Key Developments
The Finance Commission (16th) has kept the vertical devolution share at 41% and continued to use equity as the main principle for horizontal transfers. The commission also abolished revenue‑deficit grants and sector‑specific grants, urging States to bring all liabilities on‑budget and keep fiscal deficits below 3%.
- States demanded that cesses and surcharges, which now exceed 15% of gross tax revenues, be either included in the divisible pool or capped at 8‑10%.
- COVID‑19, GST reforms (rate rationalisation from four to two rates), and rising public debt have squeezed State fiscal space.
- Greater reliance on Centrally Sponsored Schemes has forced States to bear a larger share of programme costs, e.g., 40% of the National Rural Employment Guarantee.
- Four beneficiary States (Bihar, MP, UP, West Bengal) now command just under 50% of devolution, while the four southern States’ share has fallen to about 15.8%.
Important Facts
- Under the 16th FC, the weightage of criteria is: Income‑distance 42.5%, Population 17.5%, Area 10%, Forest cover 10%, Demography 10%, and Contribution to GDP (square‑root of GSDP) 10%.
- The square‑root transformation reduces the advantage of richer States: Maharashtra’s GSDP share drops from 14.23% to 8.31%.
- Alternative weighting (e.g., 25% weight to GDP contribution) would raise Maharashtra’s share by 2.39%, adding roughly ₹2.49 lakh crore annually.
- Total vertical transfers estimated at ₹104 lakh crore for the award period.
Exam Relevance
Understanding the FC’s methodology is essential for GS‑3 (Economy) questions on fiscal federalism, inter‑governmental transfers, and state finances. The debate over cesses, GST reforms, and the balance between equity and efficiency illustrates the challenges of designing a fair fiscal union. The use of the square‑root transformation of GSDP and the suggestion to employ principal component analysis highlight the role of quantitative methods in policy making.
Way Forward
- Adopt a more data‑driven weighting system (e.g., PCA) to balance fiscal capacity and equity.
- Re‑evaluate the treatment of cesses and surcharges to ensure a larger, more predictable divisible pool.
- Limit the share of unconditional equalisation transfers to encourage revenue mobilisation in weaker States.
- Monitor the impact of CSS on State autonomy and consider performance‑linked funding.
- Periodically review the income‑distance and demographic criteria to reflect real‑time cost‑of‑living differences.
These steps can help future Finance Commissions achieve a more balanced fiscal federalism, reducing disparities while preserving incentives for fiscal discipline.