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16th Finance Commission: Forging India’s Fiscal Federalism
16th Finance Commission
Finance Commissions play a pivotal role under Article 280 of the Indian Constitution in defining the financial relations between the Centre and State governments in India. They are constituted every 5 years to recommend the sharing of central taxes between the Union and States and among the States themselves.
The recommendations of the Finance Commission hold great significance as they determine the transfer of resources from the Centre to the States. As per the Constitution, the President is required to constitute the Finance Commission which then submits its report to the President.
The 16th Finance Commission is now in the process of being set up as the previous 15th Finance Commission has completed its term. The Union Cabinet chaired by the Prime Minister has recently approved the Terms of Reference (ToR) which will guide the upcoming 16th Finance Commission on its functions and mandate for the period 2026-2031.
The ToR outline key focus areas for the Commission keeping in view emerging economic priorities and the changing dynamics of centre-state financial relations in India. The 16th Finance Commission will make recommendations by October 31, 2025 which gives it adequate time to conduct detailed analysis while formulating its suggestions.
Cabinet creates 3 posts for 16th Finance Commission
The Union Cabinet authorized establishing three executive posts, two Joint Secretaries and one Economic Adviser, to support the 16th Finance Commission chaired by Arvind Panagariya. These additional positions will help the Commission execute its charter to evaluate fiscal devolution across Indian states.
On December 31st, 2023, the government appointed Panagariya, former vice chair of NITI Aayog, as Commission chair. Ritvik Ranjanam Pandey was designated Secretary.
The Commission must submit recommendations to the President by October 31st, 2025 to guide five fiscal years starting April 1st, 2026. Past Finance Commissions have played a key role in central-state financial relations. The 15th Commission recently suggested increasing states’ share of central tax revenue to 41%. The 16th Commission will make the next five-year determination. Its membership and additional staff have now been formalized by the Cabinet.
Overview of 16th Finance Commission
| Sections | Details |
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| Introduction | Finance Commission crucial for fiscal federalism and development spending. 16th FC to make recommendations for 2026-31 period. |
| Key Functions |
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| Key Focus Areas |
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| Challenges |
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| Way Forward |
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| Relevant Data |
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Constitution and Mandate of Finance Commission
The Union Cabinet chaired by the Prime Minister has approved the Terms of Reference (ToR) which will guide the working of the 16th Finance Commission. As per the statement released by the government, the Commission will submit its recommendations for the 5-year period commencing April 1, 2026 and ending on March 31, 2031.
The ToR outlines the constitution and functions of the 16th Finance Commission. It has set October 31, 2025 as the deadline for the Commission to submit its final report. This allows adequate time of over 2 years for the Commission to conduct hearings, analysis and finish drafting its recommendations.
The mandate includes making suggestions regarding the vertical distribution of central taxes between the Centre and States as well as horizontal distribution of States’ share among themselves for the 5-year period. Determining grants-in-aid for States and reviewing existing arrangements related to disaster management also form part of the Commission’s mandate.
The ToR also requires the Commission to follow a consultative process involving key stakeholders while formulating the recommendations. This allows inputs from State Governments, domain experts and other stakeholders to be incorporated for a balanced outlook.
Key Functions of 16th Finance Commission
The 16th Finance Commission will carry out several key functions that shape centre-state financial relations in India. These include:
- Recommend formula for sharing central taxes between Centre and States: The Commission is tasked with suggesting the percentage share of the Centre and States in the divisible pool of central taxes like income tax, central excise, etc. for the period 2026-2031. The share of taxes determines how much revenue is devolved to States.
- Allocate shares of central taxes among States: Based on factors like population, development levels, fiscal capacity etc., the Commission will decide the formula to allocate each State’s share in the overall central taxes devolved to States.
- Suggest grants-in-aid for States: Grants-in-aid are provided to States based on principles outlined by the Finance Commission to fill the gap between expenditure needs and revenue capacity of States. These cover sectors like health, education, rural roads etc.
- Review arrangements for financing disaster management: The ToR requires reviewing the existing mechanisms available for funding relief measures for natural disasters under the Disaster Management Act 2005. The Commission has to assess their adequacy and suggest any changes needed.
Through these functions, the 16th Finance Commission plays a pivotal role in determining fiscal transfers for the 2026-2031 period and addressing the economic priorities of States.
Formulation of ToR of Finance Commission
The Terms of Reference for the 16th Finance Commission have been formulated through an extensive consultative process involving key stakeholders.
Inputs were gathered from the Working Group headed by the Finance Secretary and comprising top officials from the Ministry of Finance, NITI Aayog and the Ministry of Statistics and Programme Implementation.
Suggestions were also sought from State Governments across the country as well as Union Territories with legislatures like Delhi, Jammu and Kashmir and Puducherry.
The Working Group undertook the preliminary analysis for designing the ToR while factoring in these inputs from States, UTs and subject matter experts on taxes, the economy, budgets, statistics, programs etc.
Views and opinions were exchanged with States/UTs on issues like changing economic priorities post-COVID, GST implementation, share of central taxes, grants-in-aid etc. before finalizing the ToR.
Such multi-stakeholder consultations allow the ToR to capture ground realities and a diversity of perspectives instead of just a unilateral approach. This leads to a more balanced and inclusive process right from the stage of framing the reference points for the 16th Finance Commission.
The collaborative approach in formulating the ToR itself sets the stage for cooperative fiscal federalism for the 2026-2031 period.
Focus Areas of 16th Finance Commission
The Terms of Reference outline certain key focus areas for the 16th Finance Commission to analyze while giving its recommendations:
- Changing fiscal architecture after GST implementation: With GST leading to consolidation of major taxes like excise, VAT etc., the Commission must re-evaluate the fiscal framework and its formulas for tax devolution. Mechanisms for coordination between the GST Council and Finance Commission need to be strengthened.
- Balancing expenditure on defence and internal security: The funding requirements for defence and internal security have to be met without compromising fiscal constraints and needs of individual States. The Commission has to build upon the recommendations made in this context by the previous 15th Commission.
- Promoting fiscal efficiency and accountability: Expenditure rationalization, outcome-based budgeting, independent audits and real-time data analytics are some ways for enhancing accountability and fiscal prudence across governments.
- Strengthening fiscal autonomy of States: Tax devolution must be balanced with ensuring adequate resources for the Union government to fulfill national obligations. Incentivizing prudent debt management by States is also important.
- Addressing emerging issues like climate change: Recognizing climate change impact across sectors, the Commission must provide assistance to States for interventions related to adaptation, resilience and clean energy promotion.
- Improving data systems and methodologies: Periodic re-evaluation of data quality and analytical methodologies is vital for informed decision making on centre-state financial relations.
- Enhancing outreach and communication: Proactive communication strategies are imperative for cooperative federalism and effective implementation of recommendations among stakeholders.
Conclusion
The 16th Finance Commission plays an important role in deciding the allocation of central taxes and grants between the Centre and States. Its recommendations for the 2026-2031 period will significantly influence fiscal federalism and development spending.
Key functions involve suggesting formulas for tax sharing and grants to fill the revenue gap for States. The Commission has to balance economic priorities across sectors while addressing issues like GST implementation and climate change.
Securing cooperation from stakeholders through better data systems and communication is vital for effective implementation of recommendations. The Commission’s suggestions will shape fiscal transfers and centre-state ties over the next five years.
