Answer

Introduction

The Sixteenth Finance Commission (FC-16) has opted for continuity over correction in India’s fiscal federal architecture. In an era of constrained State revenues under GST and rising expenditure responsibilities, the Sixteenth Finance Commission sought to balance stability with incremental reform. The recommendations reflect an attempt to accommodate fiscal prudence while cautiously responding to emerging stresses in Centre–State fiscal relations.

Implications for State finances

• Constrained Fiscal Space: Retaining vertical devolution at 41%, despite States seeking 50%, fails to address the widening gap between States’ expenditure responsibilities and assured revenues, especially under the GST regime.
• Borrowing-led Adjustment: FC-16 acknowledgement that States increasingly rely on market borrowings to manage fiscal stress, raising concerns about long-term debt sustainability.
• Limited Gains from Horizontal Recalibration: Replacing the “tax effort” criterion with “contribution to GDP” (10% weight) modestly rewards productive States, but the gradualist approach dilutes its redistributive impact.
• Persistence of Central Control: A significant portion of increased transfers comes via Centrally Sponsored Schemes, reinforcing States’ role as implementers rather than autonomous fiscal actors.
  

Implications for Fiscal Federalism

• Status-quo Federalism: The refusal to expand the divisible pool or include cesses and surcharges limits genuine revenue-sharing, weakening cooperative federalism.
• Missed Structural Reform: While demographic performance weight is reduced appropriately, the absence of a roadmap for enhanced vertical devolution signals caution rather than constitutional balance.
• Asymmetric Incentives: Despite a higher weight for GDP contribution, productive States see only marginal gains, weakening the strength of efficiency-based fiscal incentives.
• Centralisation through Conditional Transfers: This reinforces a top-down fiscal structure, reducing States’ discretionary spending power and diluting the spirit of cooperative and competitive federalism.
• Erosion of Fiscal Autonomy of States: With limited expansion in untied tax devolution and increasing reliance on borrowings, States’ fiscal decision-making autonomy is constrained, altering the Centre–State balance envisioned under constitutional federalism.

Conclusion

While the Sixteenth Finance Commission acknowledges mounting pressures on State finances, its calibrated approach favours stability over structural rebalancing. Addressing fiscal stress and strengthening fiscal federalism will require expanding untied tax devolution, reducing reliance on conditional transfers, and restoring States’ constitutionally envisaged fiscal autonomy.

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