4 Feb 2026·Source: The Hindu

5 min

Polity & GovernanceEconomyEDITORIAL

16th Finance Commission: States' Share of Revenue Under Scrutiny

16th Finance Commission's recommendations prioritize the Centre, raising concerns about States' fiscal pressures.

Photo by Jakub Żerdzicki

Editorial Analysis

The authors argue that the 16th Finance Commission's recommendations prioritize the Centre's needs over those of the States, particularly concerning the distribution of tax revenues and the increasing reliance on cesses and surcharges.

Main Arguments:

The 16th Finance Commission has maintained the vertical devolution rate at 41%, representing the States’ share of the divisible pool, but this pool excludes cesses and surcharges.
The Centre's increasing reliance on cesses and surcharges effectively shrinks the shareable revenue for States.
Many States have demanded an increase in vertical devolution, but the Finance Commission's reasoning suggests that maintaining the status quo primarily serves the Centre’s interests.

Counter Arguments:

The Finance Commission argues that the Constitution does not permit a cap on cesses and surcharges and that the Centre requires these funds for emergencies.
The Finance Commission points to increased defence spending and infrastructure building as justifications for the Centre's need for greater financial support.

Conclusion

The FC’s interpretation of the fiscal landscape ultimately raises more questions than it answers. The FC has effectively forced the Centre to draw its own boundary, by refusing to play mediator.

Policy Implications

The editorial implies that there is a need for a mutual agreement between the Centre and the States, whereby the Centre voluntarily transitions a large part of its revenue collection from cesses and surcharges back into the divisible pool of regular taxes.

The 16th Finance Commission (FC)’s vertical devolution recommendations prioritize the needs of the Centre over the realities of States. The 16th FC has maintained the vertical devolution rate at 41%, representing the States’ share of the divisible pool. This divisible pool excludes cesses, surcharges, and collection costs, meaning its total volume is dictated by the Centre’s tax strategy. By favouring cesses and surcharges over standard tax instruments, the Centre effectively shrinks the shareable revenue. Data shows that post-2019, the cesses and surcharges component has nearly doubled from ₹5-7 to ₹11-13.5 for every ₹100 collected. The money collected as cesses by the Centre increased from ₹44,688 crore in FY15 to ₹3,52,650 crore in FY22 and is expected to be around ₹2,51,206 crore in FY26. Similarly, surcharges collected have risen from ₹15,702 crore in FY15 to ₹40,758 crore in FY22 and is expected to be around ₹1,72,500 crore in FY26. As many as 18 States have demanded an increase in vertical devolution from 41% to 50%. The FC notes that the Constitution does not permit a cap on cesses and surcharges. It argues that the Centre requires these funds for emergencies such as war, famine, and pandemics, concluding that imposing a limit would be “imprudent”. The FC points to “recent shifts in the external security and defence environment” as a justification for increased defence spending, while asserting that the Centre has demonstrated a “high degree of effectiveness” in infrastructure building, necessitating greater financial support.

Key Facts

Vertical devolution rate: 41%

Cesses and surcharges increase post-2019

18 States demand 50% vertical devolution

UPSC Exam Angles

GS Paper II: Functions and responsibilities of the Union and the States, issues and challenges pertaining to the federal structure, devolution of powers and finances up to local levels and challenges therein.

Connects to the syllabus through the topic of fiscal federalism and the role of Finance Commission in resource allocation.

Potential question types include statement-based questions on the functions of the Finance Commission and analytical questions on the challenges of fiscal devolution.

Visual Insights

More Information

Background

The Finance Commission (FC) is a constitutional body established under Article 280 of the Constitution. It is tasked with recommending the principles governing the distribution of tax revenues between the Union and the States. The recommendations of the FC are crucial for maintaining fiscal federalism in India. The evolution of the FC has seen significant changes over the years. Initially, the focus was primarily on revenue sharing based on population and needs. Over time, factors like fiscal discipline, infrastructure development, and environmental protection have also gained importance. These changes reflect the evolving economic landscape and priorities of the country. Constitutional Amendments have also played a role in shaping the FC's mandate. The legal and constitutional framework within which the FC operates is defined by Article 280 and related provisions. The President of India appoints the FC every five years, or earlier if deemed necessary. The FC's recommendations are presented to the Parliament, which then decides on their implementation. The Constitution does not explicitly cap cesses and surcharges levied by the Union, a point highlighted by the 16th FC.

