Constituting 16th Finance Commission (2026-2031)

Udayan Hazarika

(The writer can be reached at udayanhazarika@hotmail.com)

The Union Government has recently constituted the Sixteenth Finance Commission (SFC) by notification dated December 31, 2023. The awards of the SFC shall be effective on April 1, 2026, for five years. Hence, the Commission is requested to submit its report by October 31, 2025. It may be noted that the period of awards of the Fifteenth Finance Commission will be over by March 31, 2026. The fifteenth Finance Commission had a tenure of six years. Initially, the notification declaring the 15th FC was for the period of 2020–21 to 2024–25. However, later on November 29, 2019, the government modified the initial notification to the extent that the Commission is now required to submit two reports, one concerning the years 2020–21 and the other for 2021–2026. Thus, the tenure of the Commission lasted for six years. The present notification declaring the constitution of the 16th Finance Commission is not a complete one as it nominated only the Chairman of the Commission and the Secretary of the Commission. The names of the other members of the commission shall be notified later, as expressed by the government.  There are also the usual three terms of reference for the SFC, but while conferring the reviewing authority, the Commission is not given free rein to review various matters concerning the Commission; the issues are confined only to those related to the disaster relief fund. The government has already constituted the Advance Cell of the SFC in the Ministry of Finance so as to complete the preliminary works for enabling the SFC to begin its formal work when it is finally fully constituted. Prior to that, the Working Group for the SFC, headed by the Finance Secretary and Secretary of Expenditure, along with the Secretary of Economic Affairs and other senior officers of the Finance Department, was set up. As per the usual procedure, the five-year term of the chairman’s term commences as soon as the chairman takes over the charge. But this time, even if the chairman takes over the charge of the office before notification of the members is issued, the tenure of the members and the chairman shall not be co-terminus. This will be a unique situation. Moreover, as the election process for the Lok Sabha elections will be set into motion very soon, there is little hope that the government will come up with a notification appointing the members of the Commission before the announcement of the elections.

A Finance Commission is constituted under the provisions laid down in Article 280 of the Constitution of India for five years. The basic objective behind the constitution of an FC is to fix the ratio at which the net proceeds of the central taxes shall be distributed between the Centre and States and to determine the modalities thereof. The present Finance Commission is to decide on the devolution of the share of taxes to the States for the period from April 1, 2026, to March 31, 2031. The taxes that are to be shared between the Centre and States are mentioned in Chapter I of Part XII of the Constitution of India. Accordingly, taxes such as personal income tax and corporation tax. Central GST, the centre’s share of the integrated Goods and Service Tax (IGST), Customs, Union Excise duty, etc. The Commission, while working out the formula for transfers, takes into account several criteria and fixes weights for each such criterion. These criteria are: 1) income distance, which takes into account the distance between the concerned state and the state having the highest per capita income. The state with a lower per capita GSDP will get a higher share than the state with a higher income. The 15th FC allotted 45 marks for this criterion. Secondly, the demographic performance of the state is taken into account. For this purpose, the 15th FC took the population of the state as enumerated during the 2011 Census. This year, since the 2021 Census operation did not take place, the Commission might take the projected population of the expert Group of Health and FW Department. The 15th FC allotted 15 marks for population size and 12.5 marks for the demographic performance of the state, and thirdly, the forest and ecology criteria. Under this, the denser forest a state has, the greater its share. The 15th FC allotted 10 marks for this criterion. Fourthly, the tax and fiscal efforts of the state also have a lot to do with getting more funds from the Commission. The state’s ability to collect taxes is usually rewarded. The 15th FC had allocated 2.5 marks for this criterion.

The fifteenth Finance Commission (2020-21 to 2025-26) had recommended 41 percent of the resources under the divisible pool be transferred to the States. Later, 1 more percent was recommended for the newly created two divisions of Jammu and Kashmir (0.5 percent each). The fourteenth finance commission had recommended equal amounts (42%) for transfer to the States.

Despite such recommendations, however, the central government frequently deviates in disbursing or releasing the recommended resources to the states. This happens mainly due to two reasons, namely: i) slow collection of revenue from the sources; and ii) political reasons. This happens when different political parties rule at the centre and in the states. Recently, the southern states like Karnataka, Kerala, and Tamil Nadu have set out a protest rally in Delhi, complaining that the Centre has not been releasing their due share of taxes as recommended by the Fifteenth FC. This is undoubtedly an unfortunate happening in the parliamentary democratic system, which preaches fiscal federalism guaranteed by the Constitution. However, since the release of the Finance Commission transfers is not discretionary, the Centre will have to release the same sooner or later in due proportion.

The next term of reference of the Commission is to determine the principle that should govern the grants-in-aid of the revenues of the states out of the Consolidated Fund of India and the sums to be paid to the states by way of grants-in-aid of their revenues under Article 275 of the Constitution. Under this head, various grants have been recommended by the commissions so far. The last commission recommended the following grants: 1) the revenue deficit grant to the states that had revenue deficits. A total of Rs 2.9 lakh crore was recommended to 17 such deficit states, including Assam, to wipe out the revenue deficits. However, the state of Assam has not been able to wipe out the deficits till now. Then there were the sector-specific grants recommended for all states. This grant was meant for revamping social sectors such as health, school education, higher education, agricultural reforms, the judiciary, statistics, etc. Thirdly, there were the state-specific grants recommended for the states, which were considered by the Commission to require further boosts in certain areas such as social needs, administrative governance and infrastructure, water and sanitation, tourism, etc. An amount of Rs 49,599 crore was recommended for grant in aid under this head. Fourthly, there was the grant-in-aid to local bodies, and finally, there were grants for disaster and risk management. 

The government has hurriedly constituted the SFC, nominating Arvind Panagariya as its chairman. The government may have something in the back of their minds about nominating Pnagaria. An economist of his stature, Shri Panagaria is known for his advocacy for economic reforms and fiscal federalism. He also works on growth economics and knows the pulse of the Indian economy well. With his experience in Niti Aayog, where he worked as Deputy Chairman for two years, there is scope to expect that he could deliver us a wonderful report of the Commission.