16th Finance Commission Report

The Last Five Finance Commissions: 2000‑2026

7.15 With the 80th Constitutional Amendment having come into force in 2000, the divisible pool for the last five FCs has included all Union tax revenues except cesses, surcharges, tax revenues accruing to the Union Territories (UTs) minus the cost of tax collection. Observing that the average share of the States in the divisible pool from 1980‑81 to 1999‑2000 had been 28.3 per cent and, with three minor exceptions, the share had remained consistently in the 26‑29 per cent range, the FC‑11 recommended a 29.5 per cent share in the divisible pool for the States. The FC‑12 and FC‑13 raised the share to 30.5 per cent and 32 per cent respectively. The FC‑14 broke away from this gradual approach and hiked the States’ share to 42 per cent.

7.16 In 2019, when the work of the FC‑15 was still in progress, the Union Government reorganized the erstwhile State of Jammu & Kashmir into the union territories (UTs) of Jammu & Kashmir and Ladakh. Estimating that the tax share of the erstwhile State would have been approximately 1 per cent of the divisible pool, the FC‑15 fixed the share of the remaining twenty‑eight States at 41 per cent. Therefore, currently, the tax revenues in the divisible pool are shared in a 41:59 ratio between the States and the Union.

Long‑Term Trends in Vertical Sharing of Fiscal Resources

7.17 In this section, we first consider the long‑term trend in the sharing of revenue resources between the Union and State Governments. We then analyse the implications of this sharing of revenue resources for the revenues of each tier of the government and the distribution of the total revenue of Union and States between them. We include in our discussion of the shared resources the shareable tax revenues (divisible pool) under Article 270, FC grants under Article 275(1), and non‑FC grants by the Union government under Article 282. As we will see, two features of the long‑term trend in the transfer of fiscal resources to the States stand out. First, States have seen a steady rise in their share of the divisible pool and the overall fiscal resources. Second, with two exceptions, the increase in the States’ share of the divisible pool recommended by FCs has been gradual. The exceptions are the FC‑7 and FC‑14.

The Sharing of Tax Revenue Resources

7.18 Table 7.2 shows the evolution of the States’ share in the divisible pool, FC grants, and non‑FC grants as a percentage of the gross tax revenue (GTR) of the Union under all fifteen FCs. In Table 7.3, we report the same variables, but as a percentage of GDP. The figures in the tables are averages over the years within the award period of each FC. In the case of the FC‑15, our data includes actual financials for the years 2020‑21 to 2023‑24, provisional accounts/ revised estimates for 2024‑25 and budget estimates for 2025‑26. The award periods of the FC‑3, FC‑4, FC‑9 and FC‑15 spanned four, three, six, and six years respectively. Award periods of the remaining eleven FCs spanned the usual five years.

7.19 As can be seen from Table 7.2, the total transfers to States more than doubled from 25.1 per cent of GTR during the award period of FC‑1 to 56.4 per cent during the award period of the FC‑14. Until the award period of the FC‑6, the transfers fluctuated considerably. For example, they rose to 40.8 per cent under the FC‑2, fell to 31 per cent under FC‑3, and rose again to 36.3 per cent under the FC‑4. The fluctuations continued during the succeeding two FCs, but once the FC‑7 pushed up the transfers to 45.6 per cent of GTR, they exhibited a gradually rising trend. The only big jump after that came under the FC‑14 to 56.4 per cent from 48.8 per cent under the FC‑13.

7.20 Approximately half or more of the transfers to the States have come from tax devolution throughout the period. Devolution more than doubled from 16.0 per cent of GTR during the FC‑1 award period to 34.0 per cent during the FC‑14 award period. The first large shift in this share came under the FC‑7 when it rose to 26.9 per cent of GTR from 19.9 per cent under the FC‑6. This large increase was the result of the doubling of the States’ share in the Union excise duty by the FC‑7 to 40 per cent from 20 per cent under the FC‑6. From FC‑7 to FC‑12, the share stagnated and rose only marginally to 27.9 per cent in FC‑13. However, under the FC‑14, the share saw a step jump to 34.0 per cent.

Table 7.2 Tax Devolution and Grants (percentage of GTR)

FC	Devolution	FC Grants	FC Transfers	Non‑FC Grants	Total Transfers
FC‑1	16.0	4.5	20.5	4.8	25.4
FC‑2	19.8	7.0	26.8	14.0	40.8
FC‑3	15.2	5.1	20.3	10.9	31.2
FC‑4	17.6	7.0	24.5	11.7	36.3
FC‑5	23.3	4.6	27.9	14.9	42.8
FC‑6	19.9	6.8	26.7	12.2	38.9
FC‑7	26.9	2.3	29.1	16.4	45.6
FC‑8	25.1	3.1	28.2	18.4	46.6
FC‑9	26.5	4.4	30.9	18.0	48.9
FC‑10	27.0	3.1	30.2	14.4	44.5
FC‑11	26.6	5.3	31.9	15.1	47.0
FC‑12	25.9	5.3	31.2	15.7	46.9
FC‑13	27.9	4.6	32.5	16.3	48.8
FC‑14	34.0	5.4	39.4	17.0	56.4
FC‑15	32.1	5.5	37.7	17.6	55.3

Source: See Annexure 7.1

Table 7.3 Devolution and Grants (percentage of GDP)

FC	Devolution	FC Grants	FC Transfers	Non‑FC Grants	Total Transfers
FC‑1	0.7	0.2	0.8	0.2	1.0
FC‑2	1.0	0.4	1.3	0.7	2.1
FC‑3	1.0	0.3	1.4	0.8	2.1
FC‑4	1.2	0.5	1.6	0.8	2.4
FC‑5	1.7	0.3	2.0	1.1	3.2
FC‑6	1.7	0.6	2.3	1.1	3.4
FC‑7	2.5	0.2	2.7	1.5	4.2
FC‑8	2.5	0.3	2.8	1.9	4.7
FC‑9	2.6	0.4	3.0	1.7	4.7
FC‑11	2.4	0.5	2.8	1.3	4.1
FC‑11	2.4	0.5	2.8	1.3	4.1
FC‑10	2.4	0.3	2.7	1.3	3.9
FC‑11	2.4	0.5	2.8	1.3	4.1
FC‑12	2.8	0.6	3.4	1.7	5.1
FC‑13	2.9	0.5	3.3	1.7	5.0
FC‑14	3.7	0.6	4.2	1.8	6.1
FC‑15	3.6	0.6	4.3	2.0	6.2

Source: See Annexure 7.1

Views of the State Governments

7.36 States have overwhelmingly pitched for an increase in the States’ share in the divisible pool from 41 per cent to 50 per cent. As many as eighteen out of the twenty‑eight States have made this recommendation. Exceptions include Sikkim [40 per cent with the divisible pool expanded to the Union’s Gross Revenue Receipts (GRR) or 50 per cent with the divisible pool including cesses, surcharges and cost of collection beyond 20 per cent of GTR], Madhya Pradesh (48 per cent if the divisible pool includes the entire GTR and 40.7 per cent if it includes the entire GRR), Nagaland (48 per cent), Assam (45 per cent), and Himachal Pradesh (41 per cent). States argue that the Constitution has assigned a proportionately larger expenditure responsibility to States, particularly in sectors such as health, education, agriculture, drinking water, sanitation, welfare, and law and order. To discharge these responsibilities, they need more resources.

7.37 A majority of States have also raised concerns regarding the increasing share of cesses and surcharges in GTR, as they are not a part of the divisible pool. Many submissions – including those from Gujarat, Karnataka, Kerala, Madhya Pradesh, Tamil Nadu and Uttar Pradesh – highlighted the declining share of the divisible pool in the gross tax revenues of the Union and proposed measures to counter this trend. The measures included:

1. (i) inclusion of cesses and surcharges in the divisible pool;
2. (ii) capping their share as a percentage of gross tax revenue and transferring any amount above that cap to the divisible pool; and
3. (iii) compensatory enhancement of States' share in the divisible pool if these levies remain excluded.

7.38 Among other suggestions on cesses and surcharges, Telangana has recommended transferring them to a non‑lapsable “Infrastructure Development Fund for Backward States,” while Madhya Pradesh has advocated a Constitutional Amendment requiring the Union Government to obtain ratification by at least 50 per cent of States to introduce any new cess or surcharge, as well as maintain the existing ones. Uttar Pradesh has proposed that cesses and surcharges be subject to a review, once the objective of the levy has been served.

7.39 In addition to tax revenues, several States, including Karnataka, Rajasthan, Gujarat, Tamil Nadu, West Bengal, Kerala, Tripura, and Madhya Pradesh, have proposed the inclusion of certain non‑tax revenues of the Union Government in the divisible pool. These include revenues from the sale of natural resources such as spectrum and offshore oil, dividends from public sector undertakings, and proceeds from the monetisation of public assets. The argument made is that some of these resources originate from States or were deployed on State lands.

7.40 Some States, such as Tamil Nadu, Karnataka, and West Bengal, highlighted the need for greater fiscal flexibility in Union‑to‑State transfers. Recommendations include rationalisation or consolidation of CSS, increased Union contribution in CSS, and the substitution of specific‑purpose schemes with untied grants. These suggestions were often linked to concerns about conditionalities and implementation flexibility in areas falling under the State List.

7.41 A final set of concerns by the States relates to the GST. Three such concerns are noteworthy. First, Karnataka, Kerala, Tamil Nadu, Telangana, and West Bengal have complained of a loss of fiscal autonomy. They argue that pre‑GST, they could adjust the sales tax or VAT rates. However, under GST, they have lost this flexibility since any changes to the rates require GST Council approval. Tamil Nadu, Chhattisgarh, and Haryana contend that under GST, they have lost control over a large part of their tax base. Second, Tamil Nadu has complained about the lack of buoyancy of SGST, while Himachal Pradesh, Chhattisgarh, Gujarat, Haryana, Uttarakhand, and Punjab have argued that GST’s destination‑based nature shifted revenue to consuming States, resulting in a permanent loss of revenues. Finally, many States have noted that the cessation of transfers to States from GST compensation cess on 30 June 2022, has led to a sudden fiscal imbalance in their budgets, with Tamil Nadu reporting an estimated shortfall of nearly ₹20,000 crore in 2024‑25. Several States, including Punjab and Uttarakhand, have noted that the guaranteed 14 per cent annual growth during the transition was unrealistic, with actual buoyancy of GST falling well short of it.

Views of the Union Government

7.42 In its memorandum, the Union Government expresses concern about the persistent fiscal imbalance in its budget and the tight fiscal space facing it. It notes that significant increases in vertical devolution recommended by the FC‑7 and FC‑14 were premised on providing States with more untied resources. However, these increases have had a lasting impact on the Union's fiscal space, leading to persistent revenue deficits. The Union argues that increased untied transfers aim to strengthen the fiscal autonomy of the States, but this has not always translated into sustained fiscal prudence on their part. At the same time, the Union has experienced a decline in its non‑debt revenue resources. The Union's diminished fiscal space adversely impacts its ability to achieve national development goals. The Union calls for moderation in tax devolution (without suggesting a specific division) because it requires additional resources for defence modernization and prudent macroeconomic management. It argues that the current level of vertical devolution, where more than 49 per cent of the Gross Revenue Receipts (GRR) are estimated to be transferred to States, is not fiscally sustainable. It further states that a moderated vertical devolution would be adequate for fiscally prudent States to meet their development requirements.

7.43 As regards cesses and surcharges, the Union states that their exclusion from the divisible pool is by Constitutional design and has been upheld by successive FCs. Yet, States continue to argue for their inclusion, which is contrary to the Constitution. The Union views this as a settled issue and seeks an end to the debate on it.

7.44 The Union further argues that though not shareable, cesses often fund welfare and infrastructure schemes that benefit States. For instance, the Health and Education cess supports programmes like Samagra Shiksha and the PM POSHAN Scheme, while the Road and Infrastructure cess funds the Central Road and Infrastructure Fund (CRIF), part of which is allocated to States for development and maintenance of State Roads, among other things. The Agriculture Infrastructure and Development Cess (AIDC) supports agriculture‑related schemes. In this way, cesses are often routed back to States via CSS and other schemes.

