Finance Commission – Issues related to devolution of resources

Explained: Financial Devolution among States


From UPSC perspective, the following things are important :

Prelims level: Article 270, Article 280 (3)

Mains level: Not Much


  • Several Opposition-ruled states, particularly from southern India, have voiced concerns over the present scheme of financial devolution, citing disparities in the allocation of tax revenue compared to their contributions.
  • Understanding the concept of the divisible pool of taxes and the role of the Finance Commission (FC) is crucial in addressing these issues.

Divisible Pool of Taxes: Overview

  • Constitutional Provision: Article 270 of the Constitution outlines the distribution of net tax proceeds between the Centre and the States.
  • Share of taxes: Taxes shared include corporation tax, personal income tax, Central GST, and the Centre’s share of Integrated Goods and Services Tax (IGST), among others.
  • Finance Commission’s Role: Article 280(3) (a) mandates FC, constituted every five years, recommends the division of taxes and grants-in-aid to States based on specific criteria.
  • XVI FC: It consists of a chairman and members appointed by the President, with the 16th Finance Commission recently constituted under the chairmanship of Arvind Panagariya for the period 2026-31.

Basis for Allocation: Horizontal and Vertical Devolution


  • Vertical Devolution: States receive a share of 41% from the divisible pool, as per the 15th FC’s recommendation.
  • Key criteria for horizontal devolution: For horizontal devolution, FC suggested 12.5% weightage to demographic performance, 45% to income, 15% each to population and area, 10% to forest and ecology and 2.5% to tax and fiscal efforts.
  1. Income Distance: Reflects a state’s income relative to the state with the highest per capita income (Haryana), aiming to maintain equity among states.
  2. Population: Based on the 2011 Census, replacing the earlier 1971 Census for determining weightage.
  3. Forest and Ecology: Considers each state’s share of dense forest in the total forest cover.
  4. Demographic Performance: Rewards states for efforts in controlling population growth.
  5. Tax Effort: Rewards states with higher tax collection efficiency.

Challenges and Issues

  • Exclusion of Cess and Surcharge: Around 23% of the Centre’s gross tax receipts come from cess and surcharge, which are not part of the divisible pool, leading to disparities in revenue sharing.
  • Variation in State Contributions: Some states receive less than a rupee for every rupee they contribute to Central taxes, indicating disparities in revenue distribution.
  • Reduced Share for Southern States: Southern states have witnessed a decline in their share of the divisible pool over successive FCs, affecting their fiscal autonomy.

Proposed Reforms  

  • Expansion of Divisible Pool: Including a portion of cess and surcharge in the divisible pool could enhance revenue sharing among states.
  • Enhanced Weightage for Efficiency: Increasing the weightage for efficiency criteria in horizontal devolution, such as GST contribution, can promote equitable distribution.
  • Greater State Participation in FC: Establishing a formal mechanism for state participation in the FC’s constitution and functioning, akin to the GST council, can ensure a more inclusive decision-making process.


  • Addressing issues of financial devolution requires a collaborative approach between the Centre and the States, focusing on equitable distribution and fiscal federalism.
  • Reforms in revenue-sharing mechanisms, along with enhanced state participation in decision-making bodies like the FC, are essential for promoting balanced development and resource allocation across the country.

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