Latest Developments

Recent government initiatives have focused on strengthening cooperative federalism. The Goods and Services Tax (GST) Council, for example, is a key platform for Centre-State collaboration on fiscal matters. However, debates continue regarding the appropriate balance between the Centre's needs and the States' developmental requirements. Different stakeholders have varying perspectives on the vertical devolution of tax revenues. States often argue for a larger share to address their specific development challenges. The Centre, on the other hand, emphasizes the need for fiscal space to meet national priorities such as defense and infrastructure. Institutions like the NITI Aayog play a crucial role in facilitating dialogue and consensus-building. The future outlook involves continued discussions on refining the principles of vertical devolution. There is a growing emphasis on performance-based incentives to promote fiscal responsibility and efficiency among States. The recommendations of successive Finance Commissions will continue to shape the fiscal relationship between the Centre and the States.

Frequently Asked Questions

1. What is the vertical devolution rate recommended by the 16th Finance Commission, and what does it signify?

The 16th Finance Commission has recommended a vertical devolution rate of 41%. This represents the share of tax revenue that States will receive from the divisible pool of taxes collected by the Centre.

2. Explain the concept of 'divisible pool' in the context of the Finance Commission.

The 'divisible pool' refers to the total tax revenue that is shared between the Union (Centre) and the States. However, it's important to note that this pool excludes cesses, surcharges, and collection costs, which are retained by the Centre.

3. Why are some States demanding a 50% vertical devolution rate?

As per the topic data, 18 States are demanding a 50% vertical devolution rate. This likely reflects their perceived need for greater financial resources to meet their developmental and welfare obligations.

4. How does the increasing reliance on cesses and surcharges by the Centre impact the States' share of revenue?

The Centre's increasing reliance on cesses and surcharges reduces the size of the divisible pool, as these are not shared with the States. This effectively shrinks the States' share of overall tax revenue.

5. What is the constitutional basis for the Finance Commission, and what is its primary role?

The Finance Commission (FC) is a constitutional body established under Article 280 of the Constitution. Its primary role is to recommend the principles governing the distribution of tax revenues between the Union and the States, ensuring fiscal federalism.

6. What are the recent developments related to Centre-State financial relations, as highlighted in the topic?

Recent government initiatives have focused on strengthening cooperative federalism, such as the Goods and Services Tax (GST) Council. However, debates continue regarding the appropriate balance between the Centre's needs and the States' developmental requirements.

7. How might the 16th Finance Commission's recommendations impact the average citizen?

The recommendations influence the resources available to States for funding public services like healthcare, education, and infrastructure. If States receive a smaller share of revenue, it could potentially impact the quality and accessibility of these services for citizens.

8. What is the significance of maintaining fiscal federalism in India, and how does the Finance Commission contribute to it?

Fiscal federalism ensures a balanced distribution of financial resources between the Centre and the States, enabling States to address local needs and promote inclusive growth. The Finance Commission plays a crucial role by recommending principles for revenue sharing and grants-in-aid.

9. What are the key concerns raised in the editorial regarding the 16th Finance Commission's approach?

The editorial expresses concern that the 16th Finance Commission's recommendations prioritize the needs of the Centre over the realities of States, particularly regarding the vertical devolution rate and the increasing reliance on cesses and surcharges.

10. For UPSC Prelims, what is a key fact to remember regarding the 16th Finance Commission and revenue sharing?

Remember that the 16th Finance Commission has maintained the vertical devolution rate at 41%, which represents the States' share of the divisible pool. Also, be aware that cesses and surcharges are excluded from this divisible pool.

Exam Tip

Focus on the percentage figures and what constitutes the divisible pool. This is a frequently tested area.

Practice Questions (MCQs)

1. Consider the following statements regarding the Finance Commission (FC) in India: 1. The FC is constituted under Article 280 of the Constitution. 2. The recommendations of the FC are binding on the Union Government. 3. The Constitution permits a cap on cesses and surcharges levied by the Union. Which of the statements given above is/are correct?

A.1 only
B.2 only
C.1 and 3 only
D.1, 2 and 3

Show Answer

Answer: A

Statement 1 is CORRECT: The Finance Commission is indeed constituted under Article 280 of the Constitution. Statement 2 is INCORRECT: The recommendations of the Finance Commission are advisory in nature and not binding on the Union Government. The government has the discretion to accept or reject these recommendations. Statement 3 is INCORRECT: The Constitution does not permit a cap on cesses and surcharges levied by the Union, as noted by the 16th Finance Commission.

2. With reference to the recent discussions on vertical devolution of tax revenues, consider the following: 1. Vertical devolution refers to the distribution of tax revenues between the Union and the States. 2. The 16th Finance Commission has recommended increasing the vertical devolution rate to 50%. 3. Cesses and surcharges form part of the divisible pool of taxes. Which of the statements given above is/are NOT correct?

A.2 only
B.3 only
C.2 and 3 only
D.1, 2 and 3