16th Finance Commission (2026-31): UPSC Notes
Source: PRS Legislative Research summary, 1 Feb 2026. Relevant for GS-II (Federalism, Centre-State Relations), GS-III (Economy, Fiscal Policy, Power, PSEs).
1. Basics (Prelims Quick Facts)
- Nature: Constitutional body, constituted by the President every five years (Article 280).
- Mandate: Recommends on centre-state fiscal relations, i.e. sharing of taxes and grants-in-aid.
- Its job is to recommend how taxes should be shared between the Centre and the states, and what grants the Centre should give to states
- Chair: Dr. Arvind Panagariya.
- Period covered: 2026-27 to 2030-31.
- Tabled in Parliament: 1 February 2026.
- Divisible pool: The divisible pool is the Centre's gross tax revenue after deducting the cost of collection and all cesses and surcharges. Only this pool is shared with the states.
2. Vertical Devolution
- The 16th Finance Commission has recommended that states receive 41% of the divisible pool of central taxes, which is exactly the same as the 15th Finance Commission's recommendation.
- The Centre therefore keeps the remaining 59% of the divisible pool.
3. Horizontal Devolution: Criteria and Weights
Criterion | 15th FC (2021-26) | 16th FC (2026-31) | Change |
|---|---|---|---|
Income Distance | 45% | 42.5% | Down 2.5 |
Population (2011) | 15% | 17.5% | Up 2.5 |
Demographic Performance | 12.5% | 10% | Down 2.5 |
Area | 15% | 10% | Down 5 |
Forest | 10% | 10% | Same (redefined) |
Tax and Fiscal Effort | 2.5% | Dropped | Removed |
Contribution to GDP | Nil | 10% | New |
Total | 100% | 100% |
3.1 Income Distance (42.5%, lowered from 45%)
- Difference between a state's per capita GSDP and the average of the top three large states by per capita GSDP.
- Per capita GSDP is the average over 2018-19 to 2023-24, excluding pandemic year 2020-21.
- Lower per capita GSDP means a higher share (equity principle).
Why it was lowered: The weight was trimmed by 2.5 points because the Commission needed room for the new Contribution to GDP criterion and the higher Population weight
3.2 Population (17.5%, raised from 15%)
- Based on the 2011 Census share.
- Weight increased from 15%.
Why it was raised: A larger population means more people for whom the state government must provide schools, health care and other services, so population is the most direct measure of a state's spending needs.
3.3 Demographic Performance (10%, lowered from 12.5% and redefined)
- Introduced by the 15th FC to reward population control, using Total Fertility Rate (TFR).
- The 16th FC redefined it using population growth between 1971 and 2011, not change in TFR.
- Lower population growth means a higher share.
"The 15th Finance Commission introduced this criterion to reward states that had controlled their population, measuring it through the change in Total Fertility Rate (TFR). The 16th Finance Commission has redefined it to use population growth between 1971 and 2011. States with lower population growth over this period get a higher share"
3.4 Area (10%, lowered from 15%)
This criterion gives a larger share to states with greater geographical area, because large states face higher costs of delivering services across long distances.
3.5 Forest (10%, same weight but definition widened)
- Weight remains 10%, but the definition is wider:
- Share in the overall forest area and share in the increase in forest area between 2015 and 2023.
- Open forests are now included. The 15th FC counted only dense and moderately dense forests.
- The 15th FC used only share in overall forest area.
3.6 Tax and Fiscal Effort (2.5% in the 15th FC, now removed)
This criterion in the 15th Finance Commission rewarded states with higher tax collection efficiency.
Why it was removed: The 16th Finance Commission has replaced it with Contribution to GDP. A tax-effort measure only looks at how well a state collects revenue, whereas the new criterion directly recognises how much a state adds to the national economy. The weight of 2.5% was also very small, so it had limited effect on the final shares.
3.7 Contribution to GDP (10%, new criterion)
- Rewards a state's contribution to national GDP.
- Replaces the Tax and Fiscal Effort criterion (which rewarded tax collection efficiency).
- GSDP is the average nominal GSDP for 2018-19 to 2023-24, excluding 2020-21.
- Using the square root dampens the advantage of very large economies.
This criterion recognises the contribution of each state to national GDP. It is calculated as the square root of a state's GSDP divided by the sum of the square roots of the GSDP of all states. GSDP is the average nominal GSDP for 2018-19 to 2023-24, excluding the pandemic year 2020-21.
Why it was introduced: Without this criterion, the formula mainly rewards need and does not reward economic output. Richer, high-growth states argue that they generate most of the revenue but receive back a smaller share, and this criterion partly answers that concern. It gives states a reason to keep growing, because a bigger economy now earns a bigger share.
