The Finance Commission

Article 281 and the binding force of a recommendation

Article 281. The President shall cause every recommendation made by the Finance Commission, together with an explanatory memorandum as to the action taken thereon, to be laid before each House of Parliament.

That is the whole of the enforcement, and it is worth pausing on. The Constitution does not say the recommendations shall be binding. It says they shall be laid before Parliament with a statement of what the Government has done about them. In law, therefore, the Union may reject any recommendation; in practice a strong convention has grown up that the core recommendations on tax devolution are accepted, because the Commission is a constitutional body and rejection would be a political act requiring a public explanation on the floor of both Houses.

The Explanatory Memorandum of February 2026 illustrates exactly how this works. On the vertical share, the horizontal formula, local body grants and disaster financing it records: "The Government has accepted the above recommendations of the Commission." On the assessment of State finances it says only that the Government "takes note". On the fiscal stability recommendations it accepts the borrowing ceilings in principle and states that the rest "will be examined separately". On the recommendations about centrally sponsored schemes, the power sector, subsidies and public sector enterprises it says they will be examined "in due course".

Three grades of response, then: accepted, noted, and to be examined. A student who can describe that gradation has understood article 281 better than one who simply says "the recommendations are advisory".

Who may be appointed

Finance Commission (Miscellaneous Provisions) Act 1951, section 3.

• The Chairman shall be selected from among persons who have had experience in public affairs.
• The four other members shall be selected from among persons who:
• (a) are, or have been, or are qualified to be appointed as Judges of a High Court;
• (b) have special knowledge of the finances and accounts of Government;
• (c) have had wide experience in financial matters and in administration;
• (d) have special knowledge of economics.

A drafting curiosity worth knowing. The copy of the Act served on India Code as the searchable consolidated text prints clause (d) as "special knowledge of economies". The Act as enacted, Act 33 of 1951, reads "economics", and the other copy of the same Act on the same site prints it correctly. It is a misprint in one scanned copy and nothing more, but it is a fair warning that a bare Act downloaded from an official site is still a printed document that can carry a printer's error.

Section 4: personal interest. Before appointing a person the President shall satisfy himself that the person will have no financial or other interest likely to affect prejudicially his functions, and shall satisfy himself of the same from time to time thereafter.

Section 5: disqualifications. A person is disqualified if of unsound mind, an undischarged insolvent, convicted of an offence involving moral turpitude, or possessed of such financial or other interest as is likely to affect his functions prejudicially.

Section 6: term. Every member holds office for such period as the President's order specifies, is eligible for reappointment, and may resign by letter to the President.

Section 8: powers. The Commission determines its own procedure and has all the powers of a civil court under the Code of Civil Procedure 1908 in respect of summoning witnesses, requiring the production of documents and requisitioning public records, and may require any person to furnish information.

One point for a law student and nobody else. Section 8 as printed still refers to the Indian Income Tax Act 1922, to section 176 of the Indian Penal Code 1860 and to sections 480 and 482 of the Code of Criminal Procedure 1898, none of which is on the statute book in that form today. It is an unamended cross reference in a 1951 Act, and it illustrates the difference between an Act being in force and its text being current.

The Sixteenth Finance Commission

The vertical share: 41 per cent

The recommendation: retain the States' share at 41 per cent of the net proceeds of the divisible pool of Union taxes. Accepted.

How the figure got there.

What the States asked for. Eighteen of the twenty eight States asked for the share to be raised from 41 per cent to 50 per cent, on the ground that the Constitution places a proportionately larger expenditure responsibility on the States in health, education, agriculture, drinking water, sanitation, welfare and law and order. The Commission did not accept it.

A second recommendation, and it goes to the surcharge grievance in [Fiscal Federalism: How the Constitution Divides Money]. The Commission recommended that, to bring transparency about the divisible pool and the actual devolution, the Union Government disclose every year the data on net proceeds as certified by the Comptroller and Auditor General under article 279. Accepted.

The cess and surcharge question, answered with numbers

This is the part of the topic where most notes assert and the Commission actually measured, so it is worth taking from the source.

The States made two complaints. The Commission examined both and reached different conclusions on each, which is why an answer that treats them as one complaint is wrong.