7.45 The Union contends that the concern that these levies shrink the divisible pool is frequently raised, but data suggests otherwise. Excluding GST compensation cess, cesses comprised 6.7 per cent of gross revenue during the FC‑15 period - less than the FC‑13’s 7.0 per cent. Surcharges, too, though rising on income and corporate tax, remain within historical bounds. From the Union’s perspective, says the memorandum, retaining cesses and surcharges allows quick, targeted fiscal responses, as seen during the COVID‑19 crisis.

The Commission’s Analysis

7.46 Both the States and the Union have made strong cases for their respective positions. The arguments offered by them require careful analysis.

Constitutional Considerations Regarding Non‑Tax Revenues, and Cesses and Surcharges

7.47 Many of the recommendations by the States are not in accordance with the Constitutional provisions. The Constitution does not permit the sharing of non‑tax revenues of the Union. Nor does it allow a cap on cesses and surcharges or their inclusion in the divisible pool. Regarding the CSS, there is certainly room for improvement in their design and implementation, but under Article 282 of the Constitution, any changes to them are the prerogative of the Union Government.

7.48 Is there a need to amend the Constitution, as would be required to implement these suggestions? This Commission’s considered opinion is that the founding fathers had good reasons to include these provisions, and they have withstood the test of time. Following the design of the Government of India Act, 1935, which set the template for Union‑State fiscal relations, the Constitution, in its original form, chose to limit mandatory devolution to income tax, while giving the Parliament the option to devolve a part of the excise duties. Later, when expanding the scope of devolution to all taxes with some exceptions, the 80th Constitutional Amendment once again did not consider bringing non‑tax revenues into the divisible pool. One rationale for this exclusion is that the non‑tax revenues come from Union‑exclusive activities, such as defence production, telecom services, and central public sector enterprises (CPSEs).

7.49 As regards cesses and surcharges, the Constitution provides for them in recognition of the fact that the Union may be faced with emergencies such as war, famine, and pandemic. In such situations, it needs to raise revenue without being constrained in any way. Because the requisite amount of such revenue depends on the nature of the emergency and cannot be anticipated in advance, it would be imprudent to impose a cap on it.

7.50 An inclusion of cesses partially or wholly into the divisible pool will also conflict with the purpose of the cess itself. Cesses are earmarked for expenditures on specific heads. Therefore, their design effectively rules out the inclusion in the divisible pool unless it is levied for that purpose. However, in that case, cess can be replaced by a regular tax. Higher Devolution to Counter Cesses and Surcharges?

7.51 This brings us to the States’ suggestion on countering the increase in cesses and surcharges by a compensatory increase in the States’ share in the divisible pool. The question this suggestion raises is whether a further shift in tax revenues in favour of the States is warranted. In this regard, the Commission is of the view that the current division of tax revenues, complemented by the FC and non‑FC grants, gives the States sufficient resources to discharge their Constitutional responsibilities. The proliferation of transfers and subsidies by the States to various groups and for various causes in recent years suggests the existence of sufficient funds for developmental activities in their budgets.

7.52 From 2015‑16 to 2023‑24, the percentage share of the States in the total tax revenues has averaged 57.5 per cent (Chapter 3, Figure 3.2). In 2023‑24, the latest year for which we have data, this share stood at 57 per cent. Resources at the States’ disposal are significantly larger after we take into account FC and non‑FC transfers to them. After all transfers to States are netted out, the Union Government’s share in the nation’s non‑debt revenue resources during the FC‑15 award period averaged 32.9 per cent (Figure 7.1 in this chapter). This means that the States currently spend more than two‑thirds of the nation’s total non‑debt revenues. Their share of 41 per cent in the divisible pool thus understates their overall access to non‑debt revenue resources.

Lessons of Two Historical Episodes

7.53 When considering countering cesses and surcharges by an increase in the share of the States in the divisible pool, it is of critical importance to take into account the stress that this increase would generate on the Union finances, the shift in the Union’s incentive to rely on the conventional tax instruments it would cause, and the response it would engender from the Union to shore up its fiscal space. Two historical episodes offer sobering lessons in this regard.

7.54 The FC‑7 (1979‑80 to 1983‑84) recommended increasing the States’ share in income tax from 80 per cent to 85 per cent and in the Union excise duties from 20 per cent to 40 per cent. As the excise duties constituted a large component of the Union revenues at the time, the jump in the States’ share of them led to considerable stress on the Union’s finances. Its share in the combined tax revenues of the Union and States went down from 55.3 per cent in 1978‑79 to 48.6 per cent in 1979‑80. This sharp decline led the Union Government to begin shifting its reliance from income tax and excise duties to customs duties and corporation tax, which did not form a part of the divisible pool. As a result, the combined share of income tax and excise tax in GTR fell from 43.7 per cent in 1978‑79 to just 27.9 per cent in 1988‑89. In the meantime, as a response to the declining share of the divisible pool in GTR, the FC‑8 (1984‑85 to 1988‑89) raised the States’ share in excise duties to 45 per cent.

7.55 It was this shrinking of the divisible pool as a percent of GTR that eventually led the FC‑10 to recommend the 80th Amendment to the Constitution. In its report, the Commission argued that the significantly reduced shares had resulted in a loss of interest on the part of the Union Government in raising revenue from income tax and excise duties. To support this argument, it invoked the Ministry of Finance, which had argued, “If the Central Government wishes to raise ₹100 crores for itself through Union excise duties, it would have to raise around ₹182 crores. To get the same ₹100 crores through a personal tax yield, the Central Government would have to raise ₹667 crores.”

7.56 The FC‑10 further cited the Chelliah Committee on Tax Reform to strengthen the case for the amendment. It noted that in its 1991 report, the latter had recommended fixing the share of States in aggregate central tax revenues at 25 per cent via a Constitutional Amendment. According to the Commission, the committee had argued, “There would be certainty then for the States and the Union regarding what revenues would accrue to their respective budgets and the Centre would not have to distort the pattern of taxation by being virtually compelled to raise non‑shareable taxes.”

7.57 The second episode relates to the FC‑14. Like the FC‑7, it recommended a large increase in the share of the States in the divisible pool from 32 per cent to 42 per cent. This generated stress on the Union’s finances, in response to which it’s share in majority of CSS to non‑NEH States was brought down to 60 per cent immediately and the share of cesses and surcharges increased over time to meet development spending of the Union Government. Non‑FC transfers to States, mainly through the CSS, fell from 22.4 per cent in 2014‑15 to 16.4 per cent in 2015‑16 and remained below that level for the remaining four years of the award period of the FC‑14. Over time, cesses and surcharges expanded, with a corresponding shrinking share of the divisible pool in GTR, as shown in Figure 7.4.

7.58 Economic efficiency argument dictates that reliance on cesses and surcharges as the sources of revenue except for short‑term specific needs is undesirable. This is because efficiency is best served by broad‑based taxation while cesses and surcharges are often applied to a narrow base: a specific commodity or a specific group of taxpayers. Reliance on cesses and surcharges for revenues in the long run also impedes tax reform. If the Union Government is raising a large part of its revenue from cesses and surcharges, it is likely to lose interest in the standard instruments of taxation, as noted by the FC‑10 in the context of its recommendation for the 80th Amendment. The resulting neglect may adversely impact the efforts to raise revenue buoyancy of those instruments to the detriment of the States’ interests.

Higher Devolution in Place of the CSS Transfers?

7.59 An argument is sometimes made that the Union’s share in the CSS be passed on directly to the States in untied form through a higher devolution with the role of the CSS substantially reduced or even eliminated. The argument made in favour of this change is that the States are closer to the people and are in a better position to determine the needs of their people. The diversity of India and the different levels of development imply that the needs of different States are different. Therefore, the “one size fits all” CSSs do not make optimal use of the nation’s development resources. The FC‑14 had cited this among the motivations for recommending raising the States’ share in the divisible pool from 32 per cent to 42 per cent. While none of the States has made this argument to the present Commission, given its salience among scholars and commentators, it is incumbent upon the Commission to address it.

7.60 The CSS have played a crucial role in the nation’s development. While the dominant role of the States in development is fully recognized in the Constitution as well as by successive FCs, with fiscal resources progressively shifted towards them, in some critical development areas, the Union has led the way. Therefore, we are persuaded to maintain the status quo insofar as the issue of replacing the CSS transfers with increased devolution is concerned.

7.61 A different issue related to the CSS, raised by some States, concerns their rationalisation and consolidation, and greater flexibility for the States in implementing them. While the Commission has no direct role in the design and implementation of the CSS, it appreciates the value of regular evaluation and rationalization to pave the way for the discontinuation of schemes that are not performing as expected. It is also sympathetic to giving the States greater flexibility in choosing among different CSS since their needs differ considerably due to the differences in their levels of development and diversity in other dimensions. In Chapter 6, we recommend a High‑Powered Committee to be appointed by the Union Government to carry out a fresh assessment of the schemes and recommend closure of the schemes that are not spending resources productively.

Higher Devolution to Counter the Adverse Effect of GST on the States’ Revenues?

7.62 The case for increased devolution to States due to a reduction in their revenues or loss of fiscal autonomy following the adoption of GST raises two issues. First, if the adoption of GST did lead to a reduction in the States’ revenues or autonomy, in all likelihood, it also led to a reduction in the Union’s revenues or autonomy. The right solution to the problem is for the States and the Union to work jointly within the GST Council to reform the GST such that the revenue loss to both entities is reversed.

7.63 The second issue concerns the factual basis of the decline in the States’ revenues following the adoption of GST. The GST was introduced on 01 July 2017. At the time, it was anticipated that there would be a period of adjustment to the new regime during which the States’ revenues may decline. Therefore, under the GST compact, the States were guaranteed a 14 per cent growth in SGST revenues over the base year revenues yielded by the taxes that the GST came to replace for five years. This five‑year period ended on 30 June 2022. In the meantime, the GST has achieved considerable stability and begun to generate significantly higher levels of revenues. This full restoration of revenues is also reflected in the States’ revenues. The rates of six‑year and three‑year averages of own tax revenue of States to GDP ratios ending in 2016‑17 were 6.2 per cent and 6.1 per cent, respectively. In comparison, the same ratio has been 6.3 per cent in 2022‑23 and 6.4 per cent in 2023‑24. Therefore, the combined own‑tax‑revenue‑to‑GDP ratio of the States, which must be the basis of any shift in devolution shares, has not fallen following the adoption of the GST.

7.64 A decline in the ratio of own tax revenue to GSDP of an individual State following the adoption of GST is consistent with a lack of decline in the corresponding aggregate ratio. But such a decline cannot form the basis of an increase in the aggregate share of the States in the divisible pool. For the individual States, shortfalls in revenues are dealt with as a part of the State‑level evaluation of revenues and expenditures by the Commission during its award period.

7.65 Finally, the issue of the loss of flexibility due to the GST decision being taken jointly by the Union and States in the GST Council is beyond the remit of the FC. However, we note that within its federal structure, the Indian Constitution provides for many such compromises in the larger national interest. The existence of the FC itself is an example of such a compromise. In the opinion of this Commission, GST too will emerge as a similarly outstanding example.

The Union’s Case

7.66 Though the Union has made no explicit submission regarding a shift in the share of the divisible pool in its favour, it has emphasized the need for a larger share of the nation’s revenues. There is no doubt that the recent shifts in the external security and defence environment call for increased capital expenditures on defence. The Union has also shown a high degree of effectiveness in building the nation’s infrastructure, an effort that must be supported with more financial resources.

