New Delhi: As India redraws its fiscal roadmap for the next five years, all eyes are on the 16th Finance Commission. Tasked with determining how the Centre’s tax revenues will be shared with states until FY31, the Commission’s recommendations will shape the fiscal lifeline of every state, governing their ability to spend on welfare, infrastructure, and growth.
The Union government has granted the panel a one-month extension, shifting its deadline to 30 November 2025, following extended consultations with states and stakeholders. The Commission, led by economist Arvind Panagariya, which completed its round of state visits in June, is reviewing detailed memorandum submitted by states and departments to inform its final report for the 2026–31 period. Mint examines why its recommendations matter.
What’s at stake and why do the recommendations matter?
At the heart of India’s fiscal architecture, the Finance Commission determines how the country’s tax revenue is allocated, a process that decides who pays for India’s development and who benefits from it.
Every five years, the Commission recalibrates how trillions of rupees in central tax revenues are divided between the Centre and the states, and how that pool is shared among the 28 states.
These aren’t just technical formulas as they shape the very foundation of India’s cooperative federalism. The Commission’s recommendations influence the extent to which states have financial freedom to design and fund their own priorities, including welfare spending, public health, education, rural development, and infrastructure.
For states, the stakes are immense. A higher share of central taxes can expand fiscal space and spur local investment; a smaller share can force austerity, limit new schemes, or push state governments deeper into debt.
The recommendations will also determine how resources flow between richer and poorer regions, influencing the pace of regional convergence and the country’s broader growth trajectory.
In essence, the Finance Commission’s report will decide not only how money is shared, but also how power, responsibility, and opportunity are distributed across India’s federal landscape for the next five years.
What are states asking for?
In their submissions, most states have sought a larger share of central taxes, raising devolution from 41% to 50%, arguing that it would help them tackle poverty, fund infrastructure, and strengthen local economies.
Wealthier states such as Tamil Nadu, Maharashtra, Karnataka, Telangana, and Gujarat have pressed for recognition of their contribution to national growth.
Tamil Nadu has proposed a new criterion giving 15% weight to a state’s contribution to India’s GDP, while suggesting that the “income distance” weight, which benefits poorer states, be reduced from 45% to 35%. Maharashtra wants it trimmed to 37.5%.
Demands haven’t come only from richer states. India’s hilly and border states, such as Himachal Pradesh, Uttarakhand, Jammu and Kashmir, and several northeastern states, have urged the Commission to grant extra fiscal room, arguing that natural disasters and the high costs of governance in difficult terrains demand more flexibility.
“Some states, particularly those prone to natural disasters, have called for targeted provisions to bridge fiscal gaps and strengthen resilience, especially in vulnerable areas,” said a person familiar with the consultations. “They have also urged the Commission to relax borrowing limits,” the person added.
Currently, states can borrow up to 3% of their gross state domestic product (GSDP), with an additional 0.5% leeway for those meeting reform milestones, especially in the power sector. Many states hit by floods, landslides, or cyclones say these limits leave them little room to rebuild or adapt to mounting climate risks.
What is the income distance debate?
Income distance measures how far a state’s per capita income lags behind the richest state in the country. The wider the gap, the larger the fiscal support that the state receives through tax devolution.
In practice, this means that poorer states such as Bihar or Uttar Pradesh get a bigger slice of central tax revenues to help them catch up, while richer states, those that generate a larger share of national GDP and tax revenue, receive proportionately less.
But the formula has long drawn criticism from high-performing states in the south and west, which argue that it effectively penalizes efficiency and growth.
These states contend that the current formula, by rewarding low-income levels, disincentivizes fiscal prudence and economic reform. They have asked the 16th Finance Commission to reduce the weight assigned to income distance and to include new criteria, such as contribution to national GDP or success in implementing reforms, that better reflect states’ performance and governance quality.
The 15th Finance Commission (for FY21–26) had given income distance the highest weight, at 45%, followed by area (15%), population (15%), demographic performance (12.5%), forest cover (10%), and tax effort (2.5%).
Southern and western states now want this mix recalibrated to reflect both fairness and performance, arguing that the existing approach has tilted too far toward redistribution at the expense of growth incentives.
What are the demands from India’s weaker states?
As natural disasters grow more frequent and intense, India’s hilly and border states are demanding that the Finance Commission acknowledge their unique vulnerabilities. From floods devastating Punjab, Himachal Pradesh, and Assam to recurring landslides in Uttarakhand and cyclones battering Odisha and West Bengal, these regions say they are paying the steepest price for climate change, and the existing fiscal framework isn’t keeping up.
In their submissions, many of these states have urged the Commission to create a more flexible and climate-responsive fiscal design. This includes higher revenue deficit grants, funds that help bridge the gap between a state’s revenues and expenditures after accounting for its share of central taxes, as well as special allocations for disaster mitigation and resilience-building.
Several states have also called for relaxed borrowing limits, arguing that the current cap of 3% of gross state domestic product (GSDP), with an additional 0.5% for reform-compliant states, leaves little room for recovery spending after extreme weather events.
Beyond disaster relief, states such as Himachal Pradesh, Sikkim, Arunachal Pradesh, and Jammu & Kashmir have asked the Commission to account for the steep costs of delivering public services in mountainous terrain and remote border regions, where infrastructure projects are expensive, logistics are difficult, and fiscal buffers are thin.
How will the 16th Finance Commission shape India’s fiscal future?
The 16th Finance Commission’s task is unfolding against a vastly changed economic and political landscape, one marked by uneven regional growth, rising climate risks, and fiscal strains across states. Its terms of reference are notably leaner than those of its predecessor, a move that many states had demanded for years.
By simplifying the mandate, the Centre has given the Commission greater flexibility to craft recommendations suited to today’s economic realities, rather than box it into rigid formulas.
Yet, this simplicity belies the scale of the challenge. The Commission must now balance competing demands, from richer states seeking recognition for their contribution to national growth, to poorer and disaster-prone states calling for greater fiscal cushioning.
The timing of this exercise makes its recommendations even more consequential. With private investment still subdued, states have become the primary engines of on-the-ground economic momentum, driving capital expenditure and welfare programmes that directly impact livelihoods.
Simultaneously, recurring natural disasters, from floods in the north to cyclones along the eastern coast, have exposed the fiscal vulnerabilities of many states and underscored the need for a more climate-resilient transfer system.
“The Sixteenth Finance Commission may have to go a bit beyond the standard parameters while computing the share of the country’s revenue kitty in line with the demands of the more developed states,” Manoj Panda, a member of the commission, had earlier told Mint.
In this context, the 16th Finance Commission’s report will go far beyond mere numbers. It will determine how India distributes not just revenue, but responsibility, how it balances growth with equity, fiscal prudence with flexibility, and national priorities with state autonomy.