16th Finance Commission Favors North, Neglects High-Performing South: Tamil Nadu Loses Out

When the Centre cleared the 16th Finance Commission’s (FC) report earlier this month, southern states were not looking for generosity so much as balance. For fiscally disciplined states such as Tamil Nadu, the hope was that this round would finally tilt the scales towards performance considering the years of uneven post-pandemic recovery and a GST system that has changed state finances. Public debt too is rising, while the Centre withholds cesses and surcharges from the divisible pool, levies that account for about 15% of the Centre’s total tax revenue. In this context, Tamil Nadu and 17 other states demanded a 50% share of central tax revenues.States raised concerns over changes in the devolution criteria and weights adopted by successive FCs, which make it difficult to predict their share from one commission to the next. Many states hoped the new formula would reward fiscal discipline and tax effort more clearly. They also wanted the income distance criterion to be adjusted using purchasing power parity, so that differences in cost of living are better reflected with reduced weight. Other expectations included reducing or merging Centrally sponsored schemes, increasing the Centre’s contribution to such schemes, and replacing tightly controlled schemes with untied grants.The Commission accepted the Centre’s argument that cesses and surcharges cannot be shared and that they are often used to fund welfare and infrastructure schemes that benefit states. It noted that more than 49% of the Centre’s gross revenue is already transferred to states in various forms. Based on this, it recommended that 41% of the Centre’s tax revenue be devolved to states for 2026-2027 to 2030-2031, the same share fixed by the 15th Finance Commission.To decide how much money could be shared with states, the FC examined fiscal data for Centre and states from 2018-2019 to 2023-2024 (excluding the Covid year of 2020-2021). It also used indicators such as population, per capita income and forest area.But the Commission made some adjustments. It increased the weight for population, reduced the weight for area, slightly lowered income distance, retained forest cover, and replaced total fertility rate with population growth as a demographic indicator. It removed tax effort and introduced a new factor — contribution to GDP — measured through a state’s share in national GSDP. This was presented as a proxy for efficiency, fiscal discipline and economic performance, and was welcomed.Using these revised criteria, the Commission recommended new tax devolution shares for states. Fourteen states saw marginal increases compared to the previous commission. Karnataka gained the most, followed by Kerala and Gujarat. Andhra Pradesh and Telangana recorded small increases, while Tamil Nadu saw only a marginal rise from 4.079% to 4.097%. At the same time, the shares of 14 states declined. Madhya Pradesh faced the largest cut, followed by Arunachal Pradesh and Uttar Pradesh.A longer-term comparison shows that disparities remain large. During the 6th FC period, four large northern states received 42.5% of total tax devolution, while the four southern states received 24.8%. By the time of the 15th FC, the top four states’ share rose to 51%, while the southern states’ share fell to 15.8%. Under the 16th Finance Commission, the southern states’ combined share has increased slightly to 17%, while the share of the largest beneficiary states has fallen to just under 50%. This represents a shift of about 1.2% in favour of the southern states. However, within the southern region, Tamil Nadu has gained the least, and the increase is almost negligible.The balance between equity and efficiency has also changed only marginally. Under the 15th Finance Commission, efficiency-related criteria accounted for 25% of the weight, while equity criteria made up 75%. Under the 16th Commission, this has shifted to 30% and 70%, an increase too small to make a big difference.Uttar Pradesh, Bihar, Madhya Pradesh and West Bengal continue to get higher shares than the fiscally stronger and better-performing Karnataka, Tamil Nadu, Gujarat, Punjab and Haryana. Ideally, the efficiency weight should be raised to about 45%.The FC has also abolished revenue deficit grants and ended sector-specific and state-specific grants. It has also recommended that the Centre reduce its fiscal deficit to 3.5% of GDP by the end of the award period, including allocations for long-term, interest-free loans to states for capital investment. States are expected to keep deficits to less than 3%. This places the burden of fiscal correction largely on states, which are asked to improve tax collection, rationalise expenditure, discontinue off-budget borrowings and bring all liabilities onto their budgets.The Commission also cautions against rising state subsidies, particularly power subsidies and cash transfers, highlights persistent stress in power distribution companies (DISCOMs), and recommends privatisation as a solution.Overall, the 16th FC’s tax devolution framework represents an incomplete course correction. While the slight shift towards efficiency-oriented criteria and the recognition of states’ contribution to GDP are welcome in principle, their diluted operationalisation has resulted in negligible gains for a fiscally disciplined, high-performing state such as Tamil Nadu. Without stronger incentives and support for better performing states, it will be difficult to accelerate the pace of development required to achieve the Viksit Bharat goal.ON THE LOSING SIDEAlthough the Commission claims to recognise efficiency and states’ contribution to GDP, this criterion is diluted by the formula used.To ‘moderate dispersion’, the FC uses the ratio of the square root of a state’s GSDP rather than the actual GSDP and 10% weight, not 25%This ends up reducing recognition of better-performing states such as Tamil Nadu.In the case of Tamil Nadu, it’s actual GSDP share of 9.14% is reduced to 6.67%.Fiscal equity gap created by this formula translates into massive financial impacts. For TN, given the 16th FC’s projected transfers, this represents an annual (notional) loss of 27,872cr(The writer is economic consultant to Tamil Nadu govt)