THE 16th Finance Commission (FC), constituted on December 31, 2023, with Aravind Panagariya as chairman, is currently preparing its report. The FC has already started visiting state governments and holding discussions on the memorandum submitted by the state governments. Recommendations of the 16th FC will cover a five-year period starting on April 1, 2026.

Article 280(1) of the Indian Constitution outlines how a Finance Commission is established. The terms of reference for the 16th Finance Commission include inter alia: the distribution of net tax proceeds between the union and states, the principles governing grants to state revenues from the Consolidated Fund of India, measures to enhance the state’s consolidated fund to support panchayats and municipalities, and a review of current financing for disaster management initiatives.

The reports and awards of the Finance Commission (FC) have been key in shaping fiscal federalism in India. They influence how resources are distributed vertically between the union and state governments and horizontally among the states. Constitutionally, the union government has power to raise a larger share of gross tax revenues than the states, the inequality thus created has been worsening over the period. Meanwhile, states have taken on many developmental responsibilities that often generate little or no revenue. According to the 15th Finance Commission report, the states collect only about 37 per cent of the combined revenues of the central and state governments, while about 63 per cent of expenditure obligations were at the state level. Central taxes are generally more buoyant than those of the states, partly due to the inclusion of new areas like services in the central tax net and additional revenue from spectrum sales and profit shares from the Reserve Bank of India. Finance Commissions established every five years are expected to address this imbalance. The Finance Commission is responsible for ensuring a fair distribution of national resources among states with different abilities to raise resources.

The vertical and horizontal imbalances in India's fiscal system have increased over time, reaching a critical point with the recommendations of the 15th Finance Commission. The system of cooperative federalism is now in serious crisis. Kerala is one of the states most affected by this imbalance. Other states, regardless of the political party in power, are also suffering from this situation. In this context, the government of Kerala staged a protest in Delhi and also had to approach Supreme Court for demanding its due share in national resources. Consecutively, the government of Kerala organised a conclave of finance ministers from like-minded states. Ministers from Punjab, Tamil Nadu, Telangana, and Karnataka participated in the conclave in addition to the chief minister and finance minister of Kerala.

The objective of the conclave was to have a broad consultation on the states' memorandum to be submitted to the 16th Finance Commission. In addition to the ministers, former finance minister of Kerala, Thomas Isaac, noted academics, senior bureaucrats and the leader of opposition in the Kerala legislative assembly also participated in the conclave.

One of the common views that came out in the conclave was that there has been a reduction in the size of the divisible pool over the period. One of the main reasons for this has been pointed out as the practice of the union government raising revenue through sources that are not divisible, such as cesses and surcharges, disinvestments, the monetisation of public assets, and RBI profits. In 2011-12, cesses and surcharges made up only 9.4 per cent of total taxes, but by 2022-23, this increased to 22.8 per cent. During the 15th Finance Commission, it was decided that 41 per cent of the tax collected by the union government would be in the divisible pool. However, due to the significant rise in cesses and surcharges, only 29.6 per cent of central taxes effectively go into the divisible pool. In this way, the union government is undermining the constitutional rights of state governments.

During the 10th Finance Commission, the government of Kerala received 3.875 per cent from the divisible pool. However, during the 15th Finance Commission period, this dropped significantly to 1.92 per cent. The criteria used to determine the share of the divisible pool do not favour Kerala. The state's high level of human development is viewed negatively, and the decrease in population is also affecting Kerala's share.

The introduction of GST affected the revenue of many state governments, as they gave up a significant part of their taxing rights. While GST was expected to increase revenue for both the union and state governments, it has not met this promise. The overall revenue growth has been below the projected 14 per cent, with states facing a larger revenue shortfall than the centre. The 16th Finance Commission should take the impact of GST into account and consider compensating states for their revenue losses.

Another area of concern is the centrally sponsored schemes. While the centre controls the choice and design of these schemes, states must share the expenses. States can only access central funds for these schemes if they agree not only to the cost-sharing but also the conditionalities prescribed unilaterally by the union government. These schemes are designed by the centre without considering region-specific issues. It's also worth noting that the central government has discontinued some schemes and significantly reduced the union share in others. This resulted in additional burden to the state government to carry forward with the projects.

The conclave of finance ministers was inaugurated by the chief minister Pinarayi Vijayan. In his speech, he highlighted the need to address the distribution of taxes among the states. The 16th Finance Commission faces the challenge of balancing the interests of states with low per capita income and larger populations, and those that have met the goals of the national population policy.

Krishna Byre Gowda, minister for revenue, Karnataka, praised the Kerala government for organising the conclave. He said that states contribute greatly to the union by generating financial resources and creating opportunities, which boosts the national GDP. He emphasized that states play a major role in the well-being of the union and that all are committed to making it the best in the world. However, for the union to thrive, all its parts must be treated fairly. He also noted that if states prosper, the nation benefits, as states are the "golden geese" laying the "golden eggs" for the union. Taking care of states’ benefits the entire nation.

Tamil Nadu's finance minister, Thankam Thennarassu, pointed out that while states are responsible for most development tasks and public services like education, health, agriculture, and social welfare, the union government holds most of the revenue-generating powers. He stressed that states should collectively push for a 50 per cent share in central tax devolution. He also urged the commission to reduce reliance on discretionary grants and increase predictable and fair resource transfers.

Telangana's deputy chief minister, Bhatti Vikramarka Mallu, stated that the relationship between the centre and states regarding financial devolution is not just a technical issue but a matter of equity, autonomy, and the future of Indian federalism. He stressed the importance of revisiting the vision of the constitution's framers and reflecting on where we stand today. He also criticised the use of 2011 population figures in determining devolution, saying it punishes states that have successfully controlled population growth through good governance and social investments. This, he argued, is not only unfair but discourages good governance. Regarding the centre’s control over borrowings, he noted that the FRBM Act aimed to ensure fiscal discipline, but the centre itself has failed to maintain it, with a fiscal deficit of 6.4 per cent of GDP, far exceeding the limits set for states.

Harpal Singh Cheema, finance minister of Punjab, emphasized the need for a balanced approach that rewards progress while ensuring no state is left behind due to a lack of resources or historical disadvantages.

VD Satheesan, leader of opposition, Kerala, said the Finance Commission should recognise states' efforts in population control and provide additional funds based on performance in areas like good governance, transparency, and development. He also suggested using improvements in carbon neutrality as an incentive. According to him, the ecological issues being faced by the state should also be considered while sharing the resources horizontally.

There was a brain storming session of economists and senior bureaucrats followed by the session engaged by the ministers. Noted economists include Thomas Isaac, Prof. VK Ramachandran, Dr. Arvid Subramanian, Prof. CP Chandrasekhar, Prof. Jayati Ghosh, Prof. Govinda Rao, Prof. Susheel Khanna, Prof. MA Oommen, Dr. Rammanohar Reddy, Prof. KN Harilal, Prof. Pinaki Chakaraborty, Prof. DK Srivastava. This session also witnessed considered opinion from government secretaries of Tamil Nadu, Karnataka, Telangana and Punjab along with senior officials such as KM Chandrasekhar IAS (former cabinet secretary, government of India) and KM Abraham IAS (chief principal secretary to CM, government of Kerala). This session mainly shared the views which were mostly in tune with the ideas and opinions that came in the first session. There were a number of considered opinions that came up in this session. The state specific issues are viewed as important to be protected for maintaining the true spirit of cooperative federalism. Ageing population, inter-state migration, return migration from abroad, efforts of decentralisation, coastal erosion etc are highlighted as important areas specific to states that need special mention while discussing about the resource sharing among states in the India Union.