Formation of the Sixteenth Finance Commission of India

The Sixteenth Finance Commission (16th FC) of India has been constituted, tasked with making pivotal recommendations on the distribution of tax revenues between the central and state governments for the five-year period starting April 1, 2026. This commission’s role is crucial in ensuring equitable fiscal federalism, especially in the face of evolving economic challenges and disparities among states.

Composition and Leadership

The 16th FC is chaired by Dr. Arvind Panagariya, a distinguished economist and former Vice Chairman of the NITI Aayog. The commission also includes three full-time members and one part-time member, bringing together expertise from various fields to address the complex fiscal landscape of India​.

Terms of Reference (ToR)

The ToR for the 16th FC, approved by the Union Cabinet, outline several critical responsibilities:

• Division of Tax Proceeds: The commission is to recommend the distribution of tax revenues between the Union and the States, as well as the allocation among the states. This includes considerations under Chapter I, Part XII of the Constitution​.
• Grants-in-Aid: Establishing principles for grants-in-aid to states from the Consolidated Fund of India.
• Fiscal Consolidation: Proposing measures to augment the Consolidated Fund of India and ensuring fiscal stability across states.
• State-Specific Needs: Addressing the unique fiscal needs of different states, considering factors like population density, economic backwardness, and regional imbalances.

Key Challenges

The 16th FC faces numerous challenges that require innovative solutions and balanced approaches:

1. Vertical Imbalance: The heavy reliance of the central government on cesses and surcharges, which are not shareable with states, has created a vertical fiscal imbalance. The commission needs to address this by recommending a more equitable distribution of resources.
2. Horizontal Imbalance: There are significant disparities in per capita income and developmental indicators among states. The commission must ensure that resource allocation addresses these horizontal imbalances effectively.
3. Fiscal Sustainability: Ensuring fiscal sustainability while recommending state-specific measures to manage debt and expenditure is crucial. The commission needs to propose frameworks that help states maintain fiscal discipline.
4. Demographic Changes: States with differing demographic trends present unique challenges. States with higher population growth may need more resources for infrastructure and services, while those with declining populations face different fiscal pressures.
5. Environmental Costs: Resource-rich states often bear the environmental costs of extraction and exploitation. The commission must consider compensating these states adequately to promote sustainable development​.

The Advisory Council

An advisory council has been constituted to assist the 16th FC in its deliberations. This council comprises experts from diverse fields, providing critical insights and guidance to ensure that the commission’s recommendations are robust and comprehensive​.

Implications for Fiscal Federalism

The recommendations of the 16th FC will have far-reaching implications for fiscal federalism in India. By addressing both vertical and horizontal imbalances, and considering the unique needs of states, the commission aims to promote balanced and sustainable economic growth across the country. The focus on fiscal consolidation and equitable resource distribution underscores the importance of a stable and fair fiscal framework for India’s development trajectory​.