Complaint one: the States do not receive the full share recommended. Not supported. The Union transfers on estimates during the year and then adjusts twice: once when actual tax figures are known, and again when the Comptroller and Auditor General certifies the divisible pool under article 279. The Commission's own table for 2018-19 to 2022-23 shows the final devolution matching, to the rupee, the recommended percentage of the certified pool.

Complaint two: cesses and surcharges have shrunk the pool and wiped out the Fourteenth Commission's increase. Partly supported, and this is the honest answer. The divisible pool as a share of gross tax revenue fell from an average of 89.2 per cent in the Thirteenth Commission's period to 82.1 per cent in the Fourteenth's and 78.3 per cent in the Fifteenth's. So the pool has genuinely shrunk. But the claim that the increase was wiped out is not supported, because what actually reached the States, measured against gross tax revenue, was:

The conclusion in one sentence: the Fourteenth Commission's boost was substantially, though not fully, preserved, and the shrinking of the divisible pool is real but has cost the States about one and a half to two percentage points of gross tax revenue, not the whole increase.

The Commission's own proposal for a settlement, which is the kind of point that lifts an answer: a grand bargain, in which the Union folds a large part of its cess and surcharge revenue into the regular taxes and the States accept a smaller percentage of a larger divisible pool, with neither side losing revenue.

The horizontal formula

The Commission determines each State's share by a weighted formula. For 2026-31, from Table 8.8 of its report:

Two changes from the Fifteenth Commission worth naming.

1. Contribution to gross domestic product is new, introduced "in recognition of India's growth ambition" and asked for by many States. To stop a few very large economies dominating, the Commission does not use the share of gross state domestic product directly but the ratio of the square root of a State's GSDP to the sum of the square roots of all States', which compresses the differences.
2. Tax effort has been dropped. The Commission found that the variation across States is very small and that the tax effort weighted population shares correlate with population shares at 0.98, so the criterion was doing nothing but repeating population.

Why per capita income distance carries 42.5 per cent. It is the dominant equity variable. The Commission also explains a technical difficulty: because the three richest States' per capita incomes are now very close together, measuring distance from the single highest would produce almost nothing for the second and third. It therefore uses the average of the top three, excluding Goa and Sikkim, as the benchmark.

Some resulting shares for 2026-31, from Table 8.9, out of 100:

The pattern is the point. Uttar Pradesh and Bihar together take more than a quarter of the States' share, and Maharashtra, whose economy is the largest in the country, takes 6.441 per cent. That is the equity principle working exactly as designed: devolution moves resources from where income is high to where it is low. It is also why the richer States argue that they are penalised for their success, and why the Sixteenth Commission introduced the contribution to gross domestic product criterion.

What the Sixteenth Commission did not recommend

A break with every recent Commission, and examiners will not expect a student to know it. The Commission recommended:

• No revenue deficit grants to any State. Earlier Commissions gave large post devolution revenue deficit grants to States whose assessed expenditure exceeded assessed revenue.
• No sector specific grants and no State specific grants.

Its stated reason is that its examination of State finances, and particularly of tax revenues, committed expenditure and discretionary expenditure, shows "significant scope of increasing revenues and rationalising expenditure". The Government took note of this assessment.

Local body grants and disaster financing

Local bodies, under article 280(3)(bb) and (c):

• 7,91,493 crore rupees for rural and urban local bodies for 2026-27 to 2030-31.
• Divided 60:40 between rural and urban bodies, and 80:20 between basic and performance components in each.
• Three entry conditions: a duly constituted body under Parts IX and IX-A; provisional accounts of all local bodies for year T-1 and audited accounts for T-2 online in the public domain in year T; and a State Finance Commission constituted every five years with its action taken report laid in the State Legislature within six months.
• Half the basic component is tied to sanitation and solid waste management or water management; no local body may spend more than 20 per cent of the untied grant on roads, and untied grants may not be used for salaries or establishment.
• An urbanisation premium of 10,000 crore rupees, at 2,000 rupees per person, to encourage the merger of peri urban villages into adjoining municipal bodies, and a special infrastructure component of 56,100 crore rupees for wastewater management in urban growth centres.
• States must transfer the grants to their local bodies within ten working days, failing which they must pay interest at the rate on their own market borrowings.

