16th Finance Commission Recommendations Explained: ₹7.91 Lakh Crore for Local Bodies, New Devolution Formula, and a Compliance-Driven Shift in India’s Fiscal Federalism

What Is the Finance Commission and Why It Matters

The Finance Commission (FC) is a constitutional body under Article 280 of the Constitution of India, constituted by the President of India every five years or earlier if required. Its core purpose is to strengthen fiscal federalism by recommending how financial resources are distributed between different layers of government.

Core Functions of the Finance Commission

• Recommend the sharing of net tax proceeds between the Union and the States (vertical devolution)

• Decide the criteria for distribution among States (horizontal devolution)

• Recommend grants-in-aid to States under Article 275

• Suggest measures to strengthen the finances of Panchayats and Municipalities

• Advise on fiscal discipline, debt management, and expenditure reforms

• Examine any other financial matter referred by the President

Composition of the Finance Commission

• One Chairman

• Four Members with expertise in finance, economics, or public administration

16th Finance Commission: Period, Leadership, and Scope

The 16th Finance Commission (16th FC) covers the award period 2026–27 to 2030–31.Its report was tabled in Parliament on February 1, 2026, alongside the Union Budget 2026–27.

Chairman and Members of the 16th Finance Commission

• Chairman: Shri Arvind Panagariya (Former Vice-Chairman, NITI Aayog)

• Full-time Members:

  • Shri Ajay Narayan Jha (Former Secretary, Expenditure; Member, 15th FC)

  • Smt. Annie George Mathew (Former Special Secretary, Expenditure)

  • Dr Niranjan Rajadhyaksha (Executive Director, Artha Global)

• Part-time Member:

  • Dr Soumya Kanti Ghosh (Group Chief Economic Advisor, State Bank of India)

A Shift in Fiscal Philosophy: From Entitlements to Compliance

The 16th FC marks a significant transition from entitlement-based transfers to compliance- and performance-driven fiscal federalism.

Key Characteristics of This Shift

• Greater emphasis on fiscal discipline

• Stronger focus on performance, transparency, and accountability

• Introduction of economic contribution as a criterion

• Reduced reliance on unconditional and untied transfers

• Linking grants to institutional compliance and reforms

While these measures aim to improve efficiency, they also raise concerns about state autonomy, equity, and cooperative federalism, particularly for southern, hill, and poorer states.

16th Finance Commission Recommendations for Local Bodies: ₹7.91 Lakh Crore Grants Explained (2026–27 to 2030–31)

The 16th FC has recommended a total grant of ₹7,91,493 crore (≈ ₹7.9 lakh crore) to India’s rural and urban local bodies over five years.

Rural–Urban Split

• 60% to Rural Local Bodies (RLBs)

• 40% to Urban Local Bodies (ULBs)

This allocation reflects the Commission’s recognition of:

• Rapid urbanisation

• Continued importance of Panchayati Raj Institutions

• Need to strengthen grassroots governance

Challenges in Local Body Financing Identified by the Commission

1. Structural Revenue Gaps

• Property tax collections remain low due to:

  • Incomplete and inaccurate property records

  • Low tax coverage

  • Undervaluation of properties

2. Overdependence on Union and State Governments

• Panchayats rely on grants for over 90% of their revenues

3. Limited Access to Capital Markets

• Municipal borrowings in India are less than 0.05% of GDP

4. Institutional and Systemic Weaknesses

• Underdeveloped municipal bond market

• Data gaps and weak accounting systems

• Delays in constitution of State Finance Commissions (SFCs)

5. Weak Income-Generating Capacity

• Local bodies generate only ~0.4% of India’s GDP

• This indicates extremely low fiscal autonomy

Sources of Local Body Financing

The Commission identifies the following financing sources:

• Own Tax Revenue (Article 243X): Property tax and local taxes

• Non-Tax Revenue: Licensing fees, permits, service charges

• Inter-governmental Transfers: FC grants, State transfers, scheme-specific funds

• Borrowings: Municipal bonds, general obligation bonds

• Innovative Financing: Pooled financing for small ULBs, land monetisation

Major Recommendations to Strengthen Local Bodies

1. GIS-Based Property Tax Systems

States should create citizen-friendly, GIS-based property tax IT systems to:

• Improve coverage

• Ensure accurate valuation

• Enhance transparency and collections

2. Urbanisation Premium: ₹10,000 Crore

The Commission has allocated ₹10,000 crore as an Urbanisation Premium to incentivise:

• Merger of peri-urban villages into adjoining ULBs

• ULBs must have a population of more than 1 lakh

• States must simultaneously formulate a Rural-to-Urban Transition Policy

Per-Person Incentive

• ₹2,000 per person (based on 2011 Census)

• One-time eligibility

The Commission noted:

“Urbanisation accelerates economic growth. Physical and human resources, infrastructure, economic activities and employment opportunities are available at one place in cities.”

