 2023–24
These schemes often include conditions and matching state contributions, limiting states' financial autonomy.
7. Mitigating Freebie Culture:
Addressing excessive subsidies, the Commission may introduce measures that balance welfare initiatives with long-term fiscal health, possibly through incentives or spending guidelines.
The 16th Finance Commission UPSC will unveil its recommendations by October 31, 2025 for implementation from FY 2026–27 to FY 2030–31. These recommendations are set to shape the financial landscape of both the Union and states, influencing budgets, development strategies, and fiscal relations.
Key Financial Outcomes
Revised State Tax Shares
After consultations, some states (e.g., Uttar Pradesh) have advocated raising the states’ share in central tax revenues from the current 41% (15th Finance Commission UPSC) to 50% under the 16th FC UPSC.
The Centre has floated the idea of slightly reducing the states’ share (e.g., to 40%) due to its own expenditure pressures, highlighting a significant negotiation under the 16th Finance Commission of India.
New Grants for Underserved Sectors
As with the 15th Finance Commission UPSC, the 16th FC will likely continue grants for health, education, rural infrastructure, and local governance, possibly with added focus on climate resilience and pandemic preparedness.
Enhanced Local Governance Support
The Commission may boost funding for Panchayats and Municipalities, building on prior provisions aimed at decentralisation and better service delivery.
Disaster Relief Financing
In light of UP’s proposal, the 16th FC may allow states to increase SDRF use for state-identified disasters (up to 25%) and enhance flexibility in fund utilization - endorsing responsiveness in disaster financing under the 16th Finance Commission UPSC’s broader goals.
Vertical devolution refers to the share of central tax revenues that goes to the states. This share, determined by the Finance Commission, is a cornerstone of states’ fiscal autonomy. The 15th FC (2021–26) set this at 41% of the divisible pool. The 16th FC is expected to review this figure, potentially using the latest population data and fiscal needs to ensure fairness.
Horizontal devolution is the formula used to distribute the states’ share among them. The 16th FC will likely revise criteria (e.g. income distance, area, population, forest cover, tax effort) based on updated data.
Here are the six criteria typically used (and deliberated for the 16th Finance Commission) for horizontal tax devolution among states in India:
Criterion | Definition | Purpose |
Income Distance | Gap between a state’s per capita income and the richest state | Supports economically weaker states for equity |
Population | Total population (based on 2011 Census by 15th FC) | Reflects basic service needs and demographics |
Area (Cost Disability) | Geographical area of the state | Compensates for higher costs in large/remote regions |
Forest & Ecology (Cost Disability) | A state’s share of forest cover and ecological burden | Compensates forest-rich states for environmental costs |
Demographic Performance | Measures progress in population control (e.g., fertility rates) | Rewards states with better demographic indicators |
Tax Effort & Fiscal Discipline | Compares per-capita tax revenue to GDP and evaluates fiscal prudence | Encourages fiscal responsibility and improved revenue efforte |
This table will help in understanding the devolution through years by comparing the 14th Financial commission of India with 15th Financial Commission of india
Criteria | 14th FC (2015-20) | 15th FC (2021-26) |
Income Distance | 50.0 | 45.0 |
Area | 15.0 | 15.0 |
Population (1971) | 17.5 | - |
Population (2011)# | 10.0 | 15.0 |
Demographic Performance | - | 12.5 |
Forest Cover | 7.5 | - |
Forest and Ecology | - | 10.0 |
Tax and fiscal efforts* | - | 2.5 |
Total | 100 | 100 |
Sector-specific grants are targeted funds provided by the Finance Commission to states for crucial public services like health, education, and infrastructure. They are disbursed under Article 275 and often linked to performance outcomes.
