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An Explanatory Memorandum issued by the Ministry of Finance on February 1, 2026, is seen as a useful document, not only for what it states or approves but also for observing a pattern of what it does not.
The Union government accepted the Sixteenth Finance Commission’s (FC’s) recommendation to retain the States’ share in the divisible pool at 41%. It also accepted the horizontal formula, the local body grants, and the disaster management corpus. However, it deferred everything structural, such as amending the Fiscal Responsibility Legislation, controlling off-budget borrowings, reforming power sector distribution companies, and rationalising subsidies.
This observed asymmetry is not bureaucratic caution. It became the settlement.
The headline number deserves scrutiny before the settlement does. A 41% share sounds like continuity. In nominal terms, it is. But the divisible pool is not gross tax revenues.
Cesses and surcharges, levied and retained entirely by the Union, sit outside the pool, and their share has been growing.
As the FC16 report documents, the divisible pool as a proportion of gross tax revenues averaged 89.2% during the FC13 period, fell to 82.1% during FC14, and dropped further to 78.3% during FC15.
The Commission acknowledges this trend, notes its undesirability, and declines to fix it. Hence, 41% of a shrinking base is not 41% of total collections.
FC16 has also discontinued revenue deficit grants, sector-specific grants, and State-specific grants, instruments that offered targeted fiscal relief to States. The Commission projects that combined general government debt will fall from 77.3% of GDP in 2026-27 to 73.1% by 2030-31.
The aggregate trajectory looks orderly. It is the disaggregated picture where the real argument begins.
Structural deferrals
FC16 was aware of the fault lines it chose not to repair. Its chapters on State finances, power sector losses, and subsidies name them directly. The Commission identified States with structurally unsustainable fiscal trajectories. It called for reforms. It attached no binding enforcement mechanism to achieve them.
The most consequential gap is the residual asymmetry left by the end of GST compensation in June 2022. States lost a guaranteed 14% annual growth in SGST revenues without a structural replacement.
Tamil Nadu alone estimated a shortfall of nearly ₹20,000 crore in 2024-25. The Commission reads aggregate SGST buoyancy as evidence of recovery. The distributional stress has not followed.
The second deferral concerns off-budget borrowings and fiscal rules. FC16 documented how States borrow through government-controlled entities and service those liabilities from the budget, keeping them invisible in headline deficit figures.
It is recommended that States discontinue this practice and that the Fiscal Responsibility Legislation (FRL) frameworks be amended.
The Explanatory Memorandum accepted the quantum of borrowing ceilings in principle, then noted that off-budget controls, FRL amendments, and the Union’s own fiscal deficit path would be examined separately. That phrase has a history in Indian fiscal federalism. It means not now.
The Commission’s own inter-State comparison documents the backdrop. Punjab carried a debt-to-GSDP ratio of 42.9% in 2023-24 and a revenue deficit of 3.7% of GSDP, borrowing primarily to address revenue shortfalls rather than build capital assets.
Rajasthan’s outstanding liabilities stood at 37.9% of GSDP, West Bengal’s at 38.3%, and Andhra Pradesh’s at 34.6%. Each operates under fiscal rules that, by the Commission’s own assessment, are effectively unenforced. The recommendation to reform those rules was made. The Union noted it for later.
Rewarding the Centre’s priorities
Two choices in FC16’s transfer architecture repay close reading.
The first is the replacement of the tax and fiscal effort criterion in the horizontal devolution formula with a contribution to GDP criterion. Under FC15, States received a 2.5% weight based on their own tax revenue efficiency relative to economic capacity, rewarded for trying harder.
The new criterion, assigned a 10% weight, allocates resources in proportion to each State’s contribution to national GDP, measured as the square root of its GSDP relative to all States. Maharashtra, Gujarat, and Karnataka, large, high-GSDP States that already generate substantial own revenue, benefit structurally from this shift.
Bihar, Jharkhand, and Uttar Pradesh, which are States with lower per capita incomes and greater fiscal need, do not. This is not a technical adjustment. It is an inversion of equalisation logic: the previous criterion rewarded effort, the new one rewards weight.
The shift from tax & fiscal effort (2.5%) to contribution to GDP (10%) is the defining structural change. The second is the conditionality architecture of the local body grants. The ₹7,91,493 crore recommended for rural and urban local bodies is divided into basic and performance components, with access contingent on entry-level conditions covering constituted bodies, audited accounts, and the timely constitution of State Finance Commissions.
Performance grants add further layers tied to own-source revenue benchmarks and Central database compliance. Each condition is defensible in isolation. Together, they construct a system in which the gap between a State’s entitlement and its actual receipt depends on its capacity to meet Central monitoring requirements.
States with weaker governance infrastructure, which tend also to be States with greater fiscal need, face that gap most acutely. The FC15 period offers a precedent, where urban local body grants were released at only 62.6% of the recommended amount.
Read alongside the Commission’s report, the Explanatory Memorandum reveals a consistent logic. The Union accepts what gives it budgetary predictability: the 41% share, the formula, and the grants.
It defers what would require sharing structural authority, fiscal rule reform, off-budget liability controls, and power sector restructuring. Where FC16 diagnosed a problem and recommended a remedy, the Union took note. Where FC16 designed a flow and set an amount, the Union accepted it in full.
What makes the FC16 moment distinctive is that it arrives after years of documented State-level fiscal deterioration, the Commission’s own data confirms.
Punjab borrows to pay salaries and service existing debt, not to build infrastructure. Andhra Pradesh carries reorganisation-era liabilities that no Finance Commission has resolved. Rajasthan’s revenue deficit persists across multiple award periods. The Commission saw each of these. The Memorandum took note.
A federal structure whose transfers increasingly reward economic weight over fiscal need, whose structural stress is deferred cycle after cycle, and whose only reliable outcome is the perpetuation of Centre-State asymmetry is surely not a system in good health. It has somehow learned to look like it is – and that is deeply troubling and unsettling for the fiscal-federal character of India’s constitutional republic which can result in long-term implications and an exacerbating civic divide.
Deepanshu Mohan is professor and dean, O.P. Jindal Global University, and Director, Centre for New Economics Studies (CNES). Nagappan Arun and Saksham Raj contributed to this column from Centre for New Economics Studies, O.P. Jindal Global University.
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