Finance Commission and states’ tax shares

The 16th Finance Commission Report for the period 2026–31 was presented in the Lok Sabha by Finance Minister Nirmala Sitharaman on February 1, the same day the Union Budget was presented. According to Article 280 of the Constitution, the Finance Commission is the body that deals with financial transactions between the Centre and the states and is responsible for making recommendations to the Central Government on the distribution of the Centre’s tax revenue among the states. The Commission, headed by former NITI Aayog Vice Chairman Dr. Arvind Panagariya and comprising four members and a secretary, had submitted its report to the President on 17 Nivember 2025. This is a document that the states generally look forward to, as it defines the share they are entitled to receive. For instance, this year Kerala is receiving 2.38 percent of the distributed share. Last year, it received 1.92 percent. In monetary terms, the increase in the Rs 36,355.39 crore allocated to Kerala amounts to Rs 6,975 crore. Kerala ranks second among the states that have received an increase. As for shares among states, Uttar Pradesh gets 17.61 percent, Bihar has 9.94 percent, and Madhya Pradesh 7.34 percent.

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The imbalances in the share of states from the tax revenue collected by the Centre have been a source of considerable debate over years. For example, if a state contributes 20 per cent of the total tax revenue, the share it receives in return may be more or less than 20 per cent. However, this is not a system working on returning exactly what a state contributes. Although states accept this in principle, they want to receive shares that are more closely aligned with their contribution. More importantly, there is the question of how much of the total tax revenue collected by the Centre is distributed among the states. During the term of this Commission, 2026–31, the total devolution to the states will be 41 per cent, while the remaining 59 per cent will go to the Centre. The previous Commission had also adopted the same ratio. The states want this share to be increased to 50 per cent. Especially after the introduction of GST, the sales tax that states directly collect and spend is no longer available, leaving states without significant taxes to raise their own revenue. The Finance Commission also acknowledges this. The Commission notes that, as a result, states are struggling to find funds for increasing development and welfare expenditure and are therefore turning to borrowing from the market. Kerala’s KIIFB is a case in point.

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Cess and surcharge are not included in the calculation when central taxes are apportioned. Neither of these is shared with the states. The Finance Commission itself acknowledges in its report that states do not receive their share of this additional tax and that, as a result, their revenue growth potential is shrinking. However, it does not suggest any solution to address this issue. Nor does the Commission put forward any recommendation to include cess and surcharge in the apportioned pool. Figures are also available on how the current central government has collected revenue through cess and surcharge in this manner. During 2013–2019, the share allocated under tax and duty was 93–95 percent, while the remaining 5–7 percent came from cess and surcharge. However, coming to 2021–22, while the share that was allocated as tax was 86.5 percent, the share of cess and surcharge increased to 13.5 percent. In other words, after 2019, central revenue from cess and surcharge roughly doubled from 5–7 percent to about 11–13 percent. This is also reflected in the tax revenue figures submitted to Parliament.

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There is another consequence to this in which a certain degree of politics also comes into play. States experiencing this revenue shortfall will have limited funds for development projects or welfare activities. Meanwhile, the central government announces projects on political platforms to gain goodwill in the states, whether ahead of elections or otherwise —although whether all of these are actually implemented is another matter. Most of the tax increases made by the Centre in recent times fall under the cess and surcharge category. Around eighteen states have demanded that the tax share be increased from 41 to 50 percent. And most of the remaining states are advocating that it be raised to at least 45 to 48 percent. The Finance Commission did not recommend such a change because it probably assumed that the Centre is interested in maintaining the status quo. Overall, the current BJP government, which is keen to tighten the Centre’s control over all states and administrative units in the country, is unlikely to take a different position on this issue. While this may offer the government a temporary political advantage, this approach is far from boding well for those who seek healthy and balanced Centre–state relations in a federal system.