The 16th Finance Commission may make significant changes to the formula that determines each state’s share in the Centre’s divisible pool of taxes, Moneycontrol has learnt from people familiar with the development, possibly result in some relatively well-off states getting a higher share of central taxes from 2026-27 onwards.
Two sources privy to the matter said the weight of ‘income distance’ criteria - measured by the per capita gross state domestic product (GSDP) - is likely to be reduced from current 45%, implying that states with relatively higher per capita GSDP may not necessarily get a lower share of the divisible pool of central taxes. The 16th Finance Commission will be in place from April 1, 2026, till 2031.
The next Finance Commission may also increase the weight of ‘forest and ecology’ criteria (10% at present), incentivising several states in the North-East, another source said. The panel led by Arvind Panagariya is expected to submit its recommendation to the Centre by October 31 this year.
The current finance commission - whose recommendation are valid for 2021-26 - had suggested to assign 45% weight to income distance, which resulted in Uttar Pradesh and Bihar getting a fairly larger share of taxes, as against relatively well-off states such as Kerala, Karnataka, or Haryana.
"If the weight of income distance shrinks to (say) 40%, the well-off states might get more quantum of central taxes," said one source. "This demand has been presented by many such states to the 16th Finance Commission," the person added.
In January, Goa had argued for a substantial reduction in the weight assigned to income distance criteria - from 45% to 30% - and in place look at newer segments for assessment such as the state’s efforts on achieving sustainable development goals and undertaking financial reforms. According to Panagariya, if Goa’s recommendations are accepted, the state’s share in central taxes will increase to 1.76% from 0.39% at present.
The 15th Finance Commission had assigned 10.06% share of central taxes to Bihar, 17.93% to Uttar Pradesh, 7.52% to West Bengal, and 6.14% to Maharashtra, and 5.98% to Rajasthan. The recommendations of the commission are, however, only advisory in nature and not binding on the Centre.
"Higher income doesn’t necessarily represent higher consumption. We don’t have enough data on consumption pattern of states. It could be that the 16th Finance Commission decide to reduce the weight on income distance," M Govinda Rao, Former Member, 14th Finance Commission told Moneycontrol.
However, Sudipto Mundle, another member of the 14th Finance Commission said the latest recommendations can reduce the weight of ‘population’ criteria (15% at present) to enable states with lower population and higher per capital GSDP to receive more share in central taxes. "This is the other way to do it, if the Finance Commission doesn’t want to touch income distance," Mundle said. "Many states in the south have been expressing this concern, which is legitimate," he added.
Besides income distance, forest & ecology, and population (constituting 70% share), the 15th Finance Commission had assigned the rest of the weight to demographic performance (12.5%), tax effort (2.5%), and area (15%), and recommended a total devolution of 41% of the divisible pool of central taxes to states, which is one percent lower than the percentage recommended by the 14th Finance Commission.
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