The Report of the 16th Finance Commission (FC) containing recommendations on the devolution of Central taxes and grants to states was tabled in Parliament on Budget day. Not many changes were expected from the FC, which mostly continues on predictable lines. The last time a major change was introduced in the scheme of fiscal transfers was by the 14th FC (2015-20), which increased the share of states by 10 per cent to 42 per cent of the net proceeds of all taxes in the divisible pool comprising all central taxes sans cesses and surcharge, with consequent reduction in grants.

Vertical devolution by both the 15th and 16th FCs have practically remained unchanged since then at 41 per cent, the remaining 1 per cent accounting for J&K which was then a state but now is an UT whose share goes to the Union government. As regards horizontal devolution that determines the inter-se share of individual states, the FC divides the resources based on the three principles of equity, equalisation and efficiency. The last two FCs added a fourth: environment. But efficiency always takes a back seat, and all FCs preferred equalisation over efficiency ~ the 14th FC completely ignored it, while the 15th FC gave tax effort, a measure of fiscal efficiency, a meagre 2.5 per cent weight in determining the shares of individual states.

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To the credit of the 16th FC, it brought back the focus on efficiency, while the preference for equalisation remains. The 15th FC caused a lot of resentment for southern states, which lost their shares when the government changed the population base in the terms of reference for the 15th FC from 1971 to 2011, for determining the states’ shares in devolution. Population has always been an important parameter used by all FCs along with area, which addresses equity. Southern states, and some others as well, have stabilised their population and achieved a total fertility rate (TFR) much below the replacement level of 2.1, and they rightly felt they were being penalised for attaining this, while the shares of the Hindi-belt states went up.

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The 16th FC has, for the first time, introduced a new efficiency parameter,........

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