Overview of the 16th Finance Commission (FC)
The recommendations of the 16th Finance Commission are in effect from April 2026 to March 31, 2031. The Commission addresses two critical issues in Indian fiscal federalism: resource sharing across states (equity vs. efficiency) and handling demographic outcomes.
Vertical and Horizontal Devolution
- Vertical Devolution: Retaining states' share in the divisible pool at 41%.
- Horizontal Devolution: Incorporates a 10% weight to GDP contribution, balancing economic performance with redistributive considerations.
Grants for Equity
- Grants for disaster management and local bodies for 2021-26: ₹5.6 trillion, and for 2026-31: ₹9.5 trillion.
- Disaster relief grants: ₹1.2 trillion (2021-26) and ₹1.6 trillion (2026-31).
- Local bodies grants: ₹4.4 trillion (2021-26) and ₹7.9 trillion (2026-31).
Revenue Deficit Grants (RDGs)
The 16th FC has discontinued RDGs, shifting focus to fiscal incentives and sustainability over revenue-balancing support. This section elaborates on the reasons and implications of this decision.
Evolution of RDGs
- Historical Context: Initially, RDGs were general-purpose grants aimed at bridging revenue-expenditure gaps.
- Normative Framework: Shift to normative assessment for better revenue mobilization, although this created perverse fiscal incentives.
- Temporary Gains: State revenue surpluses reduced RDG scope temporarily, but deficits re-emerged, leading to increased RDGs.
- 15th FC Challenges: Retention of RDGs with a target of zero revenue deficit, though actual deficits showed divergence from normative assessments.
Challenges and Criticisms
- Structural Constraints: Committed expenditures and subsidies limit fiscal flexibility.
- Unconditional Cash Transfers: Increased expenditure without fostering fiscal discipline, transforming RDGs into a dependency mechanism.
- Mismatch in Deficit Assessments: Persistent gap between assessed and actual revenue deficits.
Implications of Discontinuing RDGs
The 16th FC’s decision to discontinue RDGs signifies a shift from soft budget support to a model promoting fiscal discipline and stability. The approach encourages states to enhance revenue and rationalize expenditure.
Conclusion
This shift aims to strengthen fiscal federalism by reducing dependency on gap-filling transfers and promoting sustainable fiscal policies among states.
Note: This summary is based on the personal views of the writer, who is the group chief economic advisor at the State Bank of India and a member of the 16th FC.
