What Happened
- The 16th Finance Commission (16th FC) report (Volume 1) identified Tamil Nadu as one of the top three states suffering heavy losses from public sector enterprises (PSEs) in 2022-23.
- Uttar Pradesh recorded the highest PSE losses at Rs 32,430 crore, followed by Rajasthan at Rs 18,814 crore and Tamil Nadu at Rs 16,048 crore.
- Tamil Nadu has 100 public sector enterprises, of which 35 were operating at a loss, with the state spending Rs 26,867 crore in 2022-23 to keep them running.
- The Commission recommended that state or Union PSEs incurring losses in three out of four consecutive years should be placed before the respective Cabinet for a decision on closure, privatisation, or strategic continuation.
- The Commission also called for reviewing and closing 308 inactive state PSEs across the country and formulating state-level disinvestment policies for underperforming entities.
Static Topic Bridges
Finance Commission Under Article 280
Article 280 of the Constitution mandates the President to constitute a Finance Commission every five years (or earlier). The Commission consists of a chairman and four members and makes recommendations on the distribution of net tax proceeds between the Union and states (vertical devolution) and among states (horizontal devolution), principles governing grants-in-aid, and measures to augment the Consolidated Fund of states. Its recommendations are advisory in nature, though conventionally accepted by the government.
- Article 280(1): President constitutes the Finance Commission within two years of the Constitution's commencement and thereafter every five years.
- Article 280(3)(a)-(d): Defines duties -- distribution of tax proceeds, grants-in-aid principles, augmentation of state funds for Panchayats (added by 73rd Amendment, 1992) and Municipalities (74th Amendment, 1992), and any other matter referred by the President.
- The Finance Commission (Miscellaneous Provisions) Act, 1951 governs the qualifications, appointment, and procedures.
- The 16th FC is chaired by Dr Arvind Panagariya (former Vice Chairman, NITI Aayog) and covers the period 2026-27 to 2030-31.
Connection to this news: The 16th FC's observation on PSE losses is part of its broader mandate to assess state finances and fiscal health before recommending devolution shares and grants, since persistent PSE losses directly erode state fiscal capacity and increase contingent liabilities.
Horizontal Devolution Formula: 15th FC vs 16th FC
The horizontal devolution formula determines how the states' share of central taxes is distributed among individual states. The 16th FC introduced a significant formula overhaul, most notably adding "Contribution to GDP" as a new criterion and removing the tax effort criterion.
- 16th FC criteria and weights: Income Distance (42.5%), Population 2011 (17.5%), Contribution to GDP (10% -- new), Demographic Performance (10%), Area (10%), Forest & Ecology (10%).
- 15th FC criteria and weights: Income Distance (45%), Population 2011 (15%), Demographic Performance (12.5%), Area (15%), Forest & Ecology (10%), Tax Effort (2.5%).
- GDP contribution is calculated using the square root of each state's GSDP share to moderate extremes; this benefits industrialised states (Maharashtra, Tamil Nadu, Karnataka, Gujarat).
- 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 pandemic year 2020-21).
- The vertical devolution (states' aggregate share) is retained at 41% of the divisible pool, unchanged from the 15th FC.
Connection to this news: While the horizontal formula determines how much each state receives, the PSE losses analysis reveals how efficiently states utilise those resources -- Tamil Nadu's significant PSE losses highlight that higher devolution alone does not ensure fiscal health without operational reform of state enterprises.
Public Sector Enterprise Reform and Disinvestment Policy
India's approach to public sector enterprise reform has evolved from the Industrial Policy Resolution of 1956 (which reserved strategic sectors for the state) to active disinvestment beginning in 1991. The central government has progressively reduced its footprint through strategic disinvestment and the New Public Sector Enterprise Policy of 2021, which limits government presence to strategic sectors.
- The Department of Investment and Public Asset Management (DIPAM) manages the central disinvestment programme.
- The New PSE Policy (2021) classifies sectors as "strategic" (where at least one PSE will remain) and "non-strategic" (where PSEs will be privatised, merged, or closed).
- At the state level, there is no uniform disinvestment framework; most states lack a formal policy for reviewing or exiting loss-making enterprises.
- State PSEs often serve social objectives (transport, electricity distribution, housing) that create political barriers to closure.
- The CAG regularly flags accumulated losses, eroded net worth, and unrecoverable investments in state PSEs.
Connection to this news: The 16th FC's recommendation that PSEs with losses in three out of four years be placed before the Cabinet for a closure or privatisation decision marks a significant push for states to adopt structured disinvestment frameworks similar to the Centre's approach.
Key Facts & Data
- Top three states by PSE losses (2022-23): Uttar Pradesh (Rs 32,430 crore), Rajasthan (Rs 18,814 crore), Tamil Nadu (Rs 16,048 crore).
- Tamil Nadu operates 100 PSEs; 35 are loss-making; Rs 26,867 crore spent to sustain operations in 2022-23.
- The 16th FC recommends reviewing and closing 308 inactive state PSEs nationally.
- 16th FC vertical devolution: 41% of divisible pool (unchanged from 15th FC).
- 16th FC period: 2026-27 to 2030-31; chaired by Dr Arvind Panagariya.
- Constitutional basis: Article 280; Finance Commission (Miscellaneous Provisions) Act, 1951.
- Fiscal deficit targets recommended: Centre at 3.5% of GDP by 2030-31; states capped at 3% of GSDP.