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16th Finance Commission: Among poll-bound states, 3 see a spike in tax share, Bengal dips

February 08, 2026 5 min read Polity & Governance Economics GS Paper II (Centre-State Relations) GS Paper III (Indian Economy Fiscal Policy)
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What Happened

  • The 16th Finance Commission (16th FC) report for 2026-31 revealed divergent outcomes for poll-bound states in their share of central tax devolution.
  • Kerala registered the sharpest spike among poll-bound states, with its share rising from 1.925% (15th FC) to 2.382% (16th FC) -- an increase of 0.457 percentage points, translating to Rs 36,355 crore (up from Rs 26,815 crore).
  • West Bengal saw its share decline by 0.31 percentage points under the revised horizontal devolution formula.
  • The formula overhaul introduced "Contribution to GDP" as a new criterion (10% weight), benefiting industrialised states, while the tax effort criterion (2.5% weight) was removed entirely.
  • Top gainers nationally include Karnataka (+0.48 pp to 4.13%), Kerala (+0.46 pp to 2.38%), Gujarat (+0.27 pp to 3.75%), and Haryana (+0.26 pp to 1.36%). Top losers include Madhya Pradesh (-0.50 pp to 7.34%), Uttar Pradesh (-0.32 pp to 17.61%), and West Bengal (-0.31 pp).

Static Topic Bridges

Vertical and Horizontal Devolution: The Two Dimensions of Tax Sharing

Tax devolution under the Finance Commission operates on two axes. Vertical devolution determines the aggregate share of central tax revenues transferred to states from the divisible pool. Horizontal devolution determines how that aggregate is distributed among individual states based on a formula with multiple criteria. Both dimensions are constitutionally grounded in Article 280, with the Finance Commission recommending and Parliament accepting the framework.

  • Article 270 of the Constitution governs the distribution of net proceeds of taxes between the Union and states.
  • The vertical devolution share has progressively increased: 29.5% (12th FC), 32% (13th FC), 42% (14th FC -- a historic jump), 41% (15th FC), 41% (16th FC retained).
  • The 16th FC horizontal devolution criteria and weights: Income Distance (42.5%), Population 2011 (17.5%), Contribution to GDP (10% -- new), Demographic Performance (10%), Area (10%), Forest & Ecology (10%).
  • The 15th FC weights for comparison: Income Distance (45%), Population 2011 (15%), Demographic Performance (12.5%), Area (15%), Forest & Ecology (10%), Tax Effort (2.5%).
  • Income Distance uses the gap between a state's per capita GSDP and the average of the top three high-income states, calculated over 2018-19 to 2023-24 (excluding the pandemic year 2020-21).

Connection to this news: Kerala's gain is driven primarily by the new GDP criterion rewarding states with stronger economic output, while West Bengal's decline reflects the combined effect of reduced area weight and the removal of tax effort -- criteria where it previously benefited more.

The GDP Criterion: A New Variable in Inter-State Fiscal Transfers

The 16th FC introduced "Contribution to GDP" with a 10% weight -- the first time any Finance Commission has directly rewarded states for their share of national economic output. To prevent extreme concentration (since a handful of states dominate India's GDP), the formula uses the square root of each state's GSDP share rather than the raw share, moderating the advantage of the largest economies.

  • The GDP variable is calculated as the square root of each state's share of total GSDP, normalised across all 28 states.
  • States that benefit: Industrialised and service-economy states such as Maharashtra, Tamil Nadu, Karnataka, Gujarat, Kerala, and Telangana, which contribute disproportionately to national GDP.
  • States that lose relatively: Large population states with lower per capita GSDP, such as Uttar Pradesh, Madhya Pradesh, and Bihar, whose GDP shares are large in absolute terms but whose per capita output is lower.
  • This criterion was a long-standing demand of southern and western states, which argued that their higher economic contributions were penalised by a formula that heavily weighted population and income distance.
  • The square-root transformation ensures that Maharashtra (which contributes roughly 14-15% of India's GDP) does not receive a proportionally outsized share, while smaller but productive states like Kerala and Haryana see meaningful gains.

Connection to this news: Kerala's spike in tax share is substantially attributable to the GDP criterion -- despite a modest population share, Kerala's relatively high per capita GSDP and contribution to national output are now directly rewarded in the formula, explaining its 0.46 percentage point gain.

Centre-State Fiscal Relations and Fiscal Federalism

India's fiscal federalism framework distributes financial resources and responsibilities between the Union and states through multiple channels: tax devolution (Finance Commission), grants-in-aid (Finance Commission and centrally sponsored schemes), and GST compensation. The Finance Commission is the primary constitutional mechanism, but the balance of fiscal power has evolved through successive commissions, with the 14th FC's jump to 42% devolution marking a watershed.

  • Article 280: Finance Commission constituted every five years to recommend tax devolution and grants.
  • Article 275: Grants-in-aid to states charged on the Consolidated Fund of India, as determined by Parliament on the Finance Commission's recommendations.
  • The 16th FC recommended fiscal deficit targets: Centre to reduce to 3.5% of GDP by 2030-31; states capped at 3% of GSDP.
  • Combined debt recommended to decline from 77.3% (2026-27) to 73.1% of GDP (2030-31).
  • Revenue deficit grants: The 16th FC identified states with post-devolution revenue deficits and recommended specific grant amounts.
  • The formula redesign has political implications: poll-bound states experiencing a share increase may project this as a governance dividend, while those experiencing a dip face questions about fiscal management.

Connection to this news: For poll-bound states, the 16th FC outcomes carry both fiscal and political significance. Kerala can point to a Rs 9,500+ crore increase in annual devolution, while West Bengal's relative decline feeds into the opposition narrative about formula fairness, intensifying the political debate around fiscal federalism ahead of state elections.

Key Facts & Data

  • 16th FC vertical devolution: 41% of divisible pool (unchanged from 15th FC).
  • Kerala's share: 1.925% (15th FC) to 2.382% (16th FC); increase of Rs 9,540+ crore over the award period.
  • Karnataka's share: 3.64% to 4.13% (+0.48 pp) -- largest national gainer.
  • Madhya Pradesh's share: 7.85% to 7.34% (-0.50 pp) -- largest national decline.
  • Uttar Pradesh remains the largest recipient at 17.61%, though down from 17.93%.
  • New GDP criterion weight: 10%, calculated using square root of state's GSDP share.
  • Tax Effort criterion (2.5% under 15th FC): Eliminated in 16th FC.
  • Article 280: Constitutional basis for Finance Commission.
  • Article 270: Distribution of net proceeds of taxes between Union and states.
  • 16th FC Chairman: Dr Arvind Panagariya; period: 2026-27 to 2030-31.
  • Fiscal deficit cap for states: 3% of GSDP; for Centre: 3.5% of GDP by 2030-31.