Term of reference for 16th Finance Commission is partially approved by union cabinet

The Union Cabinet led by Prime Minister Narendra  Modi has approved Terms of reference for the 16th Finance Commission.  In a post meeting conference, Minister of Information and Broadcasting Anurag Thakur said that the 16th Finance Commission will submit its report by October 2025 and the recommendations will be valid for a five-year period beginning April 2026.

Finance commission is set up under Article 280 of the Constitution, the mandate of the finance commission is to evaluate the state of finances of the Union and State governments, and recommend the sharing of taxes between them and lay down the principles determining the distribution of these taxes among States. Earlier the 15th Finance Commission headed by NK Singh  submitted its report in November 2020 that was applicable for the financial year 2021-22 to 2025-26. The work for constituting 16th Finance Commission is started way ahead to have ample time to decide crucial resource sharing between states and the centre.

This comes at a time when the states are financially overstretched and when the debate about the states unsustainable level of debt has been stirred up again and again.  The share of net proceeds has risen from 11th Finance Commission to 14th Finance Commission. The net proceeds share has risen from 29.5 per cent to 30.5 per cent to 32 per cent to 42 per cent.

One of the main tasks of the 16th Finance Commission will be to suggest the ratio in which the tax will be divided between the Centre and states for five years, starting from April 1, 2026. Tax devolution is a major source of funds for states, used for spending on development, welfare and priority-sector projects and schemes. Currently, 41 percent of taxes collected by the Centre is devolved in 14 instalments among states during a fiscal year.

New Themes of TOR
In the approved TOR for the 16th Finance Commission, experts feel that climate financing, and sustainable development goals may have acquired space in TOR.  There is expectation that TOR would also take cognisance of states progress on capital expenditure, non-productive spending. In the RBI State of Finances Report, the state's unsustainable level of debt has been linked to bailing out of Discoms, freebies. So analysts feel that these themes would definitely get some space in TOR of 16th Finance Commision. It is interesting to note that 80-85 per cent of ToRs have been fixed for horizontal devolution of states’ aggregate share which is 42 per cent since 14th FC in the divisible pool of tax.  The remaining are performance criteria demographic performance (12.5 per cent) and tax efforts (2.5 per cent) in the 15th FC award period.