Union Budget 2026: South Benefits from Devolution Formula While North Experiences Minimal Loss
When the 16th Finance Commission commenced its work, concerns arose among southern states regarding a potential decrease in their share of tax transfers from the central government. These states, having prioritized population control and human development, sought assurance that their efforts would not be penalized. The Commission, led by economist Arvind Panagariya, has responded to these worries by adjusting the resource allocation formula to better reflect states’ contributions to the national GDP. This adjustment has resulted in a more favorable distribution of tax devolution for most southern states, while also impacting others across the country.
Changes in Tax Transfer Allocations
The Finance Commission has retained the devolution of 41% of the Centre’s tax collection, ensuring that most southern states, except Tamil Nadu, will receive a larger share of these funds. This adjustment is significant as it acknowledges the demographic and economic contributions of these states. The Commission’s new allocation formula considers various efficiencies, including fiscal discipline and effective spending. Additionally, it evaluates demographic performance based on the inverse of population growth from 1971 to 2011, and has revised criteria related to forest and ecological factors.
As a result, states like Maharashtra and Gujarat are also set to benefit from this revised allocation, while states such as Madhya Pradesh, Uttar Pradesh, West Bengal, Bihar, and Rajasthan will experience a slight decline in their shares. Despite this reduction, these states will still receive over 48% of total transfers. The Commission’s decisions reflect a careful balancing act, as it aims to address the needs of all states while managing the overall fiscal health of the nation.
Concerns Over Fiscal Health and Reliance on Transfers
The Finance Commission’s award period spans from April 2026 to March 2031, during which 18 of the 28 states have requested a 50% share of the divisible pool. These states argue that additional resources are essential for improving health, education, agriculture, sanitation, and law enforcement. However, the central government has urged caution regarding tax devolution, emphasizing the need for increased spending on defense and macroeconomic management.
Moreover, many states have expressed concerns about the Centre’s growing reliance on cesses and surcharges, which are not shared with the states. The Finance Commission has rejected the idea of including these levies in the divisible pool, stating that they serve specific purposes. It has also highlighted improvements in the quality of spending and the effectiveness of subsidies, while acknowledging that tax collections are not keeping pace with economic growth. This trend has led to an increased dependency on central transfers, particularly among northeastern states and others like Uttar Pradesh and Bihar.
Rising Subsidies and Cash Transfers
The Finance Commission has raised alarms about the rising subsidies and off-budget borrowings in various states. It pointed out that the power sector, which accounts for the largest share of state subsidies, is under significant stress. The Commission has recommended privatization as a potential solution to alleviate this burden. Currently, power subsidies represent approximately 27% of total subsidies and transfers, highlighting the financial strain on state budgets.
Another pressing concern is the rapid increase in unconditional cash transfers, which are expected to reach nearly Rs 2 lakh crore this year, a significant rise from just 3% in 2018-19. The Commission has identified major cash transfer schemes, including the Majhi Ladki Bahin Yojana in Maharashtra, Gruha Lakshmi in Karnataka, and Lakshmir Bhandar in West Bengal, as key contributors to this trend. As these transfers continue to grow, the Finance Commission emphasizes the need for states to manage their fiscal responsibilities carefully to ensure long-term sustainability.
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