MUMBAI: The Southern states, led by Karnataka and Kerala gain the most from the tax devolution formula in the 16th Finance Commission awards for fiscals 2027-31, though the panel has retained the vertical devolution of the Union taxes to the states at 41% of the divisible pool, in line with the previous awards, while Northern states do not gain they don’t lose either.
According to Aditi Nayar, the chief economist at Icra Ratings, this was made possible by making meaningful changes in the horizontal devolution framework which are expected to alter the inter-se distribution of resources among the states.
“The 16th commission has introduced a new criterion, ‘contribution to GDP’, with a 10% weight, replacing the tax and fiscal effort criteria. Alongside a reduction in the weight assigned to the area criterion to 10%, these changes are expected to benefit states with healthier economic management.
“Consequently, the share of 14 of 28 states in the divisible pool is set to increase during FY27–31, with Karnataka emerging as the largest gainer, followed by Kerala, Gujarat, Haryana, Punjab, Andhra, Assam and Maharashtra.
While the share of Karnataka has gone by 0.484 points to 4.131% from 3.647% for FY27, that of Kerala has gone up by 0.457% to 2.382% from 1.925%, Gujarat (0.277%, 3.755%, 3.478%, respectively), Haryana (0.268%, 1.361%, 1.093% respectively), Punjab (0.189%, 1.996%, 1.807% respectively), Andhra (0.17%, 4.217%, 4.047% respectively), Assam (0.013%, 3.258%, 3.128% respectively), and Maharashtra at (0.124%, 6.441%, 6.317% respectively).
On the grants front, she said the 16th commission has recommended a sharp increase in local body and disaster management grants to Rs 9.5 trillion for its award period, a 72% rise over the previous award. Local body grants alone have more than doubled to Rs 7.9 trillion, with 60% of these being conditional but untied, providing greater flexibility to the states, while the remaining 40% are tied to sanitation, solid waste and water management.
Encouragingly, a high release ratio of grants during the previous award lends confidence to states’ ability to meet the stipulated conditions.
At the same time, the 16th commission has discontinued revenue deficit grants, citing their ineffectiveness in addressing structural fiscal gaps. As a result, 13 states that received such grants during the previous award are expected to see a decline in their total grants, notwithstanding higher inter-se shares for some of them.
On fiscal discipline, the commission has recommended that the states strictly adhere to a fiscal deficit ceiling of 3% of GSDP, without any additional reform-linked borrowing or carry-forward of unutilised borrowing limits.
This marks a departure from the flexibility allowed by the previous two commissions and could necessitate a recalibration of state spending priorities, she said.
Further, the commission has also explicitly recommended that states discontinue off-budget borrowings entirely and bring all such liabilities onto their budgets, supported by enhanced disclosures and audit oversight.
Despite tighter borrowing norms, the Centre sought to sustain capex momentum by increasing the allocation for 50-year interest-free capex loans to states to Rs 1.9 trillion in FY27, over and above states’ net borrowing limits, and by sharply enhancing grants-in-aid for capital assets. This is expected to shift a larger share of incremental public capex responsibility to state governments.
In disaster management, the panel has recommended a 27% increase in Union support, greater flexibility in utilisation of the state disaster response funds, and the inclusion of heatwaves and lightning as notified disasters, reflecting evolving climate risks.
Overall, she believes that the recommendations represent a decisive shift towards incentivising economic efficiency, strengthening local governance, improving fiscal transparency and reinforcing debt sustainability, while continuing to support higher capital spending by states.