Why the square root is used: Taking the square root reduces the advantage of very large economies, so a big state does not get a share that is proportionally much bigger than a smaller state.
Weightage of a State = √(GSDP of the State) ÷ Sum of √(GSDP of All States)
4. State-wise Shares (Selected, out of 100)
State | 14th FC | 15th FC | 16th FC | 15th to 16th |
|---|---|---|---|---|
Uttar Pradesh | 17.96 | 17.94 | 17.62 | Down 0.32 |
Bihar | 9.67 | 10.06 | 9.95 | Down 0.11 |
Madhya Pradesh | 7.55 | 7.85 | 7.35 | Down 0.50 |
West Bengal | 7.32 | 7.52 | 7.22 | Down 0.30 |
Maharashtra | 5.52 | 6.32 | 6.44 | Up 0.12 |
Rajasthan | 5.50 | 6.03 | 5.93 | Down 0.10 |
Karnataka | 4.71 | 3.65 | 4.13 | Up 0.48 |
Kerala | 2.50 | 1.93 | 2.38 | Up 0.45 |
Tamil Nadu | 4.02 | 4.08 | 4.10 | Up 0.02 |
Gujarat | 3.08 | 3.48 | 3.76 | Up 0.28 |
Haryana | 1.08 | 1.09 | 1.36 | Up 0.27 |
Punjab | 1.58 | 1.81 | 2.00 | Up 0.19 |
Arunachal Pradesh | 1.37 | 1.76 | 1.35 | Down 0.41 |
(Changes in the last column are calculated from the report's table.)
Key observations
- UP gets the largest share (17.62), followed by Bihar (9.95) and MP (7.35).
- Southern states broadly regain ground: Karnataka and Kerala gain the most, and Andhra Pradesh and Telangana also rise slightly.
- Gains for Gujarat, Haryana, Punjab and Maharashtra are consistent with the new Contribution to GDP criterion and the higher Population weight.
- Fall for several north-eastern states: Arunachal, Meghalaya, Manipur, Nagaland, Tripura and Sikkim.
- Jammu and Kashmir has no share in the 15th and 16th FC tables (it became a UT after 2019).
5. Grants-in-Aid
Total: Rs 9.47 lakh crore (Rs 9,47,409 crore) over five years.
Component | Amount (Rs crore) |
|---|---|
Local governments | 7,91,493 |
Rural local bodies (RLBs) | 4,35,236 |
Urban local bodies (ULBs) | 3,56,257 |
Disaster management (Centre's share) | 1,55,916 |
Total | 9,47,409 |
Discontinued Grants (recommended by the 15th FC)
- Revenue deficit grants
- Sector-specific grants
- State-specific grants
The 16th FC thus moves to a simpler structure with only local body and disaster grants.
Local Body Grants
Split: 80% basic grant and 20% performance grant.
Rural | Urban | |
|---|---|---|
Basic grant | 3,48,188 | 2,32,125 |
Performance grant | 87,048 | 58,032 |
Special Infrastructure Component | n/a | 56,100 |
Urbanisation Premium | n/a | 10,000 |
Entry-level conditions (all local body grants):
- Constitution of local bodies as per the Constitution (3 tiers of Panchayats / Municipalities, with elections).
- Provisional and audited accounts published in the public domain.
- Timely constitution of the State Finance Commission (SFC).
Basic grants
- 50% untied.
- 50% tied to (i) sanitation and solid waste management and/or (ii) water management.
Performance grants
- State performance grants: released if the state meets a minimum benchmark for transfers to local bodies from its own resources.
- Local body performance grants: linked to minimum targets for own source revenue (OSR) growth.
Special Infrastructure Component (ULBs): Rs 56,100 crore
- For a comprehensive wastewater management system.
- Only for cities with population of 10-40 lakh (Census 2011).
- 22 eligible cities, including Pune, Jaipur, Lucknow, Kanpur, Nagpur, Indore, Bhopal, Visakhapatnam, Patna, Vadodara, Ludhiana, Faridabad, Rajkot, Dhanbad, Amritsar, Howrah, Ranchi, Coimbatore, Vijayawada, Jodhpur, Madurai and Raipur.
Urbanisation Premium: Rs 10,000 crore
- One-time grant to states for (i) merging peri-urban villages into adjoining ULBs and (ii) formulating a Rural to Urban Transition Policy.
Disaster Management Grants
- Total corpus for SDRF and SDMF: Rs 2,04,401 crore.
- Centre's share: Rs 1,55,916 crore.
- Cost-sharing between Centre and states:
- 90:10 for north-eastern and Himalayan states.
