16th FC awards: Southern states gain, northern backward states lose with formula tweaks

Southern states have a reason to smile at the 16th Finance Commissions (FC) award even if the overall tax share remains unchanged at 41 per cent (vertical devolution). Their long-pending grievance has been addressed to some extent with their share rising significantly (horizontal devolution) with a change in the formula adopted.

Southern states have long complained that despite their higher contributions to the exchequer, their relative shares in the Finance Commission awards have been lower – with northern states with more population cornering higher shares despite contributing less for decades.

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The biggest gainers this time in terms of percentage points (shares) over the previous 15th Finance Commission are: Karnataka (0.48), Kerala (0.46), Andhra Pradesh (0.17), Telangana (0.07) and Tamil Nadu (0.02). Among the other top gainers are Gujarat (0.28), Haryana (0.27), Punjab (0.19), Assam (0.13), Maharashtra (0.12), Himachal Pradesh (0.08), Jharkhand (0.05) and Uttarakhand (0.02).

The biggest losers are indeed the populous but economically backward states of Madhya Pradesh (-0.50), Uttar Pradesh (-0.32), Bihar (-0.11) and Rajasthan (-0.1). Other big losers are Odisha (-0.11), West Bengal (-0.31)

The following graph presents the gainers and the losers vis-à-vis the 15th FC.

Changes in 16th FC award

The key was in recognising efficiency and states’ contributions to growth and hence, for the first time, it added the state’s contribution to GDP. It relied on other five criteria employed by previous commissions but with changed weightage: population, demography, area, forest and per capita GSDP distance. The criteria and weightage in the 15th and 16th FC are given in the pie charts below.

The other significant change was in the population criterion. It reduced the weightage of demographic performance from 12.5 per cent in the 15th FC to 10 per cent and replaced total fertility rate (TFR) with population growth and set the per capita devolution to a state “in proportion to the inverse of its population growth between 1971 and 2011 Censuses”.

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It said it wanted to move away from the population base of 1971 (which was kept unchanged to promote population control and hence, the TFR element) recognising that India risked “ageing before it becomes rich”, like Europe, Japan and China but couldn’t find the right alternate criterion.

All these are part of the commission’s award dealing with devolution of tax from the divisible pool.

The other part of the commission’s award is “grants” which are given from the central exchequer based on certain formulae, including grants for local urban and rural bodies and disaster management. The commission tweaked the formula in all these cases keeping in mind the changing dynamics.

State-specific grants criteria

Instead of following the revenue deficit grants (RDGs) – bridging the gap between state’s revenues and expenditures – for general purpose grants, it adopted state specific growth rate on base year tax revenue.

This was after some states wished it to be discontinued for discouraging fiscal indiscipline and the Centre found it redundant after the 14th FC announced a quantum jump in the tax devolution (42 per cent, which was brought back to 41% by the 15th FC due to the new UTs of Jammu and Kashmir and Ladakh) and merger of plan and non plan expenditures.

On its part, the commission expressed deep concerns at states’ rising subsidies (power subsidy in particular) and “unconditional cash transfers”.

The grants are now base on several conditions. The key ones being states making substantial transfers to local bodies from their own resources, local bodies raising their own source of revenue (OSR) and pushing for urbanisation (infrastructure) with special emphasis on waste water management (specific to urban local bodies). The grants have both tied and untied components (50 per cent of basic component tied and the rest and the entire performance components untied). The tied component is towards ‘Sanitation and Solid Waste Management’ and/or ‘Water Management’.

Alarming FC recommendation

An alarming aspect of the commission is that it recommends dispensing away with the role of State Finance Commissions (SFCs) – which is a constitutional provision – in determining the grants “through a Constitutional amendment” – centralising powers entirely in its own hands. This is after repeatedly referring to the absence of such recommendations from SFCs and stating that “all states must comply with the Constitutional provision”.

Grants for disaster management

The grants for disaster management are based on two criteria: past expenditures and Disaster Risk Index (DRI).

Building on the 15th FC, the commission assigns scores to the probability of hazards striking a state, population exposure (an addition) and the extent of vulnerability (per capita income). The hazards have been expanded to take the number to 10: Flood, drought, cyclone, earthquake, landslides, hailstorms, cold wave, cloud burst, lightning and heatwave.

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As per the DRI scores, the top 10 states with higher risks to disasters are Uttar Pradesh (413), Bihar (224), Maharashtra (182), West Bengal (167), Madhya Pradesh (154), Rajasthan (117), Gujarat (88.9), Tamil Nadu (82.8), Odisha (79.8) ad Karnataka (77.5).

The bottom 10 states are Sikkim, Nagaland, Tripura, Goa, Mizoram, Meghalaya, Manipur, Arunachal Pradesh, Himachal Pradesh and Uttarakhand. They all score between 3.5 and 16.7.

The following graph maps the DRI scores.

The allocations are based on the average expenditure (70 per cent) and DRI scores (30 per cent).

The commission recommends that the corpus should be divided between the State Disaster Response Funds (SDRFs) and State Disaster Mitigation Funds (SDMFs) in the ratio of 80:20. The total corpus is set at Rs 2.04 lakh crore for FY27-FY31. States are to contribute 25 per cent of the funds, except for the North Eastern and Hilly (NEH) states, which are required to contribute 10 per cent. The rest will be provided by the Centre.