The 16th Finance Commission (FC) has a complex task ahead as multiple states demand a larger share of central tax revenues. Many are advocating for a significant increase in their share of the divisible tax pool—from the current 41% to as much as 50%.

States argue that although their share was increased to 42% by the 14th FC (and slightly reduced to 41% by the 15th due to Jammu and Kashmir’s new status as a Union Territory), the central government has undercut these gains. By increasingly relying on cesses and surcharges—revenue streams not shared with states—the Centre has reduced the effective size of the divisible pool. RBI data shows that the shareable pool fell from 88.6% of gross tax revenue in 2011–12 to 78.9% in 2021–22, leaving states with only around 32% of the Centre’s gross tax collections on average over the past six years.

Balancing Centre-State Needs

While the states’ call for a larger share may seem fair, it raises difficult questions. The Centre faces significant budgetary pressures and already transfers substantial funds to states, which account for about 60% of total general government spending. Simply increasing transfers may strain the Centre’s fiscal position.

One solution could be to shift the composition of current transfers—moving away from tightly controlled “tied” funds (allocated for specific centrally sponsored schemes) toward more flexible “untied” funds that states can spend according to their priorities. However, this would require trimming or restructuring many central schemes, which are often politically motivated and fund state-level responsibilities outside the Union list. Changing this dynamic would mean rethinking the Centre’s spending priorities—a politically and economically sensitive task.

Efficiency of Spending Also in Question

Another concern is how effectively states would use additional untied funds. Many states are running growing revenue deficits, spending borrowed money on routine expenses like salaries, subsidies, and interest payments rather than productive investments. Even fiscally disciplined states like Karnataka are seeing slippages.

In states like Punjab, high revenue deficits have severely limited capital spending. There’s a real risk that more untied funds could simply go toward populist or non-merit subsidies (e.g., free electricity or water), rather than toward developmental or infrastructure spending.

What Lies Ahead

The Finance Commission will have to navigate these competing demands with care. Should it push for limits on cesses and surcharges? Should it redesign the Centre’s funding role? Can more untied funds lead to better public service delivery or just widen fiscal gaps?

Striking the right balance between equity, fiscal sustainability, and efficiency will be critical as the 16th FC shapes the next phase of Centre-state financial relations.