New Delhi, Feb 3 The 16th Finance Commission’s (FC) recommendations represent a decisive shift towards incentivising economic efficiency, strengthening local governance, improving fiscal transparency and reinforcing debt sustainability, while continuing to support higher capital spending by states, a report showed on Tuesday.
The 16th FC retained the vertical devolution of Union taxes to states at 41 per cent of the divisible pool for FY2027–FY2031, in line with the 15th Finance Commission period, ensuring continuity in Centre–state fiscal transfers, according to ICRA.
“However, meaningful changes in the horizontal devolution framework are expected to alter the inter-se distribution of resources among states. The 16th FC introduced a new criterion, Contribution to GDP, with a 10 per cent weight, replacing the tax and fiscal effort criterion,” the report mentioned.
Alongside a reduction in the weight assigned to the area criterion to 10 per cent, these changes are expected to benefit states with healthier economic management.
Consequently, the share of 14 out of 28 states in the divisible pool is set to increase during FY2027–FY2031, with Karnataka emerging as the largest gainer, followed by Kerala, Gujarat, Haryana, Punjab, Andhra Pradesh, Assam and Maharashtra.
On the grants front, the 16th FC recommended a sharp increase in local body and disaster management grants to Rs. 9.5 trillion for its award period, a 72 per cent rise over the 15th FC period.
Local body grants alone have been more than doubled to Rs. 7.9 trillion, with 60 per cent of these being conditional but untied, providing greater flexibility to states, while the remaining 40 per cent are tied to sanitation, solid waste and water management.
Encouragingly, a high release ratio of grants during the previous FC period lends confidence to states’ ability to meet the stipulated conditions.
“At the same time, the 16th FC has discontinued revenue deficit grants, citing their ineffectiveness in addressing structural fiscal gaps. As a result, 13 states that received such grants during the 15th FC period are expected to see a decline in their total grants, notwithstanding higher inter-se shares for some of them,” said ICRA report.
On fiscal discipline, the Commission recommended that states strictly adhere to a fiscal deficit ceiling of 3.0 per cent of GSDP during FY2027–FY2031, without any additional reform-linked borrowing or carry-forward of unutilised borrowing limits.
“This marks a departure from the flexibility allowed by the previous two Finance Commissions and could necessitate a recalibration of state spending priorities. The Commission has also explicitly recommended that states discontinue off-budget borrowings entirely and bring all such liabilities onto their budgets, supported by enhanced disclosures and audit oversight,” the report highlighted.
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