7.67 The only instrument available to the Commission to assist the finances of the Union is the share in the divisible pool. With cesses and surcharges having cut the size of the divisible pool from 89.1 per cent of GTR in 2014‑15 to a 74‑80 per cent range during the first four years of the FC‑15 award period for which actuals are available, there is no room for cutting the States’ share in it. The Commission is of the view that if an efficient and broad‑based system of taxation is to be put in place, a grand bargain would have to be struck between the Union and States in which the Union would agree to fold a large part of the revenue from cesses and surcharges into regular taxes and States would agree to a smaller share in the resulting larger divisible pool, with no loss of revenues to either side.

Recommendation

7.68 Presently, for its award period, the Commission recommends retaining the States’ share in the divisible pool at its current level of 41 per cent.

REVENUES:CHAPTER 8 .
HORIZONTAL DEVOLUTION

8.1 Horizontal devolution refers to allocating the portion of divisible pool assigned to States among individual States. Like any exercise involving the distribution of a fixed pie among numerous claimants, this is a challenging task for Finance Commissions (FCs). Any increase in the share of one State over what the previous FC awarded implies a reduction in the share of one or more of the other States. Each State also has a perception of its fair share in the pie, based on its own unique circumstances, and views the award of a smaller share as unfair. However, the sum of these perceived shares across all States exceeds one. Recognizing these challenges, FCs have generally based their recommendations on a set of transparent criteria originating in equity and efficiency, though not to every State’s full satisfaction.

Equity and Efficiency as Guides to Horizontal Devolution

8.2 The equity objective seeks to equalize the availability of public services across States. Two key factors leading to inter‑State inequities in the provision of public services are differences in: i) available revenue resources, and ii) production costs of those services. Equity‑based devolution criteria aim to compensate for both sources of differences. Devolutions based on per capita income distance address the differences in revenue resources. Area‑based allocation is an example of devolution based on cost differences.

8.3 The efficiency‑based criteria seek to encourage healthy revenue growth and fiscal stability. To the extent that revenue growth depends on Gross State Domestic Product (GSDP) growth, these criteria may also include incentives for growth. Rewarding efficiency is important since purely equity‑based devolution undermines incentives for States to raise their own revenues or spend the available revenues prudently. For example, if a State is convinced that grants by the Union will cover any gaps between its expenditures and revenues, it is likely to slack off in raising its own revenues and may also turn profligate in its expenditures.

8.4 Equity and efficiency need not conflict, but they may. For an example of harmony between the two objectives, consider the case of a public service, such as health, provided by the State Government. Other things being the same, the lower per capita income States are able to raise less revenue of their own on a per capita basis than higher per capita income States. Therefore, with equal per capita devolution out of the States’ share in the divisible pool, the lower per capita income States are able to provide health services at a lower level than the higher per capita income States. This difference implies that the marginal benefit of health expenditures in lower per capita income States exceeds that in higher per capita income States. It follows that a shift in revenue from high per capita income States to low per capita income States on the margin would yield a higher overall benefit from health services.

8.5 Another channel through which equalizing revenue devolution can contribute to efficiency is disincentivizing costly inter‑state migration. In the absence of such devolution, higher per capita income States would provide public services such as health and education at a higher level than lower per capita income States. This difference would encourage migration from the latter to the former States. By eliminating the difference, equalising transfers would eliminate the incentive for such migration.

8.6 However, pursuing equity in devolution may also undermine the allocative efficiency of revenue resources. If the expectation that revenue transfers from Union taxes would compensate for all revenue deficiency leads the lower per capita income States to slack off on their revenue efforts, then the net effect of equity‑driven devolution on the provision of public services will turn negative. This consideration has led FCs to generally include some efficiency‑driven criteria in their devolution formulae.

8.7 An alternative classification of horizontal devolution criteria divides them into need‑based, cost‑disability‑based, and efficiency or performance‑based categories. This scheme includes population under need‑based criteria; area and infrastructure distance under cost‑disability criteria; and tax effort and fiscal stability under efficiency‑based criteria. This classification can be subsumed under the one based on equity and efficiency, since need‑based and cost‑disability‑based criteria can be included under equity.

Limits to Achieving Equity

8.8 At the outset, it is important to appreciate that multiple factors limit the ability of tax devolution to achieve full equity in the provision of public services across States. First, in addition to current expenditures, the ability to provide public services also depends on past investments in public assets such as schools, colleges, hospitals, roads, and human capital. With the limited fiscal resources available for devolution and grants during its award period, the FC must take the differences in these investments as given, and it cannot neutralize inequities resulting from them except marginally.

8.9 Second, to the extent that own‑tax and non‑tax revenues of States are large relative to the States' share in the divisible pool and feasible grants out of the Consolidated Fund of India, FC is limited in its ability to bring about full equity into the States' capacity to provide public services. In effect, the differences arising from the States' own revenue resources may be too large for FC transfers to eliminate them through devolution and grants.

8.10 Third, even if the previous two factors are absent, and FC has sufficient financial resources to devolve, it is limited in its ability to fully equalize the capacity to provide public services due to a lack of data to meaningfully measure the differences in the costs of their provision across States. The costs of providing public services vary across States due to numerous geographical, environmental, social, and cultural factors. Per capita costs of providing public services in hilly States are significantly higher on average than those in the plains, and even within these groups, these costs differ significantly. Credible data is unavailable to measure these differences in the costs of providing public goods.

8.11 Fourth, economic and political economy constraints limit the extent to which FCs can allocate revenues and grants unevenly across States to equalize their capacities to provide public services. Economic constraints result from the possible adverse effects of the uneven distribution of the divisible pool and grants on efficiency, growth, and future revenue generation. Political economy considerations may arise from a sense on the part of some States that they have been denied their ‘fair’ share of tax revenues. These considerations partially explain why past FCs have avoided devolving tax revenues or awarding grants purely on equity grounds and have given some consideration to efficiency‑based criteria such as tax effort and fiscal discipline. Indeed, recognising that equal per capita allocations are often viewed as ‘fair’, the earlier FCs had relied on population as the principal devolution criterion. The political economy constraint additionally sheds light on why the successive FCs have generally been careful not to alter the allocations made by their immediate predecessor FCs by wide margins.

8.12 Finally, even if no constraint on the FC's ability to allocate tax revenues and grants existed, it could only equalize the States' capacity to provide public services across States. Ultimately, the political leadership decides how the State's fiscal resources are allocated to different expenditure heads. These decisions can result in differences in the availability of public services, even when no differences exist in the capacities of States to provide them. In the same vein, differences across States may also arise due to differences in the governance efficiency in translating expenditures into outcomes.

8.13 Continuing differences in the provision of public services across States highlight the importance of these factors. While FC allocations of tax revenues have helped arrest the inequalities in revenue expenditures across States over the past several decades, eliminating those inequalities remains a distant goal. Nevertheless, even if substantial inequities in the States' capacities to provide public services remain, after growth accelerated and began delivering significantly larger volumes of total revenues, States have been able to raise their capacities to provide public services to higher levels and at a faster pace.

8.14 Therefore, even though horizontal devolution's power emanates from the high priority it assigns to equalization, insofar as this power depends on the magnitude of revenue resources available for devolution, efficiency of taxation and expenditure can hardly be ignored. Indeed, the efficiency assumes even greater importance since it is at the heart of growth acceleration. Rapid improvements in infrastructure, education, health and skills are just as important as their balanced development across States.

8.15 We next provide an evaluation of the criteria the past FCs have deployed to allocate the States’ share in the divisible pool among the States.

Equity‑Based Criteria of Horizontal Devolution

8.16 We divide the discussion of devolution criteria applied by past FCs into those primarily aimed at achieving equity, and those that target efficiency. In principle, almost all criteria impact both equity and efficiency. As such, the classification is only suggestive and not watertight.

Population

8.17 This criterion divides a portion of the States’ share of the divisible pool in proportion to each State's share in the total population of all States. For example, if 20 per cent of the States’ share in the divisible pool is devolved based on population, a State having 5 per cent of all States’ population receives 5 per cent of 20 per cent of the States’ share in the divisible pool. This calculation translates into the State receiving 1 per cent of States’ share in the divisible pool.

8.18 If the per capita costs of public services were constant regardless of scale and were identical across States, devolving 100 per cent of the States’ share in the divisible pool, based on population shares, would equalize the per capita capacity to provide public services across States. But neither of these assumptions is valid. Other things being the same, the larger the population, the lower the per capita cost of public service provision. Likewise, the cost of provision of public services for a given size of population varies across States according to area (cost is higher in the State with larger area), terrain (cost is higher in hilly regions), past investments in infrastructure, schools, hospitals, and human capital, and other similar factors.

8.19 If the more populous States have lower per capita incomes (or a higher incidence of poverty), even an equal per capita tax revenue allocation can lend the distribution of tax revenue some progressivity. This is because of the economies of scale in the provision of public services. Other things being the same, a more populous State can provide a given level of public service at a lower cost. Alternatively, a State with larger population can provide the public service at a higher level with the same per capita tax revenue.

Area

8.20 The area gives rise to differences in the costs of providing public services between States. Ceteris paribus, the per‑person cost of public service in a State with twice the area, but the same population as another State, is higher. To compensate for this cost disability, beginning with the Tenth Finance Commission (FC‑10), FCs have devolved a part of the States’ share in the divisible pool according to the States’ respective shares in the total area across all States.

8.21 As conventionally applied, the criterion allocates the devolved funds in direct proportion to each State’s share in the total geographical area of all States. A State twice as large in area as another State receives twice as much as the latter, and a State thrice as large receives thrice as much. Empirically, the per capita cost of the provision of public services may vary, not linearly as assumed by this allocation rule, but at a diminishing or an increasing rate. However, FCs have not investigated this relationship and adopted the practical assumption of linearity in the implementation of the criterion.

8.22 It has not been generally recognized that, in terms of per capita allocation, this criterion is equivalent to an inverse‑population‑density criterion. Area divided by population is the inverse of the population density. The higher the population density of a State, the lower its allocation per capita according to this criterion. This interpretation makes it further transparent that the criterion is designed to correct for the cost disability from the higher per capita cost of provision of public services due to a greater dispersion of population.

8.23 According to the Census 2011, the population density in India varied from 16.5 persons per square kilometre to 1105.5 persons per square kilometre. The ratio of these two population densities is 67. Therefore, per capita devolution according to this criterion to the State with the lowest population density is 67 times that of the State with the highest population density.

8.24 This interpretation also throws new light on the implications of the assignment of a minimum of 2 per cent share under area criterion to each State by recent FCs for equity. To explain, consider two States with identical population densities, but one having a 2.1 per cent share in the total area and the other having a 0.2 per cent share. Applied without modification of area, the criterion would award each State equal per capita allocation. However, replacing the smaller State’s share by 2 per cent would mean cutting its population density to one‑tenth of its original level, and result in an allocation ten times that of the larger State in per capita terms.

8.25 There is another side effect of the assignment of a minimum 2 per cent share to each State. As many as twelve States in India, jointly accounting for 11.3 per cent of the total area of the twenty‑eight States, have less than a 2 per cent share each in the total area. While the modification has the intended effect of benefiting the smaller States, it also has the unintended consequence of taking away 12.7 per cent (i.e. 24 per cent minus 11.3 per cent) of the total area from the remaining sixteen States. Such a large loss of area undermines the objective of compensation for the cost disadvantage associated with a large area that the criterion is designed to promote.

Inverse Per Capita Income Criterion

8.26 Over the years, FCs have devolved a part of the States’ share in the divisible pool based on per capita income in two forms: inverse per capita income and the distance of per capita income from a benchmark level of per capita income. In the latter case, benchmark level of per capita income is generally represented by the per capita income of the highest per capita income State among the large States. In each case, the objective is to allocate a larger revenue per capita, the lower the State’s per capita income. However, the two criteria generally lead to different allocations to the States.

8.27 The idea is based on the hypothesis that States can raise equal revenue per rupee of income with equal tax effort. This implies that despite equal tax effort, States with lower per capita income have a lower capacity to raise revenue per capita than States with higher per capita income. Therefore, if fiscal capacity equalization is the goal, States with lower per capita income must receive more revenue per capita through devolution than those with higher per capita income.

