16th Finance Commission: What states asked for, and what they got, explained in 6 charts

As part of its consultations, the 16th FC invited states to submit recommendations. For each state, the central question was straightforward but contentious: how should the Centre’s tax revenues be distributed among states?

India’s 28 states weighed in, and their submissions make for an interesting read on how they saw this exercise. There’s an element of both convergence and divergence. While there was convergence among states on what criteria to adopt to answer this all-important question, there was significant divergence on how much weightage should be assigned to an individual criterion.

Weighty considerations

The 16th FC had to balance two competing objectives—rewarding states that have controlled population growth and achieved higher income levels, while supporting states with lower per capita incomes and higher fertility rates. Overlaying this was a larger concern: the risk of India’s demographic dividend fading as the population ages.

The 16th FC has made changes, big and small, to the criteria used to decide individual state shares in central tax revenues. It has introduced a new efficiency criterion—contribution to India’s GDP—and increased the population weight. On the other hand, it reduced the weights of three criteria (per capita income gap, area, and demographic performance), and removed tax and fiscal efforts entirely. It also made definitional changes to some criteria, subtly shifting the emphasis towards effort quality and long-term planning.

This was largely what even states had suggested. Five of the six criteria adopted by the 16th FC were also suggested by 23 to 28 states. Contribution to GDP, the sixth and new criterion, was suggested by 9 of the 28 states. Beyond these, states suggested 13 additional criteria, including poverty levels, vulnerability, international border overlap and infrastructure quality.

This is where it gets interesting. In the top five criteria, all of which have been carried forward by the 16th FC, there was wide variance among states in their preferred weight for these. Take the per capita income distance, which is the markup/deficit of a state’s per capita income to the average of the top three large states.

At 42.5%, this criterion has the highest weightage in the 16th FC’s methodology. While all 28 states agreed on this criterion, their preferred weight for it ranged between 15% (Haryana) and 55% (Manipur). Economically poorer states sought a higher weightage for this criterion, while economically better-off states preferred a lower weight. The average weight across the 28 states was 38.6%.

The other four top criteria also saw a similar wide variance among states. A common strand running through these numbers was states playing up factors that were favourable to them and downplaying those that were not. Thus, for example, there were four states that suggested a 20% weight for forest cover (Andhra Pradesh, Sikkim, Tripura and Uttarakhand), while two states suggested 5% (Haryana and Uttar Pradesh).

Give and take

For India, the centre-state compact is very important. The centre was always collecting a majority of taxes, including direct taxes from individuals (income tax) and from companies (corporation tax). In 2017, taxes collected from the sale of goods also came under the centre’s purview with the introduction of the goods and services tax (GST). With the idea of a one nation, one tax, the GST subsumed a host of state-specific taxes.

While the centre collects taxes, the bulk of expenditure flows through states (schools, health, law and order, etc). To bridge this mismatch, central taxes are devolved to states through two mechanisms. Vertical devolution determines what share of total tax revenues goes to states; the 16th FC has retained this at 41%. Horizontal devolution decides how this 41% is distributed among states.

Richer and better-performing states—particularly in the south, along with Maharashtra and Gujarat—have long feared being penalized for success. The inclusion of contribution to GDP has partly addressed this concern, lifting their shares of divisible revenues. Conversely, some poorer states have seen marginal declines. Uttar Pradesh’s share has fallen from 17.9% to 17.6%, and Bihar’s from 10.1% to 9.9%.

However, even the poorer states will see an increase in the absolute amount they receive, as the centre's tax revenues are expected to accelerate over the next five years. As a result, a greater share of taxes as a share of GDP will be shared with states till 2030-31.

But poorer states are facing another blow. In a departure from the past, the 16th FC has recommended doing away with grants to states meant to bridge revenue deficits. It felt that states have room to levy additional taxes and, as a principle, covering deficits encourages inefficiencies. The net result: states are going to get at least 0.5 percentage points less as a share of GDP by 2030-31, compared to the current distribution.

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