The 16th Finance Commission (FC)’s vertical devolution recommendations prioritise the needs of the Centre over the realities of States. By merely acknowledging, rather than heeding, States’ fiscal pressures, the FC has taken a distinctly conservative stance.
To grasp the underlying tensions, we must first look deeper into the structural issues. The 16th FC has maintained the vertical devolution rate at 41%, representing the States’ share of the divisible pool.
Crucially, this divisible pool excludes cesses, surcharges, and collection costs, meaning its total volume is dictated by the Centre’s tax strategy. By favouring cesses and surcharges over standard tax instruments, the Centre effectively shrinks the shareable revenue; conversely, a shift back to traditional taxation would expand it.
Data show the way the present regime has gone about it. The chart below is a simplified representation of the divisible pool.
Between 2013 and 2019, for every ₹100 collected by the Centre, about ₹93-95 was collected as taxes and duties that form the divisible pool; the remaining ₹5-7 was collected as cesses and surcharges, including the expenditure incurred in collecting these taxes. In 2021-22, for every ₹100 collected, ₹86.5 was collected as taxes and duties, while the cesses and surcharges component increased to ₹13.5.
For 2025-26, the Centre is expected to collect ₹89 as taxes and duties and ₹11 as cesses and surcharges. The GST compensation cess was not included in this analysis, as it was collected to compensate the States for revenue loss due to the implementation of GST.
Let us juxtapose the figures: post-2019, the cesses and surcharges component has nearly doubled from ₹5-7 to ₹11-13.5 for every ₹100 collected. Notably, the 16th FC has also come to the same conclusion: “In 2011-12, this non-shareable portion of revenues was 1.1% of GDP, and the divisible pool was 9.1%. By 2023-24, the non-shareable portion had expanded to 2.2% of GDP while the divisible pool stood at 9.4%.”
Further evidence of this is also seen in the chart below which are based on absolute collections data presented in Parliament on Tuesday. The money collected as cesses by the Centre — excluding GST compensation cess — increased from ₹44,688 crore in FY15 to ₹3,52,650 crore in FY22 and is expected to be around ₹2,51,206 crore in FY26.
Similarly, surcharges collected have risen from ₹15,702 crore in FY15 to ₹40,758 crore in FY22 and is expected to be around ₹1,72,500 crore in FY26.
This unbridled rise in cesses and surcharges means that the share of the divisible pool in the Centre’s Gross Tax Revenue (including the GST compensation cess) is expected to remain below 90% for the sixth consecutive year. In contrast, between FY13 and FY18, this share remained consistently above 93%.
While the debate rages over whether to maintain, raise, or lower the vertical devolution rate of 41%, the underlying divisible pool is shrinking because the Centre is increasingly collecting revenue through cesses and surcharges.
As many as 18 States — including Odisha, Haryana, and Gujarat, Kerala, and Tamil Nadu — have demanded an increase in vertical devolution from 41% to 50%. Most other States have advocated for a more moderate increase to 45% or 48%. In stark contrast, the Centre called for a “moderation in tax devolution”.
While the 16th FC kept the rate unchanged in an apparent attempt to balance these competing demands, the reasoning provided suggests that maintaining the status quo primarily serves the Centre’s interests.
First, the FC notes that the Constitution does not permit a cap on cesses and surcharges. It argues that the Centre requires these funds for emergencies such as war, famine, and pandemics, concluding that imposing a limit would be “imprudent”.
Interestingly, the FC simultaneously acknowledges that long-term reliance on these levies is “undesirable”, warning that if the Centre continues to favour them, it may “lose interest in standard instruments of taxation”, an outcome detrimental to States’ interests.
Furthermore, the FC points to “recent shifts in the external security and defence environment” as a justification for increased defence spending, while asserting that the Centre has demonstrated a “high degree of effectiveness” in infrastructure building, necessitating greater financial support.
Also, it maintains that the current distribution of tax revenues “gives States sufficient resources to discharge their constitutional responsibilities”. It concludes by suggesting that the resolution lies in a mutual agreement between the Centre and the States, whereby the Centre voluntarily transitions a large part of its revenue collection from cesses and surcharges back into the divisible pool of regular taxes.
The FC’s interpretation of the fiscal landscape ultimately raises more questions than it answers. First, could the architects of the Constitution have ever envisioned such a disproportionate rise in cesses and surcharges?
Second, by declaring a cap on cess as “imprudent,” has the FC not effectively forced the Centre to draw its own boundary, by refusing to play mediator?
Third, doesn’t the claim that the Centre demonstrates efficiency in infrastructure ignore the fact that high-performing States are getting the raw end of the bargain?
Finally, if the States truly possess “sufficient” resources, why have nearly all of them — regardless of political affiliation — unanimously demanded a larger share?
Published – February 05, 2026 07:00 am IST