Disaster management:

• 2,04,401 crore rupees for the State Disaster Response Fund and State Disaster Mitigation Fund together, of which the Union's share is 1,55,915.85 crore and the States' 48,485.15 crore, in the ratio 75:25 for other States and 90:10 for the North Eastern and Himalayan States.
• Split 80:20 between response and mitigation: 1,63,521 crore and 40,880 crore.
• 79,406 crore rupees for the National Disaster Response Fund and National Disaster Mitigation Fund.

Fiscal stability

The Commission recommended that:

• States' fiscal deficit be capped at 3 per cent of gross state domestic product, strictly enforced under article 293(3);
• the Union reduce its fiscal deficit to 3.5 per cent of gross domestic product by the end of the award period;
• States discontinue off budget borrowing entirely and bring it on to their budgets;
• State fiscal responsibility legislation be amended for uniformity and alignment.

The Government's response was to accept in principle the quantum of the net borrowing ceilings and to state that the recommendations on off budget borrowing, amendments to State fiscal responsibility laws and the Union's own fiscal deficit will be examined separately. That is the clearest available illustration of the limits of article 281: a recommendation addressed to the Union's own deficit received the coolest reception of any in the report.

A worked example: how one rupee reaches a State

What beginners get wrong

"The Finance Commission is appointed every five years." Article 280(1) says at the expiration of every fifth year or at such earlier time as the President considers necessary.

"Its recommendations are binding." Article 281 requires only that they be laid before each House with an explanatory memorandum as to the action taken. The convention of acceptance covers the core, and the February 2026 memorandum shows three different grades of response.

"It is a permanent body." Each Commission is constituted afresh by order, does its work, submits its report and ceases to exist.

"It decides all Union transfers to the States." It decides devolution under article 270 and grants under article 275. Transfers under article 282, which fund centrally sponsored schemes, do not go through it.

"The Fifteenth Commission's 41 per cent is the current award." The Fifteenth Commission's award period is over. The Sixteenth Commission's award runs from 1 April 2026 to 31 March 2031, and it happens also to have recommended 41 per cent, which is a coincidence of number and not a continuation of the same award.

"Cesses and surcharges have wiped out the Fourteenth Commission's increase." The Sixteenth Commission examined this and found it unsupported: total Finance Commission transfers were 32.5, 39.4 and 37.6 per cent of gross tax revenue across the last three award periods. The pool has shrunk from 89.2 to 78.3 per cent of gross tax revenue, which is a real grievance of a smaller size.

"The Chairman must be an economist." Section 3 requires the Chairman to have had experience in public affairs; it is the four other members whose qualifications include special knowledge of economics.

Limits

The award changes every five years, so the percentage and the formula in this chapter belong to 2026-31 and will be superseded.

Terms of Reference are set by the Union, which is one party to the dispute the Commission adjudicates, and this has been a standing criticism.

The Commission cannot touch article 282, through which a large volume of conditional transfers flows.

Figures for grants are for the whole award period of five years, not for one year, and must not be compared with an annual budget figure.

The Commission's assessment of State finances is contested, and its decision to give no revenue deficit grants at all will be argued about throughout the award period.

Quick revision

1. Article 280(1): President constitutes a Commission at the expiration of every fifth year or earlier; Chairman and four other members.
2. Article 280(3) duties: (a) distribution of net proceeds between Union and States and allocation among States; (b) principles governing grants in aid; (bb) measures to augment a State's Consolidated Fund for Panchayats, 73rd Amendment; (c) the same for Municipalities, 74th Amendment; (d) any other matter referred by the President in the interests of sound finance.
3. Article 281: every recommendation is laid before each House with an explanatory memorandum as to the action taken. Not binding; the convention covers the core.
4. Act of 1951, s.3: Chairman from persons with experience in public affairs; four members from persons who are or are qualified to be High Court judges, or have special knowledge of the finances and accounts of Government, or wide experience in financial matters and administration, or special knowledge of economics. s.5 disqualifications; s.8 powers of a civil court under the Code of Civil Procedure 1908.
5. Sixteenth Commission: constituted 31 December 2023, report to the President 17 November 2025, award 2026-27 to 2030-31 from 1 April 2026.
6. Vertical share: 41 per cent, retained. History: 32 per cent (Thirteenth), 42 (Fourteenth), 41 (Fifteenth, reduced for the Jammu and Kashmir reorganisation), 41 (Sixteenth). Eighteen States asked for 50.
7. Horizontal formula: per capita GSDP distance 42.5, population 2011 17.5, demographic performance 10, area 10, forest 10, contribution to GDP 10 (new). Tax effort dropped, correlation with population 0.98. Maharashtra 6.441, Uttar Pradesh 17.619, Bihar 9.948.
8. The measured cess and surcharge finding: the divisible pool fell from 89.2 to 82.1 to 78.3 per cent of gross tax revenue across three award periods, but total Commission transfers were 32.5, 39.4 and 37.6 per cent of gross tax revenue, so the Fourteenth Commission's boost was largely preserved. Proposed cure: a grand bargain, folding cesses into regular taxes for a smaller share of a larger pool.
9. No revenue deficit grants, no sector specific grants, no State specific grants.
10. Local bodies 7,91,493 crore for five years, 60:40 rural to urban, 80:20 basic to performance, three entry conditions, ten working days for a State to pass the money on.
11. Disaster funds 2,04,401 crore for the States plus 79,406 crore at the national level.
12. States' fiscal deficit capped at 3 per cent of GSDP, enforced under article 293(3); the Union to reach 3.5 per cent of GDP by 2030-31, which the Government has said it will examine separately.

