The Finance Commission of India (FC) is one of India’s most credible institutions. It is a constitutional body whose function is to make recommendations to the Government of India on how to divide tax revenues between the Union and the states, and between states, and what percentage of Union taxes should be devolved to local governments.
The FC is unique in at least two specific ways. First, it is temporary. It works for two years and then gets dissolved. Second, it has a stellar track record of its recommendations being accepted (almost in full, and almost without exception) by the government, over a long period of 75 years. While some Finance Commissions, including the 15th FC, had additional items included in their terms of reference (ToR), the 16th FC enjoyed a pristine ToR, aligned to the language of the Constitution, which is a positive. Like many of its predecessors, it had the benefit of being led by an economist of global repute, Arvind Panagariya. The 16th FC may have just missed the distinction of being the first FC in the AI generation.
Access the Report of Sixteenth Finance Commission
Prima facie, the 16th FC appears to have adopted a carefully considered stance of gradualism, to be fair to both the Union and states, yet not rock the boat of fiscal-federal relations. Maintaining predictability in fund flows was rightly an important consideration. It has, therefore, maintained the states’ share at 41% of the divisible pool. Divisible pool refers to the total amount of money that the Commission deals with. This has largely remained the same from the 14th FC onwards. The Commission has ignored the demand from some states for a higher share, and taken a view that cesses and surcharges are constitutionally permitted to be excluded from the overall pool of funds, a bone of contention between the Union and states. The 16th FC has recommended a high-powered committee to review, consolidate, and rationalise centrally sponsored schemes, another bugbear, that are run by the Union government but largely dealt with by subnational governments.
Given the purported electoral appeal of such schemes, it would be unsurprising if the Union government reduces them over a period of time, with or without a committee. Given the upcoming census, states do have a rightful claim to a larger share, given most of their expenditure obligations (health, education, public infrastructure in villages and cities) are directly impacted by population growth, as against those of the Union government (defense, nuclear, highways), which are likely less elastic.
In determining how the 41% share of states gets divided between each of the 28 states, the 16th FC has tweaked some of the criteria used by the 15th FC and added a new one, that of states’ contribution to GDP. This should at least partially alleviate the concerns of southern states. All the southern states — Kerala, Tamil Nadu, Karnataka, Andhra and Telangana — have received larger shares compared to the 15th FC, at the cost of states like Bihar, Uttar Pradesh, West Bengal and Rajasthan. We may know the exact amounts in due course.
Two other focus areas of the 16th FC have been on power distribution companies, where they have recommended privatisation, and subsidies and direct benefit transfers by state governments, on which they have recommended a far greater degree of fiscal prudence and deliberate targeting of stakeholders. Historically, recommendations of Finance Commissions that are not tied to funds have not found much uptake. Perhaps, public finance management, including fiscal prudence, should have been an explicit devolution criterion.
A frontier on which the 16th FC has been ground-breaking is local body grants. By awarding a whopping ₹7.9 lakh crore (7.9 trillion rupees, 90 billion dollars) to local governments, the commission may have finally moved away from a modest 4% share to a significantly higher share of the divisible pool, though it’s hard to confirm in the absence of explicit disclosure to that effect in their report. Particularly for urban local governments (ULGs), a 45% share of local government grants indicates a historic push for urban as opposed to rural infrastructure and services. The quantum of untied grants for ULGs, which gives them the flexibility to spend on their needs and priorities, has seen a massive 455% increase from the 15th FC, which had recommended substantial tied grants. This has the potential to substantially improve the quality of first-mile infrastructure and services, particularly in small towns. The 16th FC could have been more innovative and emphasised in strengthening public finance management systems, including project-level transparency in end-use of local government grants, besides a differentiated approach to devolution by population categories of cities.
One of the disruptive events in this 16th FC’s award period will be the census, which will happen after a long gap of 16–17 years. The 16th FC has remained largely silent on the upcoming census, even as they have been bold in using the 2026 population projections of the Ministry of Health and Family Welfare in local government devolution. The Union government should evolve a strategy to factor in implications of the upcoming census, especially if the relative share of populations of states varies considerably from 2011. It would also be useful for states to harmonise the State Finance Commission award periods with the FC timelines. They would also need to evolve a strategy for post-census redistribution of grants among their local governments, so as to retain predictability in quantum and timing.
The average citizen in India is generally distant from complex public finance arrangements which have both indirect and direct impact (through local government grants) on our lives. As we cross the quarter mark in the 21st century, we are moving into a world that, thanks to Artificial Intelligence (AI), will be very different from anything we have experienced before in terms of technology and communication. Large-scale dissemination of simplified information in multiple languages is no longer a challenge.
Similarly, there is no reason why future FCs cannot listen to the voices of citizens at scale. The 16th FC and its report may be the last of its kind in the pre-AI era. It has done well to strike a good balance, hopefully ushering in an exciting new era for the 17th FC in just three years.
This opinion article was written by Srikanth Vishwanathan and originally appeared in the Hindustan Times. Srikanth Vishwanathan is CEO of the nonprofit Janaagraha, which advocates for inclusive and empowered cities in India. The views expressed are personal.
