Grants expanded under 16th Finance Commission recommendations, but Gram Panchayats face stricter compliance requirements

The 16th Finance Commission report was tabled in Parliament by Union Finance Minister Nirmala Sitharaman on 1 February 2026. On paper, it marks a significant fiscal moment for rural India. But how should one interpret its recommendations for rural areas and panchayats? The answer is far from straightforward.

The 16th Finance Commission has increased the allocation by 84 per cent from the previous award to Rs 4.35 lakh crore. However, the increase is only marginal in real terms, as the annual grant has been determined without factoring in inflation. In these circumstances, panchayats will not benefit from the buoyancy of central taxes in an economy that is on a high growth path.

In contrast, previous Union Finance Commissions (UFC), except the 15th UFC, enhanced these grants to nearly three times the previous allocation. The 13th UFC even recommended that the grant be given as a share of the Union divisible pool, which was commendable. The 16th Finance Commission has, however, continued the reform measures set by earlier commissions — such as accounting reforms, incentives for the constitution of State Finance Commissions (SFC), and the conduct of regular panchayat elections.

As with past UFCs, the allocated grants are divided into two categories: basic and performance. The basic grant component — 80 per cent of the total allocation to panchayats — amounts to Rs 3.48 lakh crore for over a quarter of a million panchayats. This is likely to prove inadequate for panchayats that are already fiscally strained.

Following earlier commissions, even the basic component is conditional. These conditions include regular elections, publication of provisional and audited accounts, and the timely constitution of SFCs, along with the laying of an Action Taken Report (ATR) within six months of submission of the SFC report. The untied grant may be spent on any purpose except establishment-related expenditure, including salaries.

This implies that panchayats will have limited additional funds at their disposal for projects of local interest. Further, no more than 20 per cent of the untied allocation may be spent on the construction and maintenance of roads. Fifty per cent of the basic grant is tied and must be utilised for sanitation and solid waste management and/or water management. It appears that this recommendation has been influenced by the Union Ministry of Jal Shakti.

The performance grant — 20 per cent of the total grant to panchayats — comprises two components: the panchayat performance grant and the state performance grant, each with its own eligibility criteria. What is particularly intriguing is that states are incentivised from within the panchayat grant itself. It appears that the 16th UFC intended to curb the practice of states re-appropriating the additionality recommended by the commission. By incentivising a 20 per cent matching contribution from states on the total basic grant, the 16th UFC has made a significant strategic intervention.

An urbanisation premium

Let us also look at the Commission’s proposal for an ‘urbanisation premium’. The Commission has also sought to incentivise urbanisation by allocating Rs 10,000 crore over five years, for areas transitioning from rural to urban status and for the formulation of transition policies.

Although the amount is modest, it is a welcome step towards promoting planned urbanisation and addressing the growth of haphazard settlements, particularly those inhabited by migrants. 

The issue has received serious consideration in the reports of the Sixth State Finance Commissions of Himachal Pradesh and Tamil Nadu, as well as the Fifth SFCs of Tamil Nadu, Uttarakhand and West Bengal. It was also highlighted in the Indian Institute of Public Administration’s report submitted by us to the 16th UFC in June 2025.

The OSR threshold debate

A more contentious recommendation relates to own source revenue (OSR) — the income generated independently by Gram Panchayats through taxes, fees, and charges, rather than relying on state or central transfers. To qualify for the performance component of the rural local body grant, Gram Panchayats must ensure that their total OSR is at least Rs 1,200 per household per year, or meet a prescribed growth criterion.

In my assessment, the recommendation relating to OSR will serve as an incentive in states where Gram Panchayats have the capacity to collect taxes. However, it may not be effective in states where Gram Panchayats’ OSR is negligible, such as Bihar and Jharkhand. Moreover, some states have not even framed the rules governing OSR.

The more significant issue is capacity building and sensitisation of residents regarding the payment of taxes and user charges.

To promote OSR effectively, an environment of trust and self-respect must be fostered among residents as part of nation-building. Citizens should perceive tangible benefits from paying taxes. This can only be ensured through transparency and accountability. Accountability, in turn, requires proper accounting. Therefore, incentivising audited accounts is a welcome measure.

For capacity building, the 16th Finance Commission has urged the Ministry of Panchayati Raj to conceptualise and roll out an appropriate system.

V N Alok is a Professor of Public Finance at the Indian Institute of Public Administration (IIPA).

Views expressed are the author’s own and don’t necessarily reflect those of Down To Earth