Analysis of the Sixteenth Finance Commission

The Sixteenth Finance Commission had significant flexibility in its approach, drawing directly from constitutional provisions. It addressed two key dimensions of fiscal transfers: the vertical and horizontal aspects.

Vertical and Horizontal Fiscal Transfers

• The increase in the share of States in the divisible pool of central taxes from 32% to 42% by the Fourteenth Finance Commission, justified by the discontinuation of State plan grants.
• Subsequent reduction to 41% due to Jammu and Kashmir's status change.

Fiscal Space Concerns

The Centre expressed concerns about reduced fiscal space due to increased state shares, leading to:

• Increased non-shareable cesses and surcharges.
• Reduced share in financing centrally sponsored schemes.
• Non-acceptance of sector-specific/State-specific grants recommended by the Fifteenth Finance Commission.

Recommendations and Observations

• The Sixteenth Finance Commission retained the States’ share at 41%, creating a semi-permanent status.
• Did not address non-shareable cesses and surcharges, suggesting a ‘grand bargain’ between the Centre and States for merging cesses with regular taxes.
• Discontinued revenue deficit grants and did not recommend State and sector-specific grants, reducing States' share compared to the Fifteenth Finance Commission.

Transfer of Resources

The proportion of resources transferred as a percentage of the Centre’s pre-transfer gross revenue receipts:

• Increased to 35.6% during the Fourteenth Finance Commission period.
• Marginally reduced to 34.4% in the Fifteenth Finance Commission period.
• Projected at 32.7% for 2026-27, possibly overestimated due to assumed nominal GDP growth.

Efficiency Consideration and Criterion Changes

• Introduced a new efficiency criterion based on State’s Gross State Domestic Product (GSDP).
• Utilized the square root of GSDP to moderate effects on some States.
• Dropping the tax effort/fiscal discipline criterion was inconsistent with the narrative.

Impact on States

The main States that have lost in the Sixteenth Finance Commission devolution scheme include:

• Madhya Pradesh, Uttar Pradesh, West Bengal, Bihar, Odisha, Chhattisgarh, Rajasthan.
• Northeast and small States like Arunachal Pradesh, Meghalaya, Manipur, Nagaland, Tripura, Sikkim, and Goa.

Recommendations for Revenue Gap Grants

Consideration for using Article 275 for fiscal transfers addressing State-specific ‘needs’ and equalizing standards of critical services like health and education.

Experts’ Views

C. Rangarajan, former RBI Governor, and D.K. Srivastava, Chief Policy Adviser at EY India, express that while ad hoc State-specific grants aren't ideal, equalization grants are necessary for balanced development.