Deciphering finance panel recommendations and importance in 3 charts | Number Theory

.

Fiscal year 2026-27 marks the beginning of the five-year period for awards of the 16th Finance Commission (FC). The key takeaways from the 16th FC awards – unchanged vertical tax devolution share of 41% and changes in its horizontal distribution across states – have been already reported. But the beginning of a new FC award period also calls for a larger explanation of the fiscal federalism framework in India and the role played by FC in it. This two-part series will do this. The first part will explain the importance of tax devolution across and among states and the second part will look at changes in this arrangement over various FCs.

Members of the 16th Finance Commission, led by chairman Arvind Panagariya, call on President Droupadi Murmu to submit the Commission's report for 2026-31. (Rashtrapati Bhavan)

Deciphering finance panel recommendations and importance in 3 charts

• 
  Some states need central taxes more than others

  These pages explained last Saturday how states spend more than the Centre, but it is the latter which collects more taxes. In the absence of transfers from the Centre, states will be unable to carry on their functions. What makes this arrangement geographically and politically sensitive is the fact that some states need central taxes more than others because their own revenues are lower. This is best seen in the ratio of states’ own tax revenue with their total spending. This number is over 50% for states such as Maharashtra and Karnataka, not even 10% for half the small north-eastern states, and just around 20% for even a big state such as Bihar. As is to be expected, it is the richer states which raise more in their own tax revenues compared to their spending.
• 
  Successive FCs have tried to address this by using income-distance to calculate awards

  Equality continues to be the proverbial lodestar of India’s fiscal federalism framework. Poorer states are given more money than the richer states by following what the FC calls an “income-distance criteria”. Simply speaking, it is the distance between a state’s per capita income and the highest per capita income among big states. While the weight of income criteria has come down over successive FCs by about 20 percentage points between the 11th FC (2000-05) and the 16th FC, the latter has for the first time introduced a state’s contribution to the country’s GDP as a determinant of horizontal devolution. This puts a premium on being rich rather than poor, although equality is still the largest driver of horizontal distribution of central taxes among states.
• 
  What complicated this pursuit was the concurrent factor of demography

  Bringing in demography as a determinant of horizontal devolution is perfectly intuitive. A higher population necessitates more resources. However, state-wise population shares have diverged significantly over time in India. In 1971, Bihar and Uttar Pradesh had a share of 23.4% in the population of 28 states (as they exist now). This number was 17.1% for Tamil Nadu, Kerala and Karnataka. By the 2011 census, these numbers had become 25.8% and 14.1% respectively. If the government’s projected population projections are to be believed, it will change to 27.1% and 13.2% by March 1, 2026. This means that states which have done well to control their population growth can rightfully complain that they are being penalized for it. Most high population growth states are also those which continue to be the poorest. The 1971 census figures are important because these numbers were used for calculating demographic weights of states for horizontal devolution until the 14th FC awards. 1971 population is still the benchmark for distribution of parliamentary representation among states, which will be changed under the next delimitation exercise and likely be based on the 2027 census numbers. The 15th FC shifted to the 2011 census numbers for the first time and this has continued to be the case for the 16th FC as well. To be sure, from the 14th FC onwards, the demographic weight has been divided across population share and demographic performance, thereby trying to mitigate the pain of states which have done well to control their population.
• Conclusion...

  The central contradiction facing the distribution of fiscal federalism awards among states is to balance the objective of equality while appearing to be fair to the economically and demographically performing states. How well has the 16th FC been able to deliver on this challenge in comparison to its predecessors? The second part of this series will try to answer this question.