The 16th Finance Commission has refused to concede two core state demands: raise the vertical devolution of central taxes above 41%, and include cesses and surcharges in the divisible pool. That has revived the old argument over whether the pool itself remains fair. The Commission’s report was tabled in Parliament on February 1, 2026, alongside the Union Budget, and the Union government accepted the 41% recommendation.
This is not just a dispute over formula design. It is a negotiation over power, responsibility and legitimacy in the Union. The 16th Commission has changed the weights in the horizontal devolution formula. More important, it has changed the political reading of who gains and who loses.
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16th Finance Commission formula changes
The most consequential change is the introduction of a 10% weight for a state’s contribution to national GDP. Earlier commissions leaned more heavily toward equalisation. The 16th Commission explicitly rewards economic output. PRS notes that this new parameter replaces the 15th Commission’s tax and fiscal effort criterion.
To make room for this shift, the Commission reduced the weight of area from 15% to 10%, demographic performance from 12.5% to 10%, and income distance from 45% to 42.5%. Population (2011 Census) rose from 15% to 17.5%. Forest remains at 10%. Tax and fiscal effort has been dropped. These changes mark a clear move from a pure equalisation logic to a mixed model that gives more room to aggregate output.
That does not make the formula anti-equity. Income distance still carries the highest weight at 42.5%. But it does mean the Commission is signalling that growth contribution now deserves explicit reward.
South versus north narrative after the report
The political narrative has shifted after the report. Before it, much of the debate, especially in the south, was framed around being penalised for development and population control. After the recommendations, that argument became harder to sustain in its earlier form.
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The state-wise shares show gains for Andhra Pradesh (4.05 to 4.22), Karnataka (3.65 to 4.13), Kerala (1.93 to 2.38), Tamil Nadu (4.08 to 4.10) and Telangana (2.10 to 2.17). At the same time, several large northern and central states see lower shares, including Bihar (10.06 to 9.95), Madhya Pradesh (7.85 to 7.35), Rajasthan (6.03 to 5.93) and Uttar Pradesh (17.94 to 17.62). Chhattisgarh also declines (3.41 to 3.30).
This reversal is politically significant. It weakens the simple north-versus-south framing, even if it does not end the underlying dispute over fiscal space.
Vertical devolution, cesses and surcharges
The 16th Commission has retained vertical devolution at 41%, the same as the 15th Commission. The Union government accepted this recommendation in the Budget for 2026-27.
That continuity will disappoint states that wanted a higher share. Their argument was not only about percentages. It was about the growing use of cesses and surcharges, which are excluded from the divisible pool.
Here, the Commission’s position is more constitutional than discretionary. In Volume I, it states that the Constitution does not permit capping cesses and surcharges or including them in the divisible pool, and that changes to centrally sponsored schemes fall under the Union’s prerogative under Article 282. The report also lays out the wider transfer architecture: tax devolution under Article 270, Finance Commission grants under Article 275(1), and other Union grants under Article 282. That institutional structure is why states contest cesses and CSS design at the same time: tax devolution is only one part of actual fiscal space.
The Commission also makes an argument that has drawn criticism: it says an efficient tax system would require a “grand bargain” in which the Union folds more cess and surcharge revenue into regular taxes while states accept a smaller share in a larger divisible pool. Whether or not that is politically viable, it shows that the Commission sees the problem as one of overall Centre-state fiscal design, not only a devolution ratio dispute.
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Fiscal federalism after revenue deficit grants
The 16th Commission’s grants reset is as important as its devolution formula. The Explanatory Memorandum says it has not recommended revenue deficit grants, sector-specific grants, or state-specific grants. It has instead retained and expanded a structured grants architecture around local bodies and disaster management.
This matters because the stress point is not only regional politics. It is also the position of grant-dependent states, irrespective of whether they are in the north or south. States that relied on revenue deficit grants will have to adjust through higher own revenue effort, expenditure rationalisation, or both. The Commission has chosen a cleaner transfer architecture, but the transition will not be painless.
The broader claim that the 16th Commission is straightforwardly adverse to the south is no longer tenable on devolution shares. But the fiscal strain on weaker states may now show up more through the grants channel than through the horizontal formula.
Delimitation, Census, and politics of devolution
The larger significance of the 16th Commission lies beyond tax arithmetic. It sits in the shadow of the post-2026 Census and a future delimitation exercise. If northern states gain parliamentary representation because of faster population growth, southern states will see that as a loss of political weight.
In that context, a devolution formula that protects, and in some cases improves, the south’s share of economic resources can be read as a balancing move within the federal compact. The Commission has not said this in political language. It did not need to.
For now, the 16th Finance Commission appears to have done enough to contain what could have become a sharper north-south confrontation, even while leaving the cesses-and-surcharges dispute unresolved and pushing the harder adjustment burden onto the broader architecture of state finances.
One more signal in the report should not be missed. The Commission’s fiscal roadmap recommends a 3% of GSDP annual fiscal deficit limit for states, alongside stricter treatment of off-budget borrowing. This means the next phase of Centre-state friction may move from tax shares to compliance, borrowing room and reform conditionality.
That is where the politics of fiscal federalism is likely to shift next.