The end of revenue deficit grants as a safety net: What to expect

The 16th Finance Commission’ call to abolish these aims to reduce moral hazard but may hurt relatively prudent states too

- PRACHI MISHRA & VIJAY SINGH CHAUHAN

The 16th Finance Commission (FC) report, covering 2026-31, arrives at a consequential moment for India’s fiscal federalism. It is wide-ranging, analytically rich and notable for making underlying data publicly available. It warrants careful examination.

Any FC begins with a fiscal asymmetry baked into the Indian Constitution. Following its three-list division, state governments account for roughly 60% of general government spending; but they collect only 36% of revenues. This vertical imbalance is inherent to India’s federal design. The 16th FC has chosen not to alter vertical devolution, or the aggregate share of the divisible tax pool flowing to states. Therefore, this piece focuses on horizontal devolution—i.e., how that pool is distributed across states—and one significant change that the 16th FC has introduced.

On the horizontal side, the 16th FC report departs meaningfully from its predecessor. It introduces contribution to GDP as a new criterion, rewarding states for their share in national output. It revises the definition of ‘demographic performance,’ shifting from the (inverse of) total fertility rate to population growth between the 1971 and 2011 Censuses. It removes ‘tax effort’ as a criterion, a change with implications we will return to. The FC has tightened its role in making grant recommendations by tying local body transfers to strict audit and election milestones, making performance-based transfers the cornerstone of its architectural shift.