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The Union government has accepted the tax-sharing recommendations of the 16th Finance Commission, effective from April 1, 2026 to March 31, 2031. Finance Commission is a constitutional body established every five years by the President of India to recommend the distribution mechanism of net proceeds of taxes between the Union government and states. This divisible pool of tax does not include cess and surcharge levied by the Union government. The Finance Commission recommends the principles that govern grants-in-aid—payments in the nature of assistance, donations or contributions—to states from the Consolidated Fund of India and to panchayats and municipalities. The Finance Commission reviews and recommends the financing mechanism of funds constituted under the Disaster Management Act, 2005.
On February 1, Union finance minister Nirmala Sitharaman laid the 16th Finance Commission report in the Lok Sabha and informed the house of its acceptance by the government. The report has recommended states’ share of the divisible pool at 41 per cent, same as was recommended by the last Finance Commission. This is known as the vertical devolution.
To calculate each state’s share from the vertical devolution—known as the horizontal devolution—the 16th Finance Commission applied six criteria: income distance [defined as “the difference between the per capita GSDP (gross state domestic product) of a state and the average of the per capita GSDP of the top three large states with the highest per capita GSDP”], population, demographic performance, area, forest and contribution to India’s gross domestic product (GDP). This is the first time that the Finance Commission has added state’s share to GDP as a criterion. The previous Finance Commissions used other criteria (see ‘Change in share’).
During deliberations, the 16th Finance Commission noted that 18 states (including Kerala, Odisha, Haryana, Gujarat and Tamil Nadu) demanded an increase in the devolution percentage to 50 per cent.
The Union government sought “moderation in tax devolution” citing that currently 49 per cent of gross revenue receipts are transferred to the states. “(It) is not fiscally sustainable,” the Union government said. The 16th Finance Commission, thus, added the criterion of state contribution to GDP to give more weightage …
This article was originally published in the February 16-28, 2026 print edition of Down To Earth