Budget 2026: 16th FC avoids rocking the boat, but rewards GDP contributors

The members of the 16th Union Finance Commission (UFC) have largely avoided rocking the boat, but have made one significant change in how funds are shared among states, following representations from richer states.

 

They decided that during the 2026-2031 period, for every ₹100 in the divisible pool of taxes, about ₹59 will go to the Centre and the remaining ₹41 to state governments. This split, known as vertical devolution, is the same as that proposed by the 15th UFC. In that sense, the Commission has not rocked the boat.

 

In their representations to the UFC, some states had sought an increase in the states’ share to 50 per cent. Another proposal the Commission did not accept was to include cesses and surcharges in the divisible pool. It also chose not to replace centrally sponsored schemes by raising the states’ share of the divisible pool. A debate is now likely over whether the Commission erred in not increasing the states’ share.

 

The Commission, however, broke new ground by adding a new criterion to determine each state’s share. Under the formula, the weights are: 17.5 per cent for population (2011), 10 per cent for demographic performance, 10 per cent for area, 10 per cent for forest cover, 42.5 per cent for per-capita gross state domestic product distance (PCGSDP), and 10 per cent for contribution to gross domestic product (GDP).

 

One can arrive at each state’s share by combining these weights. Compared with the 15th UFC, the weight for population has been raised by 2.5 percentage points, while the weights for area, demographic performance and PCGSDP have been cut by 5, 2.5 and 2.5 percentage points, respectively. The Commission has also removed the 2.5 per cent weight for tax effort. The new 10 per cent weight for contribution to GDP is seen as an olive branch to better-performing states.

 

Compared with the 14th UFC’s awards, states such as Telangana, Karnataka, Kerala and Andhra Pradesh lost out under the 15th UFC’s formula. The 16th UFC has sought to address this by giving a higher share to states that contribute more to India’s GDP. These include Telangana, Karnataka, Haryana, Tamil Nadu, Gujarat, Maharashtra and Kerala. By lifting the combined share of these states by nearly 1.7 percentage points, the Commission has sought to channel more resources towards the more productive and urbanised states.

 

The Union Budget for 2026-27 has also placed a clear bet on urbanisation as an engine of growth. The Commission has highlighted and praised the Odisha government’s rural-urban transition policy. Around ₹10,000 crore has been set aside to support the merger of peri-urban villages with urban local bodies.

 

The Commission has also sounded an alarm. It has noted that the Constitution requires it to base its recommendations on those of the State Finance Commissions (SFCs). However, apart from a few states, most have been lax in constituting SFCs to determine fund flows to local bodies. Since the UFC did not receive meaningful inputs from SFCs, it has recommended amending the Constitution to remove the requirement that it refer to SFC recommendations. While one hopes this recommendation is not accepted, it should serve as a wake-up call for state governments to take SFCs more seriously. Just as UFC awards are debated, SFC reports also deserve wider scrutiny and debate.

 

The author is a professor at the Indira Gandhi Institute of Development Research, Mumbai. Views are personal