16th Finance Commission

Syllabus: Indian Economy – Fiscal Federalism

Source:  Indian Express

Context: As states demand greater fiscal autonomy and a larger share of the divisible tax pool, the 16th Finance Commission (FC) faces a complex challenge.

About the 16^th Finance Commission

• The 16th Finance Commission (FC)was constituted under Article 280  in December 2023, chaired by  Arvind Panagariya, to recommend tax devolution and fiscal federalism reforms for 2026-31.

Current Structure of Devolution:

• States’ Share: Fixed at 41% by the 15th FC (reduced from 42% post J&K’s reorganization).
• De Facto Share: States receive only about 32% of Centre’s gross tax revenues due to the rise in cesses and surcharges (not shareable).

Key Issues Before the 16th Finance Commission:

• Shrinking Divisible Pool and Rising Cesses: Cesses and surcharges have reduced the size of the divisible pool from 88.6% (2011–12) to 78.9% (2021–22) of the Centre’s gross tax revenue (RBI data).
  • States argue for restoring fairness by capping these levies and increasing their share to 50%.
• Fiscal Constraints of the Union Government:
  • High Demand on Centre’s Budget: It may not be feasible to raise total transfers without fiscal stress.
  • Borrowing for Transfers: Centre is borrowing to fund grants, raising questions on spending priorities.
• Tied vs. Untied Transfers – Need for Rebalancing:
  • Current Scenario: Excessive reliance on centrally-sponsored schemes (CSS) ties states to Centre-dictated spending.
  • Proposal: Increase untied transfers to allow states more discretion within the existing transfer envelope.
  • Challenge: Requires pruning of CSS, which are politically and developmentally sensitive.

Implications of Increasing Untied Transfers:

• Quality of State Spending:
  • Rising Revenue Deficits: Many states, including Karnataka and Punjab, are facing worsening revenue balances.
  • Risk of Misuse: Untied funds may be diverted towards revenue expenditure or non-merit subsidies (e.g., free electricity, water), rather than capital investments.
• Rise in Cash Transfer Schemes:
  • Quasi-Universal Transfers: 14 states have launched income support schemes, totalling 0.6% of GDP (Axis Bank report).
  • Concern: More untied funds could be used for electoral populism instead of systemic improvements.
• Equity in Public Service Delivery:
  • Inter-State Disparities: Low-income states like Bihar spend significantly less per capita on public services.
  • Question: Will more untied funds lead to convergence in service delivery standards across states?
• Devolution to Local Governments:
  • Neglect of the Third Tier: Panchayats and municipalities receive a much smaller share of total public spending compared to countries like China and South Africa.
  • Hope: More untied funds could incentivize states to devolve more resources to local governments.

Way Forward:

• Reform Transfers Framework: Consider capping cesses, rationalizing CSS, and increasing untied transfers with accountability safeguards.
• Strengthen Institutional Capacity: Build monitoring systems to ensure untied funds are spent on productive and equitable outcomes.
• Incentivize Local Devolution: FC can recommend performance-based grants to states promoting third-tier empowerment.
• Adopt Differentiated Approaches: Tailor devolution mechanisms to reflect state capacity, developmental needs, and fiscal health.

Conclusion:

The 16th Finance Commission must navigate the fine line between enhancing fiscal autonomy for states and safeguarding national fiscal stability. A rebalanced transfer structure—one that ensures equitable, accountable, and convergent public service delivery—will be crucial in deepening India’s cooperative federalism.

PYQ: