16th Finance Commission and the Vertical Devolution Debate

The Finance Commission

Article 280 requires the President to constitute a Finance Commission every five years to recommend the distribution of the net proceeds of taxes between the Union and the States ('vertical devolution'), the allocation among States ('horizontal devolution'), grants-in-aid under Article 275, and measures to augment State funds for Panchayats and municipalities.

• The 16th FC was constituted in December 2023; its terms of reference notably omitted a separate mandate on disaster funding norms, which it nonetheless examined.
• The 15th FC (Chair N.K. Singh) had recommended 41 per cent vertical devolution for 2021-26, down from 42 per cent after Jammu & Kashmir became a Union Territory.

The Devolution Debate

• States' demand: raise devolution to 50 per cent and cap cesses and surcharges — which are outside the divisible pool and grew to about 15 per cent of gross tax revenue.
• Centre's view: rising defence, interest and centrally sponsored scheme obligations leave limited headroom.
• Horizontal formula: the 15th FC weights were income distance 45%, population (2011) 15%, area 15%, forest & ecology 10%, demographic performance 12.5%, tax effort 2.5%.
• Southern States argue that population-linked criteria penalise demographic success; the 'demographic performance' criterion was introduced to offset this.

Assessment

The Commission's report lands amid a fraying fiscal compact: shrinking divisible pool through cesses, conditionalities on grants, and unequal gains from GST. A credible award must widen the pool, reward efficiency without punishing demographic transition, and give predictable, untied grants to the third tier — the real test of cooperative federalism.