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Informist, Sunday, Feb. 1, 2026

 

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--Recommend keeping states' share of divisible tax pool at 41%
--Centre should disclose audited divisible tax pool receipts
--17.5% weight to population criteria for horizontal tax share
--10% weight to demographic performance for horizontal tax share
--10% weight to area for horizontal tax share
--10% weight to forest for horizontal tax share
--10% weight to contribution to GDP for horizontal tax share
--42.5% weight to per capita GSDP distance for horizontal tax share
--Didn't recommend revenue deficit grants to states
--Recommend states fiscal deficit be capped at 3% of GSDP
--Recommend Centre cuts fiscal deficit to 3.5% of GDP by FY31
--Govt to examine 3.5% of GDP fisc gap by FY31 recommendation
--Recommend states completely discontinue off-budget borrowing
--See Centre's outstanding debt-to-GDP 47.6% by FY31
--See states' debt-to-GDP 27.2% by FY31 if 3% fisc gap adhered to
--See general govt debt-to-GDP 73.1% FY31

 

NEW DELHI – The 16th Finance Commission, whose report was accepted by the Union government in Parliament on Sunday, recommended 41% vertical tax devolution to states for five years starting 2026-27 (Apr-Mar). The commission, chaired by economist Arvind Panagariya, kept the vertical devolution share unchanged from the previous commission's level but tweaked the formula for determining the horizontal tax share. 

 

Vertical devolution refers to tax revenue sharing from the central government to state governments, while horizontal devolution pertains to the distribution of states' share among individual states. To bring more transparency about the divisible pool of taxes and actual devolution, the Centre should disclose the data on net proceeds after it is certified by the Comproller and Auditor General, according to the report. 

 

The 16th Finance Commission cut the weight given to income distance criteria – the largest determinant of horizontal share - to 42.5% from 45% weightage given by the previous panel. It hiked the weight given to population criteria to 17.5% from 15?rlier, and cut the weightage given to demographic perfomance by 2.5% to 10%. The Panagariya-led panel kept the weightage given to area and forest cover metrics unchanged at 10?ch. Interestingly, it removed the tax and fiscal efforts metric – atrracting 2.5% weight under the 15th panel – entirely, and introduced a new metric – contribution to GDP with a 10% weight. 

 

Informist had reported in June that the 16th Finance Commission was likely to "broadly" stick to the current 41% vertical tax devolution ratio to balance political considerations and fiscal imperatives. 

 

The 16th Finance Commission also recommended that states reduce their fiscal deficit as a percentage of gross state domestic produce to 3% by FY31, and the Centre reduce its fiscal gap to 3.5% of GDP. 

 

For the current fiscal year, states' aggregate fiscal deficit is expected to be 3.2% of GSDP, with seven states expected to have a fiscal deficit higher than the recommended level. These include Madhya Pradesh and Sikkim projecting their fiscal deficit at 4% of their respective GSDP, Andhra Pradesh and Punjab projecting their fiscal gap at 3.8% of their respective GSDP, Himachal Pradesh at 3.6%, followed by Rajasthan at 3.5%, and West Bengal at 3.2%. 

The Centre's fiscal deficit, on the other hand, is projected at 4.4% of GDP in FY26.

 

Should the central and state governments adhere to the roadmap given by the panel, the general government debt-to-GDP ratio is projected at 73.1% by FY31. Individually, however, the Centre may only be able to bring its debt-to-GDP ratio down to 47.6% by March 2031, while states' share of debt-to-gross state development product would be 27.2% in the base case, with the latter netting out interest-free loans.

 

"The government accepts in-principle, the recommendation of the quantum (expressed as a per cent of GSDP) of net borrowing ceilings for the States," the Union finance ministry said. "Other recommendations of the Commission including those related to Off-Budget Borrowings, amendment to State FRLs (fiscal responsibility legislation), Union Government Fiscal Deficit will be examined separately."

 

The panel recommended that the central government should target a fiscal deficit of 4.2% of GDP in FY27, against its budgeted aim of 4.3%. This should decline to 4.0% by FY28, then 3.8% by the end of FY29. Eventually, the deficit should be only 3.6% of GDP in FY30 and 3.5% of GDP at the end of the panel's advisory period. These will include the interest-free loans given to states for capital expenditure, which was pegged at INR 1.85 trillion in FY27.

 

The commission did not recommend that states receive revenue-deficit grants as they remove the incentive to undertake necessary fiscal reforms and increases the dependency on the Centre. These grants were being given to states under earlier finance commissions to meet revenue gaps and provide critical spending. The panel also did not recommend state- or sector-specific grants.

 

The commission also recommended that states actively explore strategies such as bond switches and buybacks adopted by the Centre to smoothen their redemption profile in specific years. States should also issue bonds in benchmark, heavily-traded securities like the Centre does. Further, they should reissue more securities to improve secondary market liquidity in bonds, which are seldom traded compared with central government bonds.

 

Informist had reported in December that the panel had likely recommended to state governments ways in which they could reduce their debt to align their fiscal management with the Centre's debt-to-GDP ratio targeting. The report said there was significant scope for states to increase revenue, as well as cut expenditure.  End

 

Reported by Priyasmita Dutta and Aaryan Khanna

Edited by Avishek Dutta

 

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