India’s fiscal federalism runs on a deceptively simple bargain: the Union collects most broad-based taxes while the states carry the frontline responsibility for essential public services — schools, hospitals, policing, local roads, water supply and much else. The tax revenues and spending duties do not match. Indeed, states have two-thirds expenditure obligations, but control only about a third of revenues.

So, the Constitution created a neutral referee — the Finance Commission (FC) — to periodically recommend how the ‘divisible pool’ of Central taxes should be shared between the Union and the states (vertical devolution) and among the states (horizontal devolution).

The Commission is reconstituted every five years, so that the division formula can adapt to changing realities rather than be frozen forever. The core job of the Commission follows from Article 280 and the implementation of recommendations from Article 281. In practice, FC awards become the financial ‘operating system’ of Indian federalism. They affect the monthly cash that states receive, their budget space for welfare and capital spending and even their ability to borrow.

With the 16th Finance Commission (FC-16) report now accepted by the Union government and placed before Parliament, the new formula will shape Centre-state fiscal relations for 2026–31. The key question is not just ‘who gets how much’ but what incentives the system creates — especially in a federation where prosperity and political power are unevenly distributed.

Like the previous Commission, FC-16 has retained the states’ share at 41 per cent of the divisible pool. There was a demand from 22 states to increase their share to 50 per cent. This was partly due to their grievance concerning the trend of the Union’s rising reliance on cesses and surcharges, which typically sit outside the divisible pool and therefore are not........

© National Herald