The Centre will set up the Sixteenth Finance Commission (FC) by November to assess the tax resources of the Union government and suggest a formula for their devolution to states and among them, for the five years between FY27-FY31.

Normally, it takes two years for a Finance Commission to give its recommendations. The 15th FC award period is valid till FY26.

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The 16th FC has to submit its report by October 30, 2025 so that it is deliberated on and factored in the Budget for FY27 to be presented on February 1, 2026.

The process to identify key personnel of the commission, such as the chairman and members, would begin soon, an official said.

The Finance Commission’s award consists of two main categories: Tax devolution is made to states from the divisible pool of the central taxes under Article 280 of the Constitution and no condition can be attached to its release.

The other component is grants, including revenue deficit grants, that are paid out of the Consolidated Fund of India under Article 275 of the Constitution.

Due to Covid and the expansion of the terms of reference (ToR) to include funding matters related to defence, the 15th FC gave its award in two phases — one for FY21 and the other for FY22-FY26.

It recommended that 41% of the divisible segment of central taxes will go to all states as J&K was recategorised from a state to a union territory. This is against a 42% share for all states, including the then J&K, during the 14th Finance Commission (FY16-FY20).

The ToR for 16th FC would be of much interest given there was discontent among southern states with regard to ToR of 15th FC.

The 15th FC ToR mandated the use of the 2011 Census data, while the 1971 Census numbers were mostly used by the previous finance commissions. Many sothern states said the use of 2011 census data could hurt tax devolution to them as they have implemented population control measures.

Striking a judicious balance, the 15th FC, in its award, assigned a lower weight of 15% to ‘population’ than 27.5% by the previous FC while giving a ‘respectable’ weight of 12.5% to progress made in curbing population growth to balance the needs represented by the latest population and progress towards population control, for inter-se distribution of resources among states from the Centre’s divisible tax pool.

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The 16th FC ToR might include a mandate to look into the issue of freebies and how to disincentivise states for indulging in such fiscal imprudence. The revenue deficit grants to states, for instance, could be linked to the curbing of freebies.

The freebies matter had recently reached Supreme Court, but it did to make any headway on curbing such practices.

In its final report in November 2020, the 15th FC allocated Rs 2.95 trillion to 17 states to eliminate their revenue deficit between FY21 and FY26.