3. Special Urban Infrastructure Grants

• ₹56,100 crore recommended

• For comprehensive wastewater management systems

• Applicable to cities with populations between 10–40 lakh (2011 Census)

4. Constitutional Amendment Recommendation

The Commission has recommended amending:

• Articles 280(3)(bb) and 280(3)(c)

Reason

These articles require the Central Finance Commission to make recommendations **“on the basis of” State Finance Commission (SFC) reports.

The 16th FC observed that:

• Many states do not constitute SFCs on time

• SFC methodologies are inconsistent

• Scope and quality of reports vary widely

Hence, it recommends removing this phrase so the Central FC can rely on uniform, independent criteria, while still recognising the importance of SFCs.

Tax Devolution: Vertical and Horizontal

Vertical Devolution

• States’ share in the divisible pool retained at 41%

• Unchanged from the 15th FC

• Divisible pool excludes:

  • Cesses

  • Surcharges

  • Cost of collection

States had demanded an increase to 50%, especially after GST reduced their revenue autonomy.

Horizontal Devolution: Revised Formula

Criterion	15th FC	16th FC
Income Distance	45%	42.5%
Population (2011)	15%	17.5%
Demographic Performance	12.5%	10%
Area	15%	10%
Forest	10%	10%
Tax & Fiscal Effort	2.5%	—
Contribution to GDP	—	10%
Total	100%	100%

Explanation of Key Devolution Criteria

Income Distance

• Gap between a state’s per capita GSDP and the average of the top three large high-income states

• Uses average GSDP for 2018–19 to 2023–24

• Pandemic year 2020–21 excluded

Population (2011 Census)

• Reflects expenditure needs based on population size

Demographic Performance

• Shift from TFR-based assessment (15th FC)

• Now based on population growth between 1971 and 2011

• Rewards long-term population control

Forest Criterion

• Based on:

  • Share in total forest area

  • Increase in forest cover (2015–2023)

• Includes open forests, unlike the 15th FC

Contribution to GDP

• New parameter

• Replaces tax and fiscal effort

• Calculated as:

  • √(State GSDP) ÷ Σ√(GSDP of all states)

• GSDP based on 2018–19 to 2023–24 averages

Grants-in-Aid: ₹9.47 Lakh Crore

Total grants recommended: ₹9.47 lakh crore, limited to:

• Rural and urban local bodies

• Disaster management

Discontinued Grants

• Revenue deficit grants

• Sector-specific grants

• State-specific grants

Structure of Local Body Grants

Grant Composition

• Basic Grants: 80%

  • 50% untied

  • 50% tied to:

    • Sanitation & solid waste management

    • Water management

• Performance-Based Grants: 20%

  • Split between:

    • Local body-level outcomes

    • State-level reforms

Entry Conditions

Grants released only if:

• Local bodies constituted as per Constitution

• Provisional and audited accounts publicly disclosed

• State Finance Commissions constituted on time

Disaster Management Grants

• ₹2,04,401 crore for SDRF and SDMF

• Cost-sharing:

  • 90:10 for North-Eastern & Himalayan states

  • 75:25 for other states

• Centre’s share: ₹1,55,916 crore

Fiscal Roadmap and Discipline

• Centre fiscal deficit target: 3.5% of GDP by 2030–31

• States’ annual fiscal deficit cap: 3% of GSDP

• Complete end to off-budget borrowings

• All liabilities to be included in deficit and debt calculations

• Combined Centre–State debt projected to fall:

  • 77.3% of GDP (2026–27) → 73.1% (2030–31)

Other Major Reform Recommendations

Power Sector

• Privatisation of DISCOMs encouraged

• Legacy debt to be parked in SPVs

• Repayment supported via Special Assistance Scheme for Capital Investment

• Assistance available only after privatisation

Subsidy Rationalisation

• Unconditional cash transfers flagged

• Across 21 states:

  • Cash transfers = 20.2% of subsidy spending (2025–26)

  • Up from 3% (2018–19)

• Large-group cash transfers alone = 47.4%

• JAM trinity cited as enabling factor

• Uniform accounting and disclosure framework recommended

Public Sector Enterprise Reforms

• Closure of 308 inactive SPSEs

• Loss-making PSEs (3 of 4 years) to be reviewed by Cabinet

• Options: closure, privatisation, or continuation based on strategic importance

Impact on States

Southern States

• Andhra Pradesh: 4.047% → 4.217%

• Karnataka: 3.647% → 4.131%

• Kerala: 1.925% → 2.382%

• Tamil Nadu: 4.079% → 4.097%

• Telangana: 2.102% → 2.174%

Large Northern States

• Uttar Pradesh: 17.939% → 17.619%

• Bihar: 10.058% → 9.948%

Concerns Raised About the 16th Finance Commission

• Stagnation in vertical devolution at 41%

• Shrinking untied funds due to cesses and surcharges

• Reduced equity focus in horizontal devolution

• Phasing out demographic incentives

• Discontinuation of revenue deficit grants

• Over-centralisation through tied grants

• Risk of “aging before becoming rich” for southern states

Measures Suggested to Strengthen Fiscal Federalism

• Elasticity-linked transfers

• Floor guarantee during transition

• Matching grants for SFC implementation

• Legislative cap on cesses/surcharges (e.g., 10% of GTR)

