The Sixteenth Finance Commission (16th FC) has maintained the vertical tax devolution to the state governments at 41% of the divisible pool of taxes of the Government of India (GoI) during FY2027-FY2031, in line with what had been recommended by the 15th FC for FY2022-FY2026. To determine the state-wise share in tax devolution, the 16th FC has retained five of the six horizontal devolution criteria used by the 15th FC, with some changes in weights and/or calculation methodology. Among these criteria, the changes related to the Area criterion to 10% would lower the inter-se share of states with very large and very small geographical areas. Further, the 16th FC replaced the tax and fiscal effort criterion used by the 15th FC (2.5% weight) with a new criterion, Contribution to gross domestic product (GDP; 10% weight). This change is one of the key factors in enhancing the inter-se share of states with largely healthy economic management, in ICRA’s view.

• Based on the vertical devolution and the inter-se share recommended by the 16th FC, the share of half of the 28 states in the divisible pool would increase during FY2027-FY2031, relative to the 15th FC’s award period, with Karnataka being the biggest gainer. Kerala, Gujarat, Haryana, Punjab, Andhra Pradesh (AP), Assam, Maharashtra, Himachal Pradesh (HP), Telangana, Mizoram, Jharkhand, Uttarakhand, and Tamil Nadu (TN) are the 13 other states that will gain from this rise in inter-se share in the said period.
• On the grants side, the 16th FC continued to follow the approach of previous FCs of linking the release of grants to completing some basic reforms and/or tying the amount for a particular sector. The 16th FC has recommended a sharp increase in local body (LB) grants to Rs. 7.9 trillion for FY2027-FY2031, from Rs. 3.9 trillion transferred during FY2022-FY2026 revised estimates (RE). Given that a sizeable 90% of the largely conditional LB grants recommended by the 15th FC were released to the states, during FY2022-FY2026 RE, it imparts confidence that the states will be able to fulfill the conditions stipulated by the 16th FC for such grants and avail a much higher amount. Encouragingly, 60% of the LB grants are conditional but untied and 40% are conditional and tied towards sanitation, solid waste and water management.