The 16th Finance Commission’s recommendations aim to promote economic efficiency, enhance local governance, ensure fiscal transparency, and maintain debt sustainability while supporting increased capital spending by states. For the fiscal years 2027 to 2031, the Commission has kept the vertical devolution of Union taxes to states at 41% of the divisible pool, similar to the 15th Finance Commission’s period, to ensure consistency in fiscal transfers between the Centre and states, as per ICRA.
Changes in the horizontal devolution framework are anticipated to impact the distribution of resources among states. The 16th Finance Commission has introduced a new criterion, Contribution to GDP, with a 10% weight, replacing the previous tax and fiscal effort criterion. Additionally, the weight assigned to the area criterion has been reduced to 10%, potentially benefiting states with stronger economic management.
During the period of FY2027 to FY2031, it is projected that the share of 14 states out of 28 in the divisible pool will rise. States like Karnataka, Kerala, Gujarat, Haryana, Punjab, Andhra Pradesh, Assam, and Maharashtra are expected to see an increase in their shares, with Karnataka being the largest gainer.
The 16th Finance Commission has proposed a significant hike in local body and disaster management grants to Rs. 9.5 trillion for its award period, marking a 72% increase compared to the 15th Finance Commission’s period. Notably, local body grants have more than doubled to Rs. 7.9 trillion, with 60% being conditional but untied, offering states greater flexibility. The remaining 40% of grants are tied to specific areas like sanitation, solid waste, and water management.
In terms of fiscal discipline, the Commission has recommended that states adhere strictly to a fiscal deficit ceiling of 3.0% of GSDP during FY2027–FY2031. States are advised against additional reform-linked borrowing or carrying forward unutilized borrowing limits. The Commission has also urged states to discontinue off-budget borrowings entirely and bring all such liabilities onto their budgets, supported by increased disclosures and audit oversight.