Test yourself

1. Discuss the composition, qualifications and duties of the Finance Commission. Under article 280(1) the President shall, at the expiration of every fifth year or at such earlier time as he considers necessary, by order constitute a Finance Commission consisting of a Chairman and four other members appointed by him. Article 280(2) permits Parliament to determine the qualifications and manner of selection, and it has done so by the Finance Commission (Miscellaneous Provisions) Act 1951, section 3 of which requires the Chairman to be selected from among persons who have had experience in public affairs, and the four other members from among persons who are, have been, or are qualified to be appointed as judges of a High Court, or have special knowledge of the finances and accounts of Government, or have had wide experience in financial matters and in administration, or have special knowledge of economics.

Section 4 requires the President to satisfy himself that a person to be appointed has no financial or other interest likely to affect his functions prejudicially, and section 5 disqualifies a person of unsound mind, an undischarged insolvent, one convicted of an offence involving moral turpitude, or one having such an interest. Under article 280(3) the duties are to recommend the distribution between the Union and the States of the net proceeds of shareable taxes and their allocation among the States, the principles governing grants in aid of the revenues of the States out of the Consolidated Fund of India, the measures needed to augment the Consolidated Fund of a State to supplement the resources of Panchayats and of Municipalities on the basis of the State Finance Commission's recommendations, and any other matter referred by the President in the interests of sound finance. Article 280(4) leaves the Commission to determine its own procedure, and section 8 of the 1951 Act gives it the powers of a civil court under the Code of Civil Procedure 1908 to summon witnesses, require documents and requisition public records.

2. Are the recommendations of the Finance Commission binding on the Union Government? They are not binding in law. Article 281 provides only that the President shall cause every recommendation, together with an explanatory memorandum as to the action taken on it, to be laid before each House of Parliament, and nothing in Part XII makes acceptance compulsory or gives any State a right to enforce a recommendation. In practice a strong constitutional convention has grown up that the core recommendations on the sharing of taxes are accepted, because the Commission is a constitutional body appointed by the President and a rejection would have to be explained publicly on the floor of both Houses.

The Explanatory Memorandum laid in February 2026 on the Sixteenth Commission's report shows how the convention actually operates, since it distinguishes three grades of response: the recommendations on the vertical share of 41 per cent, the horizontal formula, local body grants and disaster financing are recorded as accepted; the assessment of State finances is merely noted; and the recommendations on fiscal stability are accepted only in principle as to the borrowing ceilings, with those on off budget borrowing, on State fiscal responsibility legislation and on the Union's own fiscal deficit reserved for separate examination, while the recommendations on centrally sponsored schemes, the power sector, subsidies and public sector enterprises are to be examined in due course. The pattern is instructive: what binds in practice is the sharing of revenue, and what the Union treats as advice is what constrains the Union itself.

3. Explain the horizontal devolution formula adopted for 2026-31 and the changes it makes. The Sixteenth Finance Commission determines each State's share by six weighted criteria. Per capita gross state domestic product distance carries 42.5 per cent and is the dominant equity variable, measuring how far a State's per capita income falls below a benchmark so that poorer States receive more; because the incomes of the three richest States are now very close, the Commission takes the average of the top three, excluding Goa and Sikkim, as the benchmark rather than the single highest. Population according to the 2011 Census carries 17.5 per cent and measures need. Demographic performance carries 10 per cent and offsets the unfairness of using a 2011 population, which would penalise States that succeeded in slowing population growth. Area carries 10 per cent as a cost disability, since a larger State costs more to administer.

