
Why in the News
The 16th Finance Commission has retained the size of the tax pool for States but reshaped the grants that equalise between them. The tension is between fiscal efficiency and the constitutional intent of equity across unequal States.
What is the Finance Commission?
- Constitutional body: The Finance Commission is set up under Article 280 every five years to recommend the sharing of taxes between the Union and the States.
- Vertical devolution: It fixes the share of central taxes that goes to States as a whole.
- Horizontal devolution: It sets the formula distributing that share among individual States.
What are the Key Recommendations of the 16th Finance Commission?
- Vertical devolution retained at 41%: The States’ share of the divisible pool stays at 41%, the same level as the 15th Finance Commission, giving continuity and predictability.
- Income distance weight trimmed: The income distance weight in the horizontal formula is cut from 45% to 42.5%.
- New GDP contribution weight: A 10% GDP contribution weight is introduced in the horizontal formula.
- Revenue Deficit Grants eliminated: The Revenue Deficit Grants that plugged the gap for States unable to meet committed expenditure are discontinued.
- Sector and State specific grants cut: Most sector specific and State specific grants are removed.
- Grants in aid share halved: Grants in aid fall from 19.4% to 8.3% of total transfers.
Why do the changes raise equity concerns?
- Rewarding the prosperous: A GDP contribution weight favours already prosperous States that contribute more to national output.
- Removing the equaliser: Revenue Deficit Grants had cushioned States that cannot meet committed expenditure from their own revenue.
- Constitutional intent: Grants in aid under Article 275 are meant to lift weaker States, and a shrinking grant share works against that purpose.
Conclusion
The award tilts the transfer system toward fiscal performance and away from equalisation. The unresolved question is whether poorer States can meet their obligations once the grant cushion is withdrawn.
What is Fiscal Federalism?
- About: Fiscal federalism is the division of taxation powers, expenditure responsibilities, borrowing powers, and intergovernmental transfers among the different levels of government in a federal system.
- Rationale: It is not merely a mechanism for dividing taxes, it ensures that a citizen’s access to essential public services does not depend excessively on the fiscal capacity of the State in which they live. Indian fiscal federalism reconciles three imbalances.
- Vertical fiscal imbalance: The Union has access to buoyant, broad based taxes, while the States carry expenditure intensive responsibilities such as health, education, agriculture, police, and local infrastructure.
- Horizontal fiscal imbalance: States differ widely in income, resources, geography, demographics, and revenue raising ability, so a lower income State cannot fund the same services as a richer one at similar tax rates.
- Third tier fiscal imbalance: Panchayats and Municipalities carry substantial service delivery duties but have limited own source revenue and depend on transfers from the Union and the States.
Constitutional Framework Governing Fiscal Federalism
- Article 246 and the Seventh Schedule: Divides legislative and taxation powers through the Union, State, and Concurrent Lists, placing public order, health, agriculture, and local government largely in the State domain.
- Article 246A: Inserted by the 101st Constitutional Amendment Act, 2016, gives Parliament and State Legislatures concurrent power over Goods and Services Tax, with Parliament exclusive over inter State GST.
- Article 270: Defines the taxes forming the divisible pool shared with the States on the Finance Commission’s recommendation.
- Article 271: Allows Union surcharges, which along with cesses are excluded from the divisible pool.
- Article 275: Empowers Parliament to give grants in aid from the Consolidated Fund of India to States in need, including for Scheduled Tribes and Scheduled Areas.
- Article 280: Requires the President to constitute a Finance Commission every five years to recommend vertical and horizontal devolution, the principles of grants in aid, and measures to augment State funds for local bodies.
- Article 282: Permits the Union or a State to make grants for any public purpose, the constitutional basis for many discretionary and centrally sponsored transfers.
- Articles 243-I and 243-Y: Require States to constitute State Finance Commissions every five years for Panchayats and Municipalities respectively.
- Article 293: Lets States borrow within India, but a State indebted to the Union needs Union consent for further borrowing.
- Article 279A: Establishes the GST Council, institutionalising cooperative Union State decision making on indirect taxes.
[2023] Consider the following :
1. Demographic performance
2. Forest and ecology
3. Governance reforms
4. Stable government
5. Tax and fiscal efforts
For the horizontal tax devolution, the Fifteenth Finance Commission used how many of the above as criteria other than population area and income distance?
(a) Only two
(b) Only three
(c) only four
(d) All five