- 75:25 for all other states.
State-wise Grant Highlights (Table 5)
- Rural basic grants are largest for UP (Rs 66,608 crore), Bihar (Rs 41,539 crore) and Maharashtra (Rs 26,254 crore).
- Urban basic grants are largest for Maharashtra (Rs 37,442 crore), Tamil Nadu (Rs 20,054 crore) and Gujarat (Rs 19,011 crore).
- Disaster management allocation is largest for Maharashtra (Rs 29,619 crore), followed by UP (Rs 15,321 crore) and Bihar (Rs 13,615 crore).
6. Fiscal Roadmap
- Centre's fiscal deficit: to be brought down to 3.5% of GDP by 2030-31.
- States' annual fiscal deficit limit: 3% of GSDP.
- Off-budget borrowings (OBBs) of states: to be strictly discontinued and brought onto state budgets.
- Definition of fiscal deficit and debt to be expanded to uniformly include all OBBs.
- Projected combined debt (Centre plus states): falls from 77.3% of GDP in 2026-27 to 73.1% in 2030-31.
7. Sectoral Reform Recommendations
Power Sector
- States should actively pursue privatisation of DISCOMs.
- To protect private investors from legacy debt, a Special Purpose Vehicle (SPV) may be created to warehouse the debt.
- Debt may be repaid using funds from the Special Assistance Scheme for Capital Investment (SASCI).
- States may use this assistance only after the privatisation process is complete.
Subsidies
- States should review and rationalise subsidy expenditure.
- Unconditional cash transfer schemes tend to have large and untargeted beneficiary bases. Set clear exclusion criteria and a rigorous review process.
- Stop financing subsidies through off-budget borrowings.
- Subsidies and transfers are misclassified (as assistance, grants or other expenditure) across states. Adopt a uniform approach to accounting and disclosure.
Public Sector Enterprises (PSEs)
- Review and close 308 inactive State PSEs.
- Formulate a state-level PSE disinvestment policy targeting inactive and underperforming SPSEs.
- State or union PSEs making losses in 3 out of 4 consecutive years should go to the respective Cabinet, which may decide on closure, privatisation or continuation based on strategic importance.
8. Key Changes at a Glance: 15th vs 16th FC
- Vertical share unchanged at 41%.
- Population weight up (15% to 17.5%) while Area weight down (15% to 10%).
- Demographic Performance redefined (TFR to population growth 1971-2011).
- Forest now includes open forests and the increase in forest cover.
- Contribution to GDP introduced and Tax and Fiscal Effort removed.
- Revenue deficit, sector-specific and state-specific grants discontinued.
- Stronger fiscal discipline: OBBs barred and the debt definition widened.
- Push for DISCOM privatisation, subsidy rationalisation and PSE closures.
9. Mains Angles (GS-II / GS-III)
Arguments in favour
- The new Contribution to GDP criterion partly addresses complaints from richer and higher-growth states about subsidising others.
- Redefining demographic performance with 1971-2011 growth is more objective and less volatile than TFR change.
- Wider forest criterion incentivises conservation and afforestation, including open forests.
- Conditional local body grants (audited accounts, SFC, OSR targets) strengthen the 73rd and 74th Amendment institutions.
- Banning OBBs improves fiscal transparency.
Concerns and criticisms
- Income Distance still has the biggest weight (42.5%), so poorer states remain major gainers while some better-performing states still lose relative share.
- Higher Population weight and the use of Census 2011 may disadvantage states that controlled population growth, though Demographic Performance partly offsets this.
- Removal of revenue deficit grants may hurt states with structural deficits.
- Growing cesses and surcharges (excluded from the divisible pool) shrink the effective share of states. The 41% headline does not reflect the actual transfer.
- Conditional privatisation of DISCOMs and subsidy curbs raise questions about state fiscal autonomy and cooperative federalism.
- Several north-eastern and smaller states lose share.
Linkages
- Article 280, Article 270 (taxes shared with states), Article 275 (grants-in-aid), 73rd and 74th Constitutional Amendments (Panchayats and Municipalities), State Finance Commissions, FRBM framework, GST Council and cooperative federalism.
10. One-Line Revision
- 16th FC: Chair Arvind Panagariya, period 2026-31, states' share 41%.
- New criterion: Contribution to GDP (10%). Dropped: Tax and Fiscal Effort.
- Grants: Rs 9.47 lakh crore, only for local bodies and disaster management.
- Fiscal deficit targets: Centre 3.5% of GDP by 2030-31, states 3% of GSDP.
- 308 inactive SPSEs to be closed. Debt projected to fall to 73.1% of GDP.