Sector Grant Comparison Table
Sector | 15th FC (₹ lakh cr) | 16th FC Proposals (Indicative) |
Health | Included | Clinics, infrastructure, pandemic preparedness |
School Education | Included | Facility upgrades, learning outcomes |
Higher Education | Included | University expansion, STEM initiatives |
Agriculture Reforms | Included | Crop resilience, irrigation |
Rural Roads (PMGSY) | Included | Connectivity focus maintained |
Judiciary | Included | Courts modernization |
Statistics | Included | Data systems support |
Aspirational Districts | Included | Enhanced funding for lagging districts |
Performance Incentives | Part of grants | Likely to continue and expand |
A clear comparison helps UPSC aspirants understand the evolution in fiscal policy and resource allocation between the two commissions:
Aspect | 15th Finance Commission UPSC | 16th Finance Commission of India |
Term | FY 2020–21 to 2025–26 | FY 2026–27 to 2030–31 |
Vertical Tax Share | 41% of divisible pool (₹42.2 lakh crore) | States demand 50%, Centre proposes 40%—under review |
Horizontal Formula Weights | Income 45%, Pop 15%, Area 15%, Forest 10%, Demo 12.5%, Effort 2.5% | States seek new weights (e.g., Income 30%, Effort↑, SDGs) |
Sector Grants Quantum | ₹1.3 lakh crore in key sectors | Expected to continue/expand with health & infrastructure focus |
Fiscal Targets | C deficit 4%, States 3%, +0.5% GSDP borrowing incentive | Shift to debt–GDP anchor; conditional waivers for reforms |
Commission Composition | Chair: N.K. Singh + experts | Chair: Arvind Panagariya + domain experts |
Q: When will the 16th Finance Commission of India submit its report?
A: It is due by Oct 31, 2025
Q: Who is the chair of the 16th Finance Commission of India?
A: The Chairman of the 16th Finance Commission is Arvind Panagariya.
Q: What key topics will the 16th Finance Commission of India cover?
A: Tax devolution, grants-in-aid, fiscal deficit management, urban/local finance and climate resilience funding
Q. What is Article 280 of the Constitution of India?
A: Article 280 of the Constitution of India provides for establishing a Finance Commission, which consists of a Chairman and four other members appointed by the President.
Q: How will the 16th Finance Commission of India support urban local bodies?
A: It will examine urban finances and suggest sustainable funding models for cities and municipalities
Q. What is the agenda of the 16th Finance Commission?
A: The agenda of the 16th Finance Commission includes recommending the tax revenue sharing formula between the Centre and States, reviewing disaster management financing, and augmenting resources for local bodies like Panchayats and Municipalities.
The 16th Finance Commission plays a pivotal role in shaping India’s fiscal architecture for 2026–2031. It will decide how tax revenues are shared, how much financial aid states receive, and how fiscal challenges (like disaster relief and post-pandemic recovery) are addressed. For UPSC aspirants, mastering the details of the 16th Finance Commission — its composition, terms of reference, comparison with the 15th Finance Commission, and likely recommendations — is critical. The Commission’s final report (due Oct 2025) will influence Union and state budgets significantly. Therefore, thorough study of its mandate and potential impacts (as done above) will prepare candidates to tackle exam questions on fiscal federalism and financial planning. For further reading on UPSC topics and exam strategy, see the Padhai AI UPSC Blog.
Internal Linking Suggestions
How to Begin Your UPSC Preparation : The Ultimate Guide For Beginners
UPSC Previous Year Question Papers with Answers PDF - Prelims & Mains (2014-2024)
upsc optional subject list and syllabus-for-cse-exam-2025-complete-guide
How to Prepare Current Affairs for UPSC Exam: A Comprehensive Guide
51st G7 Summit 2025 – Countries, Key Issues, India’s Role & UPSC
External Linking Suggestions
UPSC Official Website – Syllabus & Notification: https://upsc.gov.in/
Press Information Bureau – Government Announcements: https://pib.gov.in/
NCERT Official Website – Standard Books for UPSC: https://ncert.nic.in/