• Reactivation of Inter-State Council (Article 263) for real-time fiscal coordination

The 16th Finance Commission represents a decisive move toward compliance-driven, performance-linked fiscal federalism. While it strengthens discipline, transparency, and long-term sustainability, it also constrains state flexibility and fiscal autonomy, particularly for ecologically and structurally vulnerable regions.

Ultimately, its success will depend on balancing rewards for performance with equitable support for diversity within India’s federal structure.

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FAQs: 16th Finance Commission Recommendations

Q. What are the key 16th Finance Commission recommendations?

Ans. The 16th Finance Commission recommendations include retaining states’ share of central taxes at 41%, allocating ₹7.91 lakh crore to rural and urban local bodies, introducing a new devolution criterion for contribution to GDP, providing an urbanisation premium of ₹10,000 crore, discontinuing revenue deficit grants, and enforcing stricter fiscal discipline by capping state deficits at 3% of GSDP.

Q. How much money has the 16th Finance Commission allocated to local bodies?

Ans. Under the 16th Finance Commission recommendations, a total of ₹7,91,493 crore (about ₹7.9 lakh crore) has been allocated to rural and urban local bodies for the period 2026–27 to 2030–31, with a 60:40 split between rural local bodies and urban local bodies.

Q. What is the urbanisation premium recommended by the 16th Finance Commission?

Ans. The 16th Finance Commission recommendations include an urbanisation premium of ₹10,000 crore, provided as a one-time incentive to states that merge peri-urban villages into nearby urban local bodies with populations exceeding one lakh and formulate a Rural-to-Urban Transition Policy. The incentive is capped at ₹2,000 per person based on the 2011 Census.

Q. Has the 16th Finance Commission changed the tax devolution formula?

Ans. Yes. The 16th Finance Commission recommendations introduce a revised horizontal devolution formula that adds a 10% weight for contribution to national GDP, while reducing the weight for income distance and demographic performance. The tax and fiscal effort parameter used by the 15th Finance Commission has been removed.

Q. What is the states’ share in central taxes under the 16th Finance Commission?

Ans. The 16th Finance Commission recommendations retain the states’ share in the divisible pool of central taxes at 41%, unchanged from the 15th Finance Commission. The divisible pool excludes cesses, surcharges, and the cost of tax collection.

Q. Why has the 16th Finance Commission recommended ending revenue deficit grants?

Ans. The 16th Finance Commission recommendations discontinue revenue deficit grants to encourage fiscal discipline and reduce dependence on unconditional transfers. However, this has raised concerns among hill and special category states, which argue that structural and geographical constraints make revenue deficits unavoidable.

Q. What conditions must states meet to receive local body grants under the 16th Finance Commission?

Ans. According to the 16th Finance Commission recommendations, local body grants are released only if states fulfil three entry-level conditions:

1. Constitution of local bodies as per the Constitution

2. Public disclosure of provisional and audited accounts

3. Timely constitution of State Finance Commissions

Q. How do the 16th Finance Commission recommendations impact southern states?

Ans. Under the 16th Finance Commission recommendations, all southern states have seen an increase in their share of tax devolution, though the rise is modest for some. For example, Tamil Nadu’s share increased marginally from 4.079% to 4.097%, while Karnataka and Kerala recorded more noticeable gains. Despite this, southern states have raised concerns about reduced rewards for demographic performance.

Q. What fiscal discipline measures are proposed by the 16th Finance Commission?

Ans. The 16th Finance Commission recommendations propose capping state fiscal deficits at 3% of GSDP, ending off-budget borrowings, including all liabilities in fiscal deficit calculations, and reducing the Centre’s fiscal deficit to 3.5% of GDP by 2030–31.

Q. Why are the 16th Finance Commission recommendations considered controversial?

Ans. The 16th Finance Commission recommendations have sparked debate because they emphasise compliance and performance over equity, reduce untied funds, increase tied grants, phase out demographic incentives, and introduce GDP contribution as a devolution criterion—raising concerns about fiscal autonomy and cooperative federalism.

Q. What is the overall objective of the 16th Finance Commission recommendations?

Ans. The overarching goal of the 16th Finance Commission recommendations is to strengthen fiscal discipline, improve transparency, reward economic performance, and promote long-term sustainability of public finances, while reshaping India’s fiscal federal structure for the period 2026–27 to 2030–31.