8.28 One approach to achieving this objective is to make the per capita allocation to a State proportionate to the inverse of its per capita income. Under this approach, the State’s share in the total transfer of tax revenue equals the inverse per capita income weighted population, divided by the sum of the inverse per capita income weighted population across all States.

Per Capita Income Distance Criterion

8.29 An alternative approach to making devolutions progressive, relative to the population criterion, is to base a State’s per capita allocation on the distance between a fixed benchmark per capita income and that State’s per capita income. Conventionally, FCs have proxied the benchmark per capita income to that of the highest per capita income State among large States, mostly Punjab until 2001‑02 and Haryana thereafter. Under the criterion, the lower a State’s per capita income, the greater the distance between the benchmark per capita income and its own, and the greater is the per capita allocation of revenues to it. Stated precisely, this criterion sets the share of a State in the tax revenue devolved equal to the ratio of its per‑capita‑income‑distance‑weighted population to the sum of the per-capita income‑distance‑weighted population of each State.

8.30 The progressivity of allocations under the per‑capita‑income‑distance criterion can be enhanced by excluding the States that lie nearest to the top of the per capita income distribution. For example, we may exclude the States with per capita income in the eightieth or higher percentile. The Fifth Finance Commission (FC‑5), which first introduced the per‑capita‑income‑distance criterion, deployed a version of this formulation. It excluded States with per capita incomes exceeding the average per capita income across all States and allocated per capita revenue in proportion to the shortfall of the State’s per capita income from the average per capita income across all States.

8.31 The Seventh Finance Commission (FC‑7) introduced the inverse per capita income criterion. However, the FC‑10 chose to drop it in favour of the per‑capita‑income‑distance criterion. It reasoned that, whereas the distance from the benchmark per capita income is linear in per capita income, inverse per capita income is convex over the positive range. It went on to note that, “… Compared to the distance formula, in the inverse income formula, owing to the implicit convexity in it, the middle‑income States have to bear a relatively higher burden of this adjustment” .

Poverty

8.32 FC‑7 and the first report of the Ninth Finance Commission (FC‑9) used poverty as a criterion of horizontal devolution. States with a higher incidence of poverty were awarded a larger revenue per capita. However, this criterion proved controversial due to a mismatch between available poverty estimates and States’ own perceptions of poverty faced by them relative to other States. As a result, even the FC‑9 dropped this criterion in its second and final report, noting, “…Several States did not approve of the introduction of the index of population below the poverty line in the devolution formula. They felt that State‑wise data on the number of poor people below the poverty line were not statistically reliable. … Since even the backward States such as Madhya Pradesh, Orissa, Rajasthan and Uttar Pradesh (UP) did not favour the use of the criterion of people below the poverty line in the devolution formula, we have decided to drop it” . Subsequent FCs have not revived the deployment of this criterion. Interestingly, however, some States have recommended to the present Commission to consider basing a part of its devolution on NITI Aayog’s Multi‑dimensional Poverty estimates.

Indices of the Level of Development

8.33 In the early decades, some FCs used different indicators of the level of economic development (or ‘backwardness’, a commonly used term at the time), including infrastructure index. Once again, the objective was to allocate more revenue resources, in per capita terms, to the less developed (more backward) States. In most cases, FCs did not specify how they quantified the development features they noted in the texts of their reports, though in some cases, they did. For example, the FC‑9 evolved an index of backwardness comprising “… A combination of two indices, namely, population of Scheduled Castes (SC) and Scheduled Tribes (ST) and the number of agricultural labourers in different States, as revealed in the Census for 1981” . The FC‑10 used an index of infrastructure reflecting “… the relative achievement of a State in providing an economic and social infrastructure to its citizens.” and specified the index so constructed along‑with the methodology used to derive it. The Eleventh Finance Commission (FC‑11) was the last to use an indicator in this category, an infrastructure index, which it did quantify.

Efficiency‑Based Criteria of Horizontal Devolution

8.34 Some consideration to efficiency has been given, beginning as far back as the First Finance Commission (FC‑1). The FC‑1 devolved 20 per cent of the States’ share in income tax revenues based on the State’s contribution to those revenues. Indirectly, the extent of the contribution depended on the State's income generation capacity, which in turn depended on the efficiency of resource use. Other efficiency criteria, such as forest cover, total fertility rate (TFR), tax effort, and fiscal discipline, have been added by more recent FCs. In our discussions with the States, the contribution to national gross domestic product (GDP) has also figured prominently. We briefly discuss these criteria in this section.

Forest Cover and Ecology

8.35 In recognition of growing concern for climate change, and the national importance of forests and ecology, the Fourteenth Finance Commission (FC‑14) introduced the State’s share in the total dense forest cover of all States as a criterion for devolution of a part of the States’ share in the divisible pool. The principal argument for including this criterion is based on economic efficiency. Forests generate wider ecological benefits for the country, while imposing a net cost on the host State by depriving it of alternative uses of the forest land. Forest‑area‑based devolution thus provides the necessary incentive for conserving and expanding forests.

8.36 In India’s special circumstances, the forest‑area criterion also serves as a partial proxy for cost disability characterizing the northeastern and hilly (NEH) States. The hilly terrains lead to significantly higher costs of transporting goods and people, and of building physical infrastructure than in the plains. The NEH States also suffer from relatively poor connectivity to the rest of the country. Because the ten NEH States account for 33.4 per cent of India’s dense forest area in 2021 but only 5.3 per cent of the population, on a per capita basis, the forest‑area criterion awards them a significantly larger revenue than other States.

Total Fertility Rate

8.37 Introduced by the Fifteenth Finance Commission (FC‑15), the TFR is the newest criterion deployed to allocate a part of the States’ share in the divisible pool. The criterion rewards States for their efforts to bring down population growth. Because higher the TFR, the higher the population growth, States with high TFR receive low allocations and vice versa. More precisely, the share of a State in the total resources devolved, based on this criterion, equals that State’s population weighted by inverse of TFR, divided by the sum of population weighted by inverse of TFR of each State.

8.38 In introducing TFR as a criterion for horizontal devolution, the FC‑15 sought to partially offset the disadvantage that the shift to the 2011 Census from the 1971 Census in implementing the population criterion had brought to the States that had successfully arrested the growth rates of their populations. In the words of the Commission, “…After almost four decades, this Commission has been mandated to use the population data of the most recent Census. As mentioned earlier, some States had raised serious concerns regarding this. We feel that the use of the latest Census data, and sudden change of underlying data, should not unfairly put some States which have performed well on the national objective of demographic management at a disadvantage” .

8.39 The FC‑15 classifies this criterion explicitly under ‘Performance‑based Criteria’. As such, within the equity‑efficiency framework, this criterion belongs under efficiency. However, consistent with the international discourse on the subject, the view that excessively low TFR, which is bound to lead to population aging, is to be resisted rather than encouraged has gained ground recently. There is now a growing concern about the country growing old before becoming rich.

Tax Effort and Tax Contribution

8.40 FC‑10 was the first to use tax effort as a criterion for devolution, which was subsequently used by FC‑11, FC‑12 and FC‑15. The rationale for including tax effort among devolution criteria is two‑fold. First, if FCs establish a tradition of basing a part of the devolution on the tax effort, States would be incentivized to make a greater effort to raise their own revenue. Second, the criterion would reward States that have made a stronger effort at tax collection.

8.41 Tax effort is measured by the own tax revenue (OTR)‑to‑GSDP ratio, that is, tax revenue raised per rupee of GSDP. The more tax per rupee of GSDP a State collects, the greater is its measured tax effort. Under this criterion, per capita devolution is proportional to this measure of tax effort. A State’s share in the revenue devolved is equated to its population weighted by tax‑to‑GSDP ratio divided by the sum of each State’s population weighted by tax‑to‑GSDP ratio.

8.42 An alternative to this approach is to allocate revenue to each State in proportion to its share of the total OTR across all States. This approach is equivalent to allocating per capita revenue based on per capita tax revenue raised by the State. The State's share in the devolved revenue, under this criterion, equals its population weighted by per capita tax revenue, divided by the sum of population weighted by per capita tax revenue of each State. In this form, the criterion may be more appropriately described as a tax contribution (rather than tax effort) criterion.

Fiscal Discipline

8.43 The FC‑11 first introduced fiscal discipline as a criterion for devolution to reward States for such discipline and incentivize them to improve upon it. It measured fiscal discipline by the extent of improvement a State made in the ratio of its own revenue receipts to its total revenue expenditure, relative to the improvement in a similar ratio for all States. The improvement was computed for a reference period over a base period. An improvement could result from a higher volume of own revenue, a lower revenue expenditure, or a combination thereof.

Horizontal Devolution by Successive Finance Commissions

8.44 We now review the history of horizontal devolution by successive FCs. For ease of exposition, we divide the discussion into three sections: the First to Seventh FC, the Eighth to Tenth FC, and the Eleventh to Fifteenth FC.

First to Seventh Finance Commissions: 1952‑53 to 1983‑84

8.45 The first seven FCs relied on only two criteria for horizontal devolution of the States’ share in the Union income tax: i) population and ii) contribution to tax revenues. FC‑1, FC‑3 and FC‑4 assigned 80 per cent weight to population, and FC‑2, FC‑5, FC‑6 and FC‑7 assigned 90 per cent. Tax contribution got the remainder of the weight in each case. In this scheme, the population served the cause of equity, while the tax revenue rewarded efficiency. Table 8.1 summarizes the criteria applied by these FCs.

8.46 Regarding Union excise duties, the first FC relied exclusively on population shares as the criterion for horizontal devolution as seen in Table 8.1. FC‑2 devolved 90 per cent of States’ share in excise duties based on population and 10 per cent based on other adjustments. FC‑3 also continued to base the devolution of these duties predominantly on population, but also considered, “… the relative financial weakness of the States, the disparity in the levels of development reached, the percentage of scheduled castes and tribes and backward classes in their population, etc.” . However, it did not explicitly spell out the relative weights of population and other criteria, nor did it explain how it measured them, providing only the final percentage shares of the States in the revenues devolved.

Table 8.1 Weights (percentage) of Different Criteria: First to Seventh FCs

	Income Tax		Excise Duty
	Population	Tax Contribution	Population	Other
FC‑1	80	20	100	.0
FC‑2	90	10	90	10
FC‑3	80	20	Not specified	Not specified
FC‑4	80	20	80	20
FC‑5	90	10	80	20
FC‑6	90	10	75	25
FC‑7	90	10	25	75

Source: First to Seventh FC Reports

8.47 FC‑4 was more explicit in assigning the weights to population and level of development. It devolved 80 per cent of the States’ share in excise duties based on population, and 20 per cent based on the social and economic backwardness of the States as measured by variables such as per capita value added in agriculture and manufacturing, labour participation rates, the share of the rural population in total population, gross enrolment ratios in grades I to V, population per hospital bed, and the shares of SCs and STs in the total population. However, once again, FC‑4 did not indicate how it quantified the indicators of development it had identified, reporting only the final allocations to different States out of the total share of the States in the Union excise duties.

8.48 The FC‑5 also devolved 80 per cent of the States’ share in Union excise revenues based on population. However, for the remaining 20 per cent, it argued, “…the States having less per capita incomes have lower potential for raising resources and are therefore placed at a disadvantage as compared to the States with higher per capita income” . It concluded that it was reasonable that, “…some portion of the States’ share should be distributed to States with per capita income less than the average of all States” . The capacity to raise revenue is an equity consideration while contribution to tax revenue is an efficiency consideration. The FC‑5, thus, introduced the State’s revenue‑raising capacity as a criterion for horizontal devolution for the first time. It also connected the revenue‑raising capacity of the State to its per capita income. Every subsequent FC adopted these two innovations in one form or another.

8.49 The FC‑5 devolved one‑third of remaining 20 per cent of the States’ share in Union excise duties based on an integrated index of backwardness among all States, and two‑thirds according to a per‑capita‑income‑distance formula. It restricted this latter allocation exclusively to States with below‑average per capita income. It stipulated that this part of the States’ share in Union excise duties “…should be distributed among States whose per capita income is below the average per capita income of all States in proportion to the shortfall of the State’s per capita income from all States’ average, multiplied by the population of the State” . The phrase in italics represented yet another innovation by FC‑5. It came to be known as the ‘income‑distance’ criterion, with the vast majority of subsequent FCs adopting it in some modified form.

8.50 The Sixth Finance Commission (FC‑6) set aside 75 per cent of the States’ share in the Union excise duties for devolution based on population shares, and the remaining 25 per cent on “…the distance of a State’s per capita income from that of the State with the highest per capita income multiplied by population of the State concerned according to 1971 census” . This criterion was an extension of the income‑distance criterion deployed by the FC‑5 to include all States as beneficiaries. Rather than restricting the devolution to States with below‑average per capita income, it included all States as beneficiaries. Only Punjab, the State with the highest per capita income, received zero allocation because its income distance from itself was nil.

8.51 Beginning with the FC‑7, the weight assigned to population directly in horizontal devolution of States’ share of Union excise revenues declined significantly, with equalizing criteria receiving larger weights. The FC‑7 assigned a weight of 25 per cent to population. Of the remainder, it devolved 25 per cent based on population weighted by inverse per capita income, 25 per cent on the State’s share in the total number of poor nationwide, and 25 per cent on the revenue equalization principle. The first of these three criteria represented a variation on the income distance formula, allocating a larger revenue per capita to a State, the lower its per capita income.

8.52 In implementing its third criterion, the FC‑7 first estimated each State’s potential per capita revenue based on per capita GSDP and a common average level of tax effort. It then allocated 25 per cent of the States’ share in Union excise duties in proportion to the population weighted by the distance between the highest estimated per capita revenue and the State’s estimated per capita revenue. As the Eighth Finance Commission (FC‑8) pointed out in its report, this criterion was equivalent to the income distance criterion .

Eighth to Tenth Finance Commissions: 1984‑85 to 1999‑2000

8.53 The Sixth and Seventh FCs had interpreted per capita income as an indicator of the level of development. However, like FC‑5, the FC‑8 returned to interpreting it as an indicator of revenue‑raising capacity. To quote FC‑8, “We are of the view that the distance of per capita income of States from the highest per capita income of any State, which is a well‑accepted indicator of the relative backwardness of States, would also be a good indicator of the capacity of States to raise resources” . Given that the goal of progressive tax revenue allocations is to equalize the ability of States to provide public services rather than equalizing per capita incomes or the level of development across States, the interpretation of income distance as an indicator of the gap in revenue‑raising capacity in the context of horizontal devolution is more appropriate. Unsurprisingly, this interpretation became conventional wisdom post FC‑8.

8.54 The FC‑8 unified the horizontal devolution criteria across income tax and Union excise duties. After setting aside 10 per cent of the States’ share in income tax revenue for devolution based on contribution and 11.1 per cent of their share in Union excise duties for allocation exclusively to revenue‑deficit States, it applied a common set of criteria to devolve the remaining share of States in income tax revenues plus the Union excise duties. It allocated 25 per cent of this revenue based on population shares, 25 per cent based on the inverse per capita income criterion, and 50 per cent according to the income‑distance formula. To avoid allocating nil revenue to the State with the highest per capita income (Punjab) under the income‑distance criterion, the FC‑8 notionally assigned it the same distance as calculated for the State with the second‑highest per capita income (Haryana). Notably, taking cognisance of several limitations of poverty estimates, FC‑8 dropped it as a devolution criterion.

8.55 The FC‑9, in its first report (applicable during 1989‑90), allocated 25 per cent of the States’ share in revenues from income tax and Union excise duties based on population share, 12.5 per cent based on inverse per capita income, 50 per cent based on per capita income distance and 12.5 per cent based on the proportion of poor population in the State. It devolved the States’ share in revenues from income tax and Union excise duties differently in its second report (applicable to 1990‑91 to 1994‑95). It allocated 10 per cent of the income tax revenue based on contribution, 45 per cent based on income distance, 22.5 per cent on the population as per the 1971 Census, 11.25 per cent on a composite index of backwardness, and 11.25 per cent on the population‑weighted inverse per capita income. Regarding Union excise duties, the FC‑9 allocated 25 per cent based on population, 12.5 per cent on the inverse per capita income criterion, 12.5 per cent on an index of backwardness, 33.5 per cent on the income‑distance formula, and 16.5 per cent on revenue deficit.

8.56 The FC‑10 was the last Commission before the 80th Constitutional Amendment came into force, which brought all taxes into a single divisible pool. Because FC‑10 had recommended what later became the 80th Constitutional Amendment, it is unsurprising that it returned to applying a common set of criteria to the devolving income tax and Union excise duties. Having set aside 15.8 per cent of the States’ share in Union excise revenues for devolving to revenue‑deficit States, it recommended allocating the remainder of the share in excise duties and the States’ share in income tax revenue according to a common set of criteria. It assigned a 20 per cent weight to population, 60 per cent to population weighted by per capita income distance, 5 per cent to area, 5 per cent to an infrastructure index, and 10 per cent to tax effort. The FC‑10, thus, introduced area as a criterion for the first time.

Table 8.2 summarises the allocation criteria and weights employed by the FC‑8 to FC‑10.

Table 8.2 Weights (percentage) of Different Criteria: Eighth to Tenth FCs

Criterion	FC‑8*	FC‑9* (First Report)	FC‑9 (Second Report)		FC‑10**
			Income Tax	Excise Duty
Population Share	25	25	22.5	25	20
Inverse Per Capita Income	25	12.5	11.25	12.5
Per Capita Income Distance	50	50	45	33.5	60
Proportion of Poor Population		12.5
Tax Contribution			10
Index of Backwardness			11.25	12.5
Revenue Deficit				16.5
Area				5
Infrastructure Index				5
Tax Effort				10
Total	100	100	100	100	100

Source: Eighth to Tenth FC Reports

Notes: *The weights in this column were applied to the States' share in income tax plus excise tax after taking out 10 per cent from the States’ share in income tax for allocation according to tax contribution and 11.1 per cent out of the States’ share in excise tax for devolution to revenue‑deficit States.
**The weights in this column were applied to the States’ share in the income tax plus excise tax after taking out 15.8 per cent from the States' share in excise revenues for devolution to revenue‑deficit States.

8.57 We may summarise some highlights of the allocation criteria deployed by the first ten FCs (1952‑2000). First, during the early decades, the FCs relied heavily on population as the basis for horizontal devolution. The first six FCs allocated 80 per cent or more of the States’ share in income tax, and 75 per cent or more of their share in Union excise tax based entirely on population. During this phase, per capita devolutions were approximately equal across States, with only a small degree of progressivity based on the differences in the levels of development or per capita income.

8.58 Second, devolution became more progressive under the FC‑7. With the States' share in Union excise revenues doubling from 20 per cent to 40 per cent under this FC, this source became a large proportion of the States’ share in the divisible pool. Moreover, the FC‑7 allocated 75 per cent of the States’ share in Union excise revenues based on criteria that lent progressivity to the allocations.

8.59 Third, this shift was sustained and accelerated under the Eighth to Tenth FCs, with the devolution criteria across revenues from income tax and Union excise tax substantially unified, and the direct weight assigned to population falling to or below 25 per cent. Finally, by the FC‑10, the income‑distance criterion had emerged as the major source of progressivity in horizontal devolution.

Eleventh to Fifteenth Finance Commissions: 2000‑01 to 2025‑26

8.60 The 80th Amendment Act, 2000, was notified on 09 June 2000, and came into force retrospectively from 01 April 1996. Under it, all Union taxes and duties (except cess, surcharges, tax revenues belonging to the Union Territories) minus the cost of tax collection, became a part of the divisible pool. Therefore, beginning with the FC‑11, a single set of devolution criteria disbursed the entire States’ share of the divisible pool to the States. Table 8.3 provides a summary of the criteria deployed by these five FCs.

Table 8.3 Weights (percentage) of Different Criteria: Eleventh to Fifteenth FCs

Criterion	FC‑11	FC‑12	FC‑13	FC‑14	FC‑15
Population (1971)	10	25	25	17.5
Population (2011)				10	15
Area	7.5	10	10	15	15
Income Distance/ Fiscal Capacity	62.5	50	47.5	50	45
Index of Infrastructure	7.5
Forest				7.5	10
Total Fertility Rate					12.5
Tax/Fiscal Effort	5	7.5			2.5
Fiscal Discipline	7.5	7.5	17.5
Total	100	100	100	100	100

Source: Eleventh to Fifteenth FC Reports

8.61 Under the last five FCs, the income‑distance criterion, with its progressive tilt, has been the basis of horizontal devolution of 45 per cent or more of the divisible pool. In addition, population, area, and infrastructure index also lean towards equity in varying degrees. Therefore, each of these five FCs has disbursed 75 per cent or more of the divisible pool based on equity. Forest cover is an efficiency‑based criterion, but it also carries an element of equity ex‑post since the seven northeastern States accounted for 25.4 per cent of India’s dense forest area in 2021, but only 3.8 per cent of the population as per the 2011 Census. Madhya Pradesh and Chhattisgarh together accounted for another 20.7 per cent of the forest area and 8.3 per cent of the population. The remaining three criteria - total fertility rate, tax effort, and fiscal discipline - are efficiency‑based but have accounted for the devolution of a relatively small proportion of the divisible pool.

State‑wise Shares: Eleventh to Fifteenth Finance Commissions

8.62 Next, we consider the shares of different States in the total share of all States in the divisible pool under the Eleventh to Fifteenth FCs. As a preliminary point, it is important to note that the States’ shares are impacted not only due to shifts in the devolution criteria applied, but also because of the changes in the values of underlying parameters. For instance, the per capita income distance of a State under the FC‑15 was not the same as under the FC‑14 because the per capita incomes of the States in the base years relevant to the former were different than those for the latter. In fact, analysis done by this Commission shows that, even if we were to retain the exact same criteria and associated weights as the FC‑15, the States’ shares shift significantly due to the updation of underlying data.

Non‑Northeastern and Hilly States

8.63 Table 8.4 shows the shares of non‑NEH States, classifying them into high, middle, and low per capita GSDP States, and listing them in order of declining per capita GSDP in current rupee terms in 2023‑24. We also include the population shares across all States (inclusive of Jammu & Kashmir) as per the 2001 and 2011 Censuses, the former for comparison with devolutions by FC‑11 and Twelfth Finance Commission (FC‑12), and the latter for comparison with devolutions by Thirteenth Finance Commission (FC‑13) to FC‑15. For FC‑15, precision requires recalculating the 2011 census share by excluding Jammu & Kashmir, but we eschew it to avoid making the data unwieldy. Until the end of FC‑13, Andhra Pradesh and Telangana formed a single State. Therefore, the 2011 population share of the undivided Andhra Pradesh should be obtained by adding the shares of the component States shown in the Table 8.4. Finally, the ideal comparison would be with the population shares during the award period, but given their wider acceptance, we opt for Census figures.

8.64 Devolution based solely on population would award each State a share equal to its share of the population. Under this scheme, each State would receive the same amount per capita. Therefore, comparing the devolution share of a State shown in Table 8.4 for a given State with its population share allows us to assess whether it got more than, equal to, or less than the per capita amount devolved nationally. Such a comparison in the light of the information on per capita GSDP levels also allows us to gain insight into the degree of progressivity of the devolutions relative to equal per capita revenue allocation.

8.65 Table 8.4 lists eight States under the high per capita GSDP category, seven under the middle per capita GSDP category, and three under the low per capita GSDP category. Each State in the first category had a per capita GSDP of 70 per cent of GSDP per capita of Telangana or higher, the highest per capita GSDP State among the large non‑NEH States in 2023‑24. Taken together, these eight States accounted for 33.7 per cent of the population in 2011 but had shares in the 21.2 to 23.7 per cent range in the devolution under the five FCs (FC‑11 to FC‑15). The three States in the third category had per capita GSDP of less than one‑third of Telangana in 2023‑24. Together, they accounted for 28.3 per cent of the population in 2011 and had a share in the 30.8 to 34.4 per cent range in the devolution under the five FCs. Therefore, the devolutions have had a progressive tilt under all five FCs relative to equal per capita shares.

8.66 Table 8.5 makes the comparison of devolution share with its population share explicit by reporting the ratio of the former to the latter. For the devolution shares under the FC‑11 and FC‑12, we use the population shares from Census 2001, and for those under the FC‑13, FC‑14, and FC‑15, we use the population shares from Census 2011. For the FC‑15, the shares in Table 8.5 are calculated after recalculating the 2011 population shares, with Jammu & Kashmir excluded.

8.67 If a State’s share in devolution happens to coincide with its share in population, the ratio shown in Table 8.5 would be exactly one. In this case, the State receives a per capita devolution equal to the per capita amount devolved in aggregate. If the ratio is less than one, the State receives a smaller amount per capita than the per capita amount devolved in aggregate. If the ratio is more than one, the State receives a larger amount per capita than the amount devolved in aggregate. An allocation pattern would be considered progressive relative to equal per capita amounts devolved across all States if the ratio is less than one at the top end of income distribution and if it rises as we move to poorer States.

8.68 Among the eight high per capita‑GSDP non‑NEH States, Goa was the only one to receive a larger share in devolution than its share in population under all five FCs. It received more than three times the overall devolution in per capita terms under the FC‑14 and FC‑15. Haryana, which has served as the benchmark State for the calculation of the income‑distance beginning with the FC‑11, stands out for its consistently low per capita devolutions relative to the overall devolution per capita. On the other hand, Telangana, Karnataka and Kerala saw a sharp decline in their relative per capita devolutions under the FC‑15 over that under the FC‑14. Relative per capita shares of Haryana and Tamil Nadu remained virtually unchanged, while those of Gujarat and Maharashtra saw a modest rise.

Table 8.4 Population and Devolution Shares under the Eleventh to Fifteenth FCs: Non‑NEH States

States	Population Share (2001)	FC‑11	FC‑12	Population Share (2011)	FC‑13	FC‑14	FC‑15
High per capita GSDP
Goa	0.13	0.21	0.26	0.12	0.27	0.38	0.39
Telangana	-	-	-	2.94	-	2.44	2.10
Karnataka	5.22	4.93	4.46	5.13	4.33	4.71	3.65
Haryana	2.09	0.94	1.08	2.13	1.05	1.08	1.09
Tamil Nadu	6.17	5.39	5.31	6.06	4.97	4.02	4.08
Gujarat	5.01	2.82	3.57	5.08	3.04	3.08	3.48
Maharashtra	9.57	4.63	5.00	9.44	5.20	5.52	6.32
Kerala	3.15	3.06	2.67	2.81	2.34	2.50	1.93
Total (High per capita GSDP)	31.34	21.98	22.35	33.71	21.20	23.73	23.04
Middle per capita GSDP
Andhra Pradesh*	7.53	7.70	7.36	4.16	6.94	4.31	4.05
Punjab	2.41	1.15	1.30	2.33	1.39	1.58	1.81
Rajasthan	5.58	5.47	5.61	5.76	5.85	5.50	6.03
Odisha	3.64	5.06	5.16	3.53	4.78	4.64	4.53
West Bengal	7.92	8.12	7.06	7.67	7.26	7.32	7.52
Chhattisgarh	2.06	-	2.65	2.15	2.47	3.08	3.41
Madhya Pradesh	5.96	8.84	6.71	6.10	7.12	7.55	7.85
Total (Middle per capita GSDP)	35.10	36.34	35.85	31.70	35.81	33.98	35.20
Low per capita GSDP
Jharkhand	2.66	-	3.36	2.77	2.80	3.14	3.31
Uttar Pradesh	16.42	19.80	19.26	16.78	19.68	17.96	17.94
Bihar	8.20	14.60	11.03	8.74	10.92	9.67	10.06
Total (Low per capita GSDP)	27.28	34.40	33.65	28.29	33.40	30.77	31.31
Memo
Jammu & Kashmir	1.00	1.29	1.30	1.05	1.55	1.85	0.00
All Non‑NEH States	94.72	94.01	93.15	94.75	91.96	90.33	89.55

Source: Reports of FC‑11 to FC‑15; Census of India 2001 and 2011.

Notes: *For comparing the devolution share of undivided Andhra Pradesh under the FC‑13 to its 2011 population share, the shares of bifurcated Andhra Pradesh and Telangana, shown in Table 8.4 should be summed. For the FC‑14, the population and devolution shares for Andhra Pradesh are as shown. For the FC‑15, all shares must be recalculated after dropping Jammu &ammp; Kashmir. Inter‑se shares of FC‑11 to FC‑14 are exclusive of the States’ shares of service taxes.

Table 8.5 Ratios of Share in Devolution to Share in Population: Non‑NEH States

State	FC‑11	FC‑12	FC‑13	FC‑14	FC‑15
High per capita GSDP
Goa	1.62	2.00	2.25	3.17	3.25
Telangana				0.83	0.71
Karnataka	0.94	0.85	0.84	0.92	0.71
Haryana	0.45	0.52	0.49	0.51	0.51
Tamil Nadu	0.87	0.86	0.82	0.66	0.67
Gujarat	0.56	0.71	0.60	0.61	0.69
Maharashtra	0.48	0.52	0.55	0.58	0.67
Kerala	0.97	0.85	0.83	0.89	0.69
Average (High per capita GSDP)	0.70	0.71	0.63	0.70	0.68
Middle per capita GSDP
Andhra Pradesh*	1.02	0.98	1.67	1.04	0.97
Punjab	0.48	0.54	0.60	0.68	0.78
Rajasthan	0.98	1.01	1.02	0.95	1.05
Odisha	1.39	1.42	1.35	1.31	1.28
West Bengal	1.03	0.89	0.95	0.95	0.98
Chhattisgarh		1.29	1.15	1.43	1.59
Madhya Pradesh	1.48	1.13	1.17	1.24	1.29
Average (Middle per capita GSDP)	1.04	1.02	1.13	1.07	1.11
Low per capita GSDP
Jharkhand		1.26	1.01	1.13	1.19
Uttar Pradesh	1.21	1.17	1.17	1.07	1.07
Bihar	1.78	1.35	1.25	1.11	1.15
Average (Low per capita GSDP)	1.26	1.23	1.18	1.09	1.11
Memo
Jammu & Kashmir	1.29	1.30	1.48	1.76
All Non‑NEH States	0.99	0.98	0.97	0.95	0.95

Source: Derived from Table 8.4

Notes: *See the explanation below. Census 2001 population shares have been used to calculate the ratios under the Eleventh and Twelfth FCs, and Census 2011 population shares for those under the Thirteenth to Fifteenth FCs. For the Fifteenth FC, the population shares have been recalculated from those shown in by excluding Jammu & Kashmir.

8.69 Among middle per capita GSDP States, devolutions to Andhra Pradesh, Rajasthan and West Bengal have hovered around the corresponding population shares. Devolution to Punjab, which served as the benchmark State from which most FCs calculated the per capita income distance until the FC‑10, has remained consistently well below its share of the population. The remaining States in this category - Odisha, Chhattisgarh and Madhya Pradesh - have received devolutions well above their population shares. Surprisingly, their shares in devolution have exceeded the corresponding population shares by a wider margin than those of the low per capita GSDP States.

8.70 Devolution shares of the three low‑income States - Jharkhand, Uttar Pradesh and Bihar, have consistently stayed above their corresponding population shares, but not by as wide a margin as Odisha, Chhattisgarh or Madhya Pradesh. In the case of Bihar and Uttar Pradesh, the shares have been significantly lower during the award periods of the last two FCs than those of the earlier three FCs. In all likelihood, the introduction of forest as a criterion under the FC‑14 shifted the devolution shares from these (and other) States to Chhattisgarh and Madhya Pradesh. With more than 3 per cent share in the forests, Jharkhand could make some gains from the inclusion of the forest as a criterion. A final point is that, under the FC‑11, the large 62.5 per cent weight assigned to the per capita income‑distance criterion worked especially to the advantage of Bihar, Odisha, Madhya Pradesh and Uttar Pradesh. At the time, per capita GSDP in Odisha and Madhya Pradesh were much closer to those of Bihar and Uttar Pradesh than today.

Northeastern and Hilly States

8.71 Table 8.6 and Table 8.7 provide devolution and population shares analogous to Table 8.4 and Table 8.5, respectively for NEH States. The last row of Table 8.6 reveals that the NEH States have jointly received significantly more per capita devolution than the overall devolution per capita. Moreover, the ratio of devolution share to the population share has steadily risen from 1.1 under the FC‑11 to 1.99 under the FC‑15. Under the FC‑15, these States have received twice the average level of devolution in per capita terms. Therefore, on average, the NEH States are amply compensated for their cost disadvantage on account of hilly terrain.

8.72 Beyond the aggregate ratio, there is considerable variation among different NEH States. Despite its high per capita GSDP status, Sikkim received over seven times the overall per capita devolution under the FC‑15. Arunachal Pradesh received almost fifteen times the overall per capita devolution, and twice that of Sikkim. Mizoram received more than five times the average per capita devolution. Nagaland, Meghalaya and Manipur each received three or more times the average per capita devolution under the FC‑15. Even Tripura, which is located on a flat terrain, received 2.3 times the per capita devolution across all States under the FC‑15. Only Assam among the northeastern States received a more modest 1.2 times the overall per capita devolution within the Northeast under the FC‑15. Its share has declined under the last two FCs.

Table 8.6 Population and Devolution Shares from Eleventh to Fifteenth FCs:NEH States

States	Population Share (2001)	FC‑11	FC‑12	Population Share (2011)	FC‑13	FC‑14	FC‑15
High per capita GSDP
Sikkim	0.05	0.18	0.23	0.05	0.24	0.37	0.39
Middle per capita GSDP
Uttarakhand	0.84	-	0.94	0.85	1.12	1.05	1.12
Himachal Pradesh	0.60	0.68	0.52	0.58	0.78	0.71	0.83
Mizoram	0.09	0.20	0.24	0.09	0.27	0.46	0.50
Arunachal Pradesh	0.11	0.24	0.29	0.12	0.33	1.37	1.76
Tripura	0.32	0.49	0.43	0.31	0.51	0.64	0.71
Nagaland	0.20	0.22	0.26	0.17	0.31	0.50	0.57
Total (Middle per capita GSDP)	2.16	1.83	2.68	2.12	3.32	4.73	5.49
Low per capita GSDP
Meghalaya	0.23	0.34	0.37	0.25	0.41	0.64	0.77
Assam	2.63	3.29	3.24	2.62	3.63	3.31	3.13
Manipur	0.23	0.37	0.36	0.24	0.45	0.62	0.72
Total (Low per capita GSDP)	3.09	4.00	3.97	3.11	4.49	4.57	4.62
All NEH States	5.30	6.01	6.88	5.28	8.05	9.67	10.50

Source: Reports of FC‑11 to FC‑15; Census of India 2001 and 2011

Note: Inter‑se shares of FC‑11 to FC‑14 are exclusive of the States’ shares of service taxes. Population shares have been calculated inclusive of Jammu & Kashmir. For the FC‑15, the 2011 Census shares should be recalculated by excluding Jammu & Kashmir.

Views of the State Governments

8.73 Consultation with the States’ Chief Ministers and their teams was the most enriching experience of the Commission. Each State argued its case passionately, backed it by data, charts, analysis, and arguments. Despite the wide variety of views expressed, some patterns emerge from the suggested criteria and associated weights for horizontal devolution that each State provided in its memorandum. Below, we summarise these patterns, classifying them under five major categories.

Table 8.7 Ratios of Share in Devolution to Share in Population: NEH States

States	FC‑11	FC‑12	FC‑13	FC‑14	FC‑15
High per capita GSDP
Sikkim	3.6	4.6	4.8	7.4	7.8
Middle per capita GSDP
Uttarakhand	1.12	1.32	1.24	1.32
Himachal Pradesh	1.13	0.87	1.34	1.22	1.43
Mizoram	2.22	2.67	3.00	5.11	5.56
Arunachal Pradesh	2.18	2.64	2.75	11.42	14.67
Tripura	1.53	1.34	1.65	2.06	2.29
Nagaland	1.10	1.30	1.82	2.94	3.35
Average (Middle per capita GSDP)	0.85	1.24	1.57	2.23	2.59
Low per capita GSDP
Meghalaya	1.48	1.61	1.64	2.56	3.08
Assam	1.25	1.23	1.39	1.26	1.19
Manipur	1.61	1.57	1.88	2.58	3.0
Average (Low per capita GSDP)	1.29	1.28	1.44	1.47	1.49
All NEH States	1.13	1.30	1.52	1.83	1.99

Source: Derived from data in Table 8.6

Note: Census 2001 population shares have been used to calculate the ratios under the FC‑11 and FC‑12, and Census 2011 population shares for those under the FC‑13 to FC‑15. For the FC‑15, the population shares have been recalculated from those shown in Table 8.6 by excluding Jammu & Kashmir.

8.74 First, we have States that have pitched for a continued dominance of equity in the devolution, recommending a weight for the per‑capita‑GSDP‑distance criterion equal to or larger than that assigned by the FC‑15, which is 45 per cent. Arunachal Pradesh, Bihar, Himachal Pradesh, Meghalaya, Odisha, Rajasthan and Uttar Pradesh recommend retaining the current weight of 45 per cent for the criterion. States recommending a higher weight include, with the corresponding weight in the parentheses, Punjab (47.5 per cent), Assam, Jharkhand, Tripura and West Bengal (50 per cent), Manipur (55 per cent). Some States have additionally recommended including the Multidimensional Poverty Index by NITI Aayog among the devolution criteria. These include Assam and Madhya Pradesh (5 per cent), Chhattisgarh and Gujarat (10 per cent) and Bihar (17.5 per cent). Some States recommend including a measure of contributions by the States to the Sustainable Development Goals (SDG), such as Sikkim (5 per cent), Mizoram (7.5 per cent) and Goa (12.5 per cent). Finally, Chhattisgarh, Himachal Pradesh, Madhya Pradesh, Odisha, Punjab and West Bengal have also recommended the inclusion of the proportion of SCs, STs, or both, in the total population among the criteria.

8.75 Second, many States have recommended reducing the weight assigned to the per‑capita‑GSDP‑distance criterion. A subset of these States has also recommended assigning a larger role to efficiency, by including the States’ contributions to the nation’s GDP, or incremental GDP over a base period. States recommending a lower weight for the per‑capita‑GSDP‑distance criterion than currently existing weight, include Haryana (15 per cent), Telangana (20 per cent), Chhattisgarh and Sikkim (25 per cent), Karnataka (25 per cent for the square root of per‑capita‑GSDP‑distance), Andhra Pradesh, Gujarat, Goa and Kerala (30 per cent), Tamil Nadu (35 per cent with GSDP adjusted for the purchasing power parity), Maharashtra (37.5 per cent) and Madhya Pradesh, Mizoram, Nagaland, and Uttarakhand (40 per cent). States that recommended the inclusion of the States’ contribution to GDP among the devolution criteria include Maharashtra and Madhya Pradesh (2.5 per cent), Gujarat (5‑10 per cent), Sikkim (10 per cent), Tamil Nadu (12.5 per cent), Karnataka (20 per cent), and Telangana (50 per cent).

8.76 Third, the tax effort is another efficiency‑based criterion which finds frequent mention in the States’ recommendations, albeit with a small weight. Bihar, Chhattisgarh, Jharkhand, Karnataka, Madhya Pradesh, Maharashtra, Nagaland, Rajasthan, Tamil Nadu, Uttarakhand and West Bengal recommended including this variable among the devolution criteria with its current weight of 2.5 per cent. States that recommended an increase in its weight include Manipur (3 per cent), Assam, Goa, Punjab and Telangana (5 per cent), Uttar Pradesh (10 per cent) and Haryana (35 per cent).

8.77 Fourth, many States have recommended maintaining the current weight of the forest and ecology criterion or increasing it. Assam, Bihar, Goa, Karnataka, Maharashtra, Mizoram and Odisha have recommended retaining the 10 per cent weight assigned by the FC‑15. States recommending an increase in the weight include Arunachal Pradesh, Chhattisgarh, Himachal Pradesh and Jharkhand (12.5 per cent), Madhya Pradesh, Meghalaya and Nagaland (15 per cent), Manipur (17 per cent for the forest‑to‑total area ratio) and Andhra Pradesh, Sikkim, Tripura and Uttarakhand (20 per cent). A few other States have also recommended keeping forest and ecology among the criteria but with a weight smaller than 10 per cent.

8.78 Fifth, the population criterion continues to enjoy wide support. The States also generally agree on the reliance on the 2011 Census population figures for this purpose. The recommended weights vary from 5 per cent (Andhra Pradesh and Telangana) to 32.5 per cent (Kerala). The closely related demography variable, based on the TFR, also receives frequent mention among the suggested criteria. States supporting its inclusion include Bihar, Chhattisgarh, Gujarat, Himachal Pradesh, Madhya Pradesh, Meghalaya and Tripura (5 per cent), Haryana and Uttar Pradesh (7.5 per cent), Maharashtra, Odisha and Telangana (10 per cent), Karnataka, Nagaland, Punjab and Rajasthan (12.5 per cent), Assam (12.5 per cent with a floor of 2.1 on TFR), Goa (12.5 per cent with the floor of 1.0 on TFR), Tamil Nadu (15 per cent), Andhra Pradesh and West Bengal (20 per cent) and Kerala (22.5 per cent). Annexure 8.1 gives the details of criteria and weights suggested by the States.

Views of the Union Government

8.79 The Union’s submission to this Commission views horizontal devolution as a key instrument of India’s fiscal federalism that has steadily evolved from a purely equity‑based exercise to one that blends equity and performance‑based criteria. This shift, shaped by successive FCs, reflects a deliberate nudge to States towards greater fiscal self‑reliance, prudent financial management, and efficient use of resources.

8.80 While recognizing the importance of population, income distance, and environmental factors like forest cover and geography, the Union noted a gradual reduction in the weight of pure equalization criteria and a growing space for performance‑linked measures such as tax effort and fiscal discipline. Against this backdrop, it recommended a recalibration of the formula that restores fiscal discipline, measured comprehensively through indicators of deficits, debt, and recoveries from State entities like electricity distribution companies, to reward sustained prudence.

8.81 The Union also expressed concern about the disruptive volatility caused by major formula changes between Commissions. As a solution, it recommended introducing caps and collars on per capita shares under each parameter, ensuring that no State experiences abrupt gains or losses, and that transfers remain predictable for fiscal planning.

Devolution Criteria and Recommendations

8.82 In its approach to horizontal devolution, this Commission has been guided by two principles. First, the change in the States’ shares in the portion of the divisible pool assigned to them as a part of the vertical devolution should be gradual. This means that any changes to the criteria and weights we recommend should take into account the magnitude of change in the States’ shares they imply. In this respect, particular care must be taken concerning States that experience a reduction in their share over that under the FC‑15.

8.83 Second, with growing ambition of the country as the backdrop, due recognition must be given to efficiency and especially the States’ contributions to growth. Accordingly, for the first time, this Commission decided to add the State’s contribution to GDP among its horizontal devolution criteria. Taking cognizance of the principle of gradualism, however, we decided that the weight assigned to the criterion should be such that it spells only a directional change without causing a drastic shift in the States’ shares. We provide the details on how we implemented this criterion below.

Devolution Criteria and Associated Weights

8.84 Other than introducing the contribution to GDP as a criterion, we rely on five criteria that have been employed by previous FCs: population, demography, area, forest and per‑capita‑GSDP‑distance. In some cases, we make adjustments to the criteria that are novel, however. We spell out these adjustments below, with further details provided in the Technical Note at the end of the chapter.

Population

8.85 In keeping with the longstanding practice, described in the section on the devolutions by the past FCs, we continue to include population among the criteria. In conformity with the uniform recommendation by nearly all States, we implement this criterion by awarding each State an allocation based on its share in the Census 2011 total population of the twenty‑eight States. We assign a weight of 17.5 per cent to this criterion. We note here that whenever any of our variables are combined with population, we rely on the 2011 Census figures. In this respect, we have fully transitioned from the 1971 Census population to the 2011 Census population data.

Demographic Performance

8.86 The FC‑15 had introduced the TFR as one of the criteria for devolution. It awarded each State a per capita share in proportion to its inverse TFR. To convert the per capita share into total, it used the 1971 Census population. It reasoned that the shift from the 1971 Census population to the 2011 Census population in implementing the population criterion, as mandated by its terms of reference, had led to too large a loss in the devolution shares of States that had successfully arrested the growth rate of the population between 1971 and 2011. The inverse TFR offset some of that loss.

8.87 The Commission deliberated the merits of this criterion at length. There are arguments that under the changed circumstances, the advantages of slower population growth had been replaced by the fears of an aging population, as exemplified by the experiences of Europe, Japan and China. The Commission found itself in sympathy with the view that as India travels on the growth path, it faces the risk of aging before it becomes rich. This could adversely impact the country’s growth prospects. Therefore, the justification for basing devolution on inverse TFR became weak over time. Accordingly, the Commission considered several alternative criteria that could replace it without large shifts in the States’ shares in devolution. Unfortunately, this effort proved unsuccessful in that the alternative criteria implied a larger shift in the shares than what would be desirable.

8.88 Therefore, while we are of the firm view that a reward for the lower population growth through TFR or other indicators must be phased out in due course from the devolution criteria, we have opted for a gradual transition by reducing the weight of the demographic performance variable from 12.5 per cent by the FC‑15 to 10 per cent. In addition, we have replaced TFR, which is a derived indicator from population data, with population growth, which is directly calculable from the Census figures. Specifically, we set the per capita devolution to a State in proportion to the inverse of its population growth between 1971 and 2011 Censuses. We convert this per capita devolution into total by multiplying it by the 2011 population. The Technical Note at the end of the chapter provides the precise formula.

Area

8.89 We have continued to include the share of a State’s area in the total area of the twenty‑eight States among our devolution criteria. Recent FCs have assigned every State a minimum share equalling two per cent in translating this criterion into practice. We noted in our earlier discussion that this assignment has two undesirable implications: i) with twelve States qualifying for the assignment, other States lose a substantial part of their actual share, and (ii) the assignment creates large inequity between States with an area just above two per cent and those with a small area and a small population in per capita terms. This Commission deliberated on these issues and concluded that a correction in this respect was required. Following the principle of gradualism and recognizing that a complete elimination or even a sharp reduction in the floor would have too large an impact on some small States, it opted for reducing the floor to 1.5 per cent. The Technical Note at the end of the chapter provides the precise formula. We assigned a weight of 10 per cent to this criterion.

Forest

8.90 During our consultations, some States had asked the Commission to include open forests in defining this variable. A handful of States had also recommended rewarding States for the expansion of the forest over a base period. We have incorporated both suggestions. The Forest Survey Report (FSR) defines very dense forest (VDF) cover as having a canopy density of 70 per cent and above, moderately dense forest (MDF) cover as having the canopy density of 40- 70 per cent, and open forest (OF) cover as having the canopy density of 10‑40 per cent. We define a weighted forest area by assigning a weight of 0.30 to OF, 0.65 to MDF, and 1.0 to VDF. These weights are the ratio of the mid‑point of the range for that category of forest to the mid‑point of the range for VDF. We have combined the share of weighted forest area of the State in the weighted forest area of all States and the share of increase in weighted forest area of the State in the increase in weighted forest area of all States in the ratio of 80:20 to arrive at the forest variable. For this purpose, the increase is calculated from 2015 to 2023 and for cases where there is a decrease, change is taken as zero. The Technical Note at the end of the chapter provides the precise formula. We assign a weight of 10 per cent to this variable.

Per capita GSDP Distance

8.91 This is now a well‑accepted and dominant equity variable. It is aimed at correcting for differences in fiscal capacity among States by devolving more to States with lower per capita GSDP. Most of the past FCs have set the benchmark per capita GSDP, from which the distance is measured, equal to the average per capita GSDP of the State with the highest average per capita GSDP among the large States. For this purpose, we use average per capita income of states over 2018‑19 to 2023‑24 excluding the COVID‑19 year of 2020‑21.

8.92 Shifts in per capita GSDPs in recent years have resulted in very narrow gaps among the per capita GSDPs of the three States with the highest per capita GSDPs (excluding Goa and Sikkim). Therefore, the per capita GSDP distances of the States with the second and third highest per capita GSDPs from the one with the highest per capita GSDP become too small to result in any meaningful devolutions to them.

8.93 To get around this problem, we take the average of the top three highest per capita GSDP States as the benchmark per capita GSDP. For this purpose, we exclude Goa and Sikkim. We then take the distance of the per capita GSDP of the State with the fourth‑highest per capita GSDP from this average. We assign this same distance to all four highest per capita GSDP States, as well as Goa and Sikkim. For the remaining States, we take the distance of their per capita GSDP from the average of the top three. Per capita devolution is set in proportion to the per‑capita‑GSDP‑distance so calculated. To convert this devolution into total, we multiply by the 2011 population of the State. The Technical Note at the end of the chapter provides the precise formula employed to calculate each State’s devolution. We assign a weight of 42.5 per cent to this criterion.

8.94 Following the past FCs, we eschew introducing the indicators of equity, such as multidimensional poverty and shares of SC and ST populations in the total population, as criteria for devolution. The Commission concluded that per capita GSDP is a more direct measure of the State’s fiscal capacity to provide public services. It also correlates positively with other measures of equity and therefore indirectly captures them.

Contribution to GDP

8.95 This is a new criterion we are introducing in recognition of India’s growth ambition. Many States have also recommended to us the inclusion of this criterion. We define the State’s contribution to GDP by the share of its GSDP in all States’ GSDP. In implementing the criterion, however, we found that these contributions are dispersed very widely, especially at the top and bottom ends, giving rise to large differences in the implied devolutions to the States. To moderate these differences, we have modified the criterion by defining the State’s share as the ratio of square root of its GSDP to sum of square root of GSDP of all States. Further details on the implementation of the criterion are provided in the Technical Note at the end of the chapter. We assign a weight of 10 per cent to this criterion.

8.96 We note that just as the per capita GSDP distance serves as a surrogate for other equity‑related criteria such as poverty and SDG achievements, the contribution to GDP serves as a surrogate for efficiency‑based criteria such as tax effort and fiscal discipline. On a per capita basis, the proportionately larger contribution to GDP is indicative of generally better economic management. Specifically concerning tax effort, we note that this criterion exhibits a limited variation across States. Variation in the tax‑effort weighted population shares of the States, which form the basis of devolution under this criterion, is determined principally by variation in the population shares. The correlation coefficient between tax‑effort weighted population shares and their population shares is 0.98 in our data. With some exceptions, the criterion allocates funds in the same proportion as population shares.

Inter se Share of States in RLB Grants

State	Area ('000 Sq.km)	Area share (10%)	Rural Population (000)	Rural Population share (90%)	Rural Interse (%)
Andhra Pradesh	162.92	0.53	32,974	3.29	3.82
Arunachal Pradesh	83.74	0.27	1,185	0.12	0.39
Assam	78.44	0.26	30,987	3.09	3.35
Bihar	94.16	0.31	1,16,546	11.62	11.93
Chhattisgarh	135.19	0.44	22,516	2.24	2.68
Goa	3.70	0.01	329	0.03	0.04
Gujarat	196.24	0.64	36,906	3.68	4.32
Haryana	44.21	0.15	17,577	1.75	1.90
Himachal Pradesh	55.67	0.18	6,806	0.68	0.86
Jharkhand	79.72	0.26	30,178	3.01	3.27
Karnataka	191.79	0.63	37,253	3.71	4.34
Kerala	38.85	0.13	6,351	0.63	0.76
Madhya Pradesh	308.25	1.01	63,685	6.35	7.36
Maharashtra	307.71	1.01	65,537	6.53	7.54
Manipur	22.33	0.07	2,213	0.22	0.29
Meghalaya	22.43	0.07	2,734	0.27	0.34
Mizoram	21.08	0.07	563	0.06	0.13
Nagaland	16.58	0.05	1,128	0.11	0.16
Odisha	155.71	0.51	38,064	3.79	4.30
Punjab	50.36	0.17	17,861	1.78	1.95
Rajasthan	342.24	1.12	61,261	6.11	7.23
Sikkim	7.10	0.02	310	0.03	0.05
Tamil Nadu	130.06	0.43	34,701	3.46	3.89
Telangana	112.12	0.37	19,258	1.92	2.29
Tripura	10.49	0.03	2,427	0.24	0.27
Uttar Pradesh	240.93	0.79	1,84,063	18.34	19.13
Uttarakhand	53.48	0.18	7,526	0.75	0.93
West Bengal	88.75	0.29	62,144	6.19	6.48
Total	3,054.25	10.00	9,03,083	90.00	100.00

Source:

1. Rural population: Population projection 2026 (Oct) – Report of the Technical Group on Population Projections, MoHFW (2020)
2. Area: MoSPI

Recommendation

8.97 Based on the above criteria and weights, the Commission has worked out the shares of the twenty‑eight States in the portion of the divisible pool assigned to the States. These criteria, their assigned weights and shares of States are reported in Table 8.8 and Table 8.9 below.

Table 8.8 Formula for Horizontal Devolution

Criteria	Weight (percentage)
Population (2011)	17.5
Demographic Performance	10
Area	10
Forest	10
Per Capita GSDP Distance	42.5
Contribution to GDP	10
Total	100

Table 8.9 Inter se Share of States

States	Share (percentage)
Andhra Pradesh	4.217
Arunachal Pradesh	1.354
Assam	3.258
Bihar	9.948
Chhattisgarh	3.304
Goa	0.365
Gujarat	3.755
Haryana	1.361
Himachal Pradesh	0.914
Jharkhand	3.357
Karnataka	4.131
Kerala	2.382
Madhya Pradesh	7.347
Maharashtra	6.441
Manipur	0.626
Meghalaya	0.631
Mizoram	0.564
Nagaland	0.481
Odisha	4.420
Punjab	1.996
Rajasthan	5.926
Sikkim	0.335
Tamil Nadu	4.097
Telangana	2.174
Tripura	0.641
Uttar Pradesh	17.619
Uttarakhand	1.141
West Bengal	7.215
Total	100

Technical Note: Horizontal Devolution Formula

Our horizontal devolution is based on six criteria: 1) Population, 2) Demographic Performance, 3) Area, 4) Forest, 5) Per‑capita GSDP distance, and 6) Contribution to GDP. In the formulas below, we represent them by index i with i = 1, 2, … 6. Each criterion is assigned an index value corresponding to its order in this list. We index the States by j, with j = 1, 2, …, 28. The share of State j in the States’ share in the divisible pool is written as,

(i) Sj = W C j = 1, 2, …, 28.

In equation (1), we define various symbols as follows:

Sj = Share of State j in the States’ share in the divisible pool.

Wi = Weight assigned to criterion i in the devolution formula. For example, for i =1, which is the population, we have W1 = 17.5 per cent or 0.175.

Cij represents the share of State j in the part of the States’ portion of the divisible pool disbursed based on criterion i.

With the Wi already specified by the devolution criteria, we only need to spell out how the Cij are determined. This is done separately for each criterion below.

1) Population (i = 1)

Under this criterion, each State receives a share in the portion of the States’ share in the divisible pool, devolved based on population, equalling its share in the total population of the 28 States. Denoting by Nk the population of State k (k = 1, 2, … 28) as per the 2011 Census, we have,

(ii) C1j = j = 1, 2, …, 28.

2) Demographic Performance (i = 2)

Under this criterion, each State receives a per capita amount in proportion to the inverse population growth between 1971 and 2011. The higher the population growth, the lower the proportionate per‑capita amount. Denoting by Gk the growth in population from 1971 to 2011 in State k, that State’s share in the portion of the States’ share in the divisible pool devolved according to this criterion is,

(iii) C2j = j = 1, 2, …, 28.

3) Area (i = 3)

Under this criterion, each State receives a share in the portion of the States’ share in the divisible pool in proportion to its share in the total geographical area of the 28 States, subject to a floor of 1.5 per cent. For this purpose, the States, having geographical area less than 1.5 per cent of the total geographical area of all 28 States, are assigned a share of 1.5 per cent; and the shares of the other States are reduced in proportion of their respective share in the total geographical area of all States, so as to restore the sum across all States to unity. Denoting by Ak the area of State k (k = 1, 2, … 28) in the total area of all 28 States, we have,

(iv) C3j = 0.015 or 1.5 per cent for all j = 1, 2, …, 28 whose share of geographical area in total geographical area of 28 States is less than or equal to 1.5 per cent (i.e. A 0.015 or 1.5 per cent), and

(v) C3j = {1 − (n 0.015)} for all j and k = 1, 2, …, 28 whose A > 1.5 per cent or 0.015, where n is the number of States having A 0.015 or 1.5 per cent.

4) Forest (i = 4)

Under this criterion, we have two components: i) based on the State’s share in the forest area of all 28 States and ii) the State’s share in the increase in forest area of all States between 2015 and 2023. The former is assigned a weight of 80 per cent and the latter 20 per cent to derive the forest variable. For this purpose, the forest area itself is defined as a weighted sum of very dense forest (VDF), moderately dense forest (MDF) and open forest (OF), with weights of 1.0, 0.65 and 0.30 respectively. Denote by Fk (k = 1, 2, … 28) the forest area, which is, weighted sum of the three types of forests, in State k. Then, the share of State j in the States’ portion of the divisible pool, devolved based on the forest variable, is written as,

(vi) C4j = 0.8 + 0.2 ∆ j = 1, 2, …, 28.

For States experiencing a decline in the forest area between 2015 to 2023, ∆Fk = 0.

5) Per Capita GSDP Distance (i = 5)

Under this criterion, each State receives a per‑capita share in the portion of the States’ share in the divisible pool devolved based on the per‑capita GSDP distance criterion in proportion to the difference between a target per‑capita GSDP and its own per‑capita GSDP. We denote the per‑capita target GSDP by y* and the per‑capita GSDP of State k by yk (k = 1, 2, …, 28). The share of State j in the States’ portion of the divisible pool, devolved based on the per capita GSDP distance criterion, is written as,

(vii) C5j = ( ) j = 1, 2, …, 28.

( ) We define y* as the average of the per‑capita GSDPs of the three large States with the highest per‑capita GSDPs: Telangana, Karnataka and Haryana. For these three States, Goa and Sikkim, the latter two being small States with the highest per‑capita GSDPs in the country, we set y*‑yk equal to the difference between y* and the per‑capita GSDP of the large State with the fourth highest per‑capita GSDP, which is, Tamil Nadu. Per‑capita GSDP of each State is derived as its average nominal per‑capita GSDPs during 2018‑19 to 2023‑24 excluding the COVID‑19 years of 2020‑21. 6) Contribution to GDP (i = 6) Under this criterion, each State receives a share in the portion of the States’ share in the divisible pool, devolved based on the contribution to GDP, equalling the share of squared root of its GSDP in the sum of squared root of GSDPs of all 28 States. Denoting by Yk the GSDP of State k (k = 1, 2, … 28), we have, (viii) C6j = , j = 1, 2, …, 28. ( ) The GSDP of each State is measured as the average of its nominal GSDPs from 2018‑19 to 2023‑24, excluding the COVID‑19 year of 2020‑21.