Finance Commission to Shape India's Tax Devolution for Next Five Years: Mohandas Pai Finance commissions (FC) have steadily expanded the share of resources devolved to states, from 20.5 per cent in the 11th FC to 42 per cent in its 14th iteration – recorded as the largest increase in the country's history. The previous one held the share at 41 per cent while also accommodating the fiscal disruptions due to the pandemic.

The recommendations of the 16th Finance Commission will shape the next five years of tax devolution between the Union and the States and their impact on India will be significant, according to T V Mohandas Pai, Chairman at 3one4 Capital.

"Today, state governments account for a larger share of public spending than the Union, yet many advanced states have expressed concern that their growth and population management efforts are not being adequately recognised in fiscal allocations," told Pai.

Finance commissions (FC) have steadily expanded the share of resources devolved to states, from 20.5 per cent in the 11th FC to 42 per cent in its 14th iteration – recorded as the largest increase in the country's history. The previous one held the share at 41 per cent while also accommodating the fiscal disruptions due to the pandemic.

Earlier this year, a MoneyControl report said that the probability of states' share in central taxes going below 41 per cent seems unlikely, with the FC looking to suggest a 41-42 per cent share, citing sources aware of the matter.

Led by Arvind Panagariya, Chairperson of the commission, is said to have concluded its consultations with all 28 states, with the majority suggesting to increase the share to 50 per cent. The commission will submit its recommendations to the government in the end of October.

According to the sources, the central government is, however, not keen on going beyond the 41 per cent. Panagariya said in a press conference that he may be able to speculate that the 22 states that recommended the increase will not get their way, and "that would be too large a jump and such a large jump upsets too many cards."

In the recent past, there have also been criticisms by the southern states about their declining share in devolution, despire proving higher economic and demographic performance. Bengaluru based VC firm 3one4 Capital's 16th Finance Commission Report highlighted that it is not the populous states like Uttar Pradesh and Bihar, as popularly assumed, as they too have faced a decline in their devolutions.

According to the report, the Northeast states that have gained, in a highly disproportionate manner, given their smaller populations, recommending that the FC must address these imbalances. The recommendation report also said that the FC's Terms of Reference returned to "constitutional essentials," now presenting an opportunity to modernise the existing framework.

Pad said that there is justified criticism that states contributing more to national tax revenues are not receiving a commensurate share, while the growing reliance on cesses has constrained resources available for equitable distribution.

"These issues must be addressed if India is to design a forward-looking fiscal framework that rewards performance, strengthens cooperation, and supports the next phase of growth and development. This report examines these questions in depth and offers a data-driven approach to building a more balanced and future-ready model of fiscal devolution," said Pai.

Also proposed in the report is a model that maintains continuity by retaining the 41 per cent vertical share for the states, while introducing a re-worked horizontal formula, that according to 3one4, better reflects demographic realities, governance quality, and developmental priorities.

The VC firm, says that the result would be a "rational and predictable" per-capita distribution, with most states hovering between INR 8,000-13,000, which is a significant improvement from the results seen from thr previous formulas.