Forest carries 10 per cent and compensates a State for keeping land under forest rather than putting it to economic use. Contribution to gross domestic product carries 10 per cent and is new, introduced in recognition of India's growth ambition and at the request of many States, and implemented not as a State's share of national output directly but as the ratio of the square root of its gross state domestic product to the sum of the square roots of all States, so that the very large economies do not dominate. The other change is the dropping of the tax effort criterion used by earlier Commissions, on the finding that the variation across States is small and that tax effort weighted population shares correlate with population shares at 0.98, so that the criterion merely repeated population.

4. What did the Sixteenth Commission find about the States' complaint that cesses and surcharges have shrunk the divisible pool? It separated the complaint into two and reached different conclusions. The first contention was that the States have not been receiving the full percentage recommended. The Commission found this unsupported, because the Union transfers during the year on the basis of estimates and then makes two adjustments, one when actual tax figures become available and a second when the Comptroller and Auditor General certifies the divisible pool under article 279, and its table for 2018-19 to 2022-23 shows the final devolution matching the recommended percentage of the certified pool exactly. The second contention was that rising cesses and surcharges have shrunk the divisible pool and wiped out the increase in devolution given by the Fourteenth Commission. Here the Commission found the premise true and the conclusion overstated.

The divisible pool did shrink as a proportion of gross tax revenue, from an average of 89.2 per cent during the Thirteenth Commission's award period to 82.1 per cent during the Fourteenth's and 78.3 per cent during the Fifteenth's. But total Finance Commission transfers, measured against gross tax revenue, averaged 32.5 per cent in the first of those periods, 39.4 per cent in the second and 37.6 per cent in the third, so the increase was substantially though not fully preserved. The Commission proposed a settlement in the form of a grand bargain, under which the Union would fold a large part of its cess and surcharge revenue into the regular taxes and the States would accept a smaller percentage of a correspondingly larger divisible pool, with neither side losing revenue.

5. What is significant about the Sixteenth Commission's decision on grants? It recommended no revenue deficit grants to any State, no sector specific grants and no State specific grants, which is a marked break from the practice of recent Commissions, several of which awarded large post devolution revenue deficit grants to States whose assessed expenditure exceeded their assessed revenue, together with grants earmarked for particular sectors and for the needs of particular States. Its stated reason is that its examination of State finances, and in particular of their tax revenues, their committed expenditure and their discretionary expenditure, disclosed significant scope for increasing revenue and rationalising expenditure, so that a grant to close a deficit would in effect reward the failure to do either. The Government recorded that it takes note of the assessment. The significance for a student is twofold. It shifts the entire burden of the Commission's transfers on to formula based devolution, which is unconditional and predictable, and away from discretionary and negotiated grants. And it will be the most contested part of the award, since the States that would have received revenue deficit grants must now either raise more revenue or spend less, and they will say so throughout the five years.

6. What did the Commission recommend on the fiscal position of the States and the Union, and how was it received? The Commission recommended that the fiscal deficit of the States be capped at 3 per cent of their respective gross state domestic product, excluding certain special assistance loans, and that this be strictly enforced in accordance with clause (3) of article 293, under which a State indebted to the Union may not borrow without the Union's consent. It recommended that the Union Government reduce its own fiscal deficit to 3.5 per cent of gross domestic product by the end of the award period. It recommended that the States completely discontinue off budget borrowing and bring all such borrowing on to their budgets, suggested a format for reporting it, and proposed that lending institutions supply an alternative source of data to strengthen the reporting framework. And it recommended that the fiscal responsibility legislation of the States be amended to remove inconsistencies and align with its consolidation roadmap. The Government's response was to accept in principle only the quantum of the net borrowing ceilings expressed as a percentage of gross state domestic product, and to state that the recommendations on off budget borrowing, on amendments to State fiscal responsibility legislation and on the Union Government's own fiscal deficit would be examined separately. That response is the sharpest available illustration of the limits of article 281, since the recommendation addressed to the Union's own deficit received the coolest reception in the memorandum.