Bridging India’s fiscal divide

Debdulal Thakur and Shrabani Mukherjee

As the 16th Finance Commission (FC-XVI) embarks on its mandate, it faces the intricate task of harmonising the fiscal aspirations of India’s diverse states. Despite their robust economic performance and substantial contributions to national growth, the southern states have repeatedly voiced concerns about perceived inequities in fiscal transfers to successive Finance Commissions. At the same time, northern and eastern states, burdened with structural disadvantages, continue to rely heavily on central support. Thus, it is a formidable challenge for FC-XVI to balance these divergent realities while preserving India’s federal cohesion.

One of the fundamental grievances from states like Tamil Nadu, Karnataka, Andhra Pradesh, Telangana, and Kerala — the southern bloc — is the shift in the population base used for devolution, from the 1971 to the 2011 Census. Implemented by the 15th Finance Commission, this change arguably penalises states that succeeded in controlling population growth and investing in human development. Tamil Nadu, for instance, contributes over 8.5% to national GDP with just 6% of India’s population, yet its share in the central tax pool has declined from 23.3% under the 2nd Finance Commission to 15.8% under the 15th. A Brookings India study found that if the 1971 population base had been retained, Tamil Nadu could have received thousands of crores more annually in devolved funds.

This is not just a Tamil Nadu issue. Karnataka, whose share fell from 4.7% to 3.6%, is a national leader in digital governance and innovation-driven industries. Kerala, with high social development indicators and demographic stability, similarly finds itself disadvantaged. The 2026 delimitation exercise, expected to recalibrate parliamentary representation based on population, has heightened these states’ fears of political and fiscal marginalisation—a “double whammy” for the South.

Nonetheless, the needs of poorer states are pressing. Bihar, Jharkhand, Chhattisgarh, and Uttar Pradesh struggle with high poverty, low literacy, weak infrastructure, and limited state capacity. Bihar’s per capita income is among the lowest in India, and UP continues to underperform in healthcare and education. These states require sustained federal support to ensure basic service delivery and long-term human development. Fiscal devolution must be sensitive to this reality—but also strategic in design.

Another major point of contention is the rise of cesses and surcharges, which are not shared with the states. Their share of gross central tax revenue rose from 10.4% in 2011–12 to over 20% in 2020–21. In 2022–23, the Centre collected Rs 5.3 trillion through such levies, many of which—such as those for health and education—fall within state jurisdiction. Southern states argue that this practice undermines transparency, reduces the divisible pool, and limits states’ fiscal space, creating a discretionary fiscal environment divorced from accountability and performance.

Critics of the southern position argue that redistribution is foundational to any federal democracy. Indeed, no Finance Commission can ignore equity. But the question is not whether to redistribute—it is how, on what basis, and with what safeguards against fiscal complacency. The current framework lacks such nuance.

The Finance Commission also faces rising asymmetry in political power. Southern states, with stable or declining populations, may see reduced influence in national policymaking after delimitation. The twin shock of fiscal decline and political dilution risks expanding regional alienation and eroding faith in the federal contract. If these trends persist, India’s federalism could drift from cooperative to extractive, undermining both equity and efficiency.

Innovation, not the usual prescriptions, is expected from the 16th FC. First, to better balance population with performance, the FC-XVI could recalibrate the devolution formula, assigning greater weight to metrics like tax buoyancy, educational outcomes, climate adaptation, infrastructure development, and health indicators. Second, it should propose that a portion of cesses and surcharges be included in the divisible pool— or, alternatively, transferred to states as tied grants to improve transparency and equity. Third, differentiated instruments (performance-based surcharges on income or corporate tax) shared proportionally by contributing states could align incentives with rewards. Lastly, to protect state autonomy and fiscal space, there is an urgent need to rationalise the centrally sponsored schemes.

It would be a mistake to view the FC merely as a budgeting institution. FCs are the moral architects of Indian federalism. Redefining fairness not just as redistribution but rather as a balance of responsibility, contribution, and empowerment is expected from its 16th avatar.

(Debdulal is Dean, Vinayaka Mission’s School of Economics and Public Policy, Chennai, and Shrabani is an associate professor, Shiv Nadar University, Chennai)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.