States and the challenge before the Finance Commission

Contact Counsellor

Last Updated07/12/2024

The recent convening of the Sixteenth Finance Commission in Tamil Nadu, chaired by Arvind Panagariya, marks a pivotal moment for India's fiscal future. With a team of distinguished experts from various fields, the Commission is tasked with addressing the evolving fiscal challenges facing the nation, while seeking to rectify the historical skew in the relationship between the States and the Union.
The decisions made will influence India’s economic trajectory not only for the next five years but also for the decades ahead, particularly as global economic dynamics are undergoing significant shifts.

Friendshoring and reshoring are transforming global trade and investment patterns, providing India with a strategic opportunity to strengthen its economic position. As Tamil Nadu stands at the forefront of India's growth, it is crucial for the Finance Commission to balance equitable redistribution with the need to incentivize growth in progressive States like Tamil Nadu.

Historically, the Finance Commission has aimed to ensure equitable distribution of resources. However, discrepancies between the objectives and outcomes have remained, especially with the Fifteenth Finance Commission.
While the vertical share of the divisible pool was set at 41%, the actual devolution was only 33.16% of the Union’s gross tax revenue. This disparity is exacerbated by the Union’s reliance on cess and surcharges, leaving States with fewer resources to meet their developmental needs.
To address this, there is a need for 50% devolution of gross central taxes to States, granting them greater fiscal autonomy to fund and implement locally relevant programs.

A key debate for the Finance Commission is whether to focus on a smaller national pie with a larger share for less-developed States, or a larger national pie with equitable distribution.
A balanced approach that expands the national economic pie would benefit both less-developed and progressive States, ensuring that all receive adequate resources to sustain growth while allowing high-performing States to continue their upward trajectory.

Progressive States, such as Tamil Nadu, face unique challenges that need to be addressed in the Commission’s recommendations. The State’s aging population is leading to a decline in consumption-based tax revenue while increasing the costs of social welfare.
To avoid the “middle-income trap”, the Commission must ensure that Tamil Nadu and other progressive States continue to grow, avoiding stagnation before reaching higher income levels.
Moreover, Tamil Nadu’s rapid urbanization presents additional challenges in terms of infrastructure and resource needs. By 2031, 57.3% of the population in the State will reside in urban areas, requiring targeted investments in infrastructure and sustainable urban planning.

The Sixteenth Finance Commission’s role is more than just determining fiscal allocations. It involves shaping a future where all States, irrespective of their developmental status, contribute to and benefit from the nation’s progress.
By addressing the needs of both urban and rural areas, fostering manufacturing, and ensuring climate resilience, the Commission’s decisions will play a vital role in securing India’s position as a global economic leader.

The Sixteenth Finance Commission has a unique opportunity to reform India’s fiscal federalism. By balancing historical inequities with emerging challenges, the Commission can lay the foundation for a more inclusive, sustainable, and prosperous future, driving the nation’s growth while benefiting all States and regions. This will ensure that India remains on a steady path to becoming one of the world’s leading economies.