Union Budget 2026: Finance Commission and Southern States’ Discomfort, Explained

With Assembly elections due in April–May, poll-bound states are closely tracking the Union Budget in anticipation of pre-election sops. Tamil Nadu, Kerala, Puducherry, West Bengal and Assam are among the states heading to the polls, and their expectations are higher than usual. Elections aside, the budget assumes added significance for all Indian states, as it could incorporate the recommendations of the 16th Finance Commission, which decides the allocation of funds from the Union government’s divisible pool of taxes.

The 16th Finance Commission, headed by Aravind Panagariya, has submitted its report to the Union government. Various state governments have put forward their requirements and memorandums before the commission

Why is the Finance Commission Recommendation Important?

The Finance Commission is a statutory body mandated by the Constitution. Article 280 of constitution. The Finance Commission is appointed by the President every five years. The 16th Finance Commission constituted on December 31, 2023, is chaired by Arvind Panagariya, the former Vice Chairman of NITI Aayog. The commission submitted its report in November 2025.

What are the responsibilities of the Finance Commission?

Its primary responsibility is to recommend the distribution of the net proceeds of taxes between the Union and the state. It serves as the key constitutional mechanism for ensuring fiscal federalism in the country.

In making its recommendations, the Commission is mandated to take into account the existing inequalities in revenue capacity and development levels among states, and to devise a formula that promotes equity and balanced regional development. By addressing vertical imbalances between the Centre and the states, and horizontal imbalances among the states, the Finance Commission seeks to bridge financial disparities and strengthen cooperative federalism.

Why are taxes shared with states?

Central taxes are shared with the states to correct fiscal imbalances and address inequalities among states. Since states differ widely in their revenue capacity and development levels, the Constitution provides for a system of tax devolution to promote equity and balanced regional development. The Finance Commission determines the share of states in central taxes by applying a formula that takes into account multiple indicators such as income distance, population, area and fiscal effort etc

Tax sharing is also necessitated by India’s fiscal structure. While the Union government collects the bulk of major taxes—such as income tax and corporate tax—the states bear a larger share of expenditure responsibilities, including spending on health, education, law and order and social welfare. To bridge this vertical imbalance between revenue powers and expenditure obligations, the Constitution envisages the sharing of central taxes.

Prior to 2000, income tax and union excise duty on certain goods was shared by the centre with states.  A constitutional amendment in 2000 allowed all central taxes to be shared with the states.

This sharing is done from the divisible pool, which refers to the portion of the Union’s gross tax revenue that is distributed between the Centre and the states. The divisible pool includes all central taxes, excluding surcharges and cesses levied for specific purposes, and is calculated net of collection charges.

What are the general criteria adopted for the sharing of taxes?

The Commission travels to all states to understand each state's economic and financial position. Generally, the division is made taking into account the state's income, population control (the larger the population, the larger the amount the state receives), and forest cover, which is another criterion used for dividing centre funds.  Forest cover indicates that states with large forest covers bear the cost of not having area available for other economic activities. Therefore, the rationale is that these states may receive a larger share. The Commission recommends dedicated grants to states for specific sectors, such as health and Education, to address targeted needs and improve service quality.

What explains the Southern states’ discomfort with the Finance Commission’s recommendations?

Southern states such as Tamil Nadu and Kerala have expressed dissatisfaction with Finance Commission recommendations, arguing that several of the criteria used for tax devolution work to their disadvantage. A key concern is the use of population-based indicators. These states point out that they achieved population stabilisation decades ago, while many northern states are still struggling to do so. As a result, they argue that they are denied the fiscal rewards of successful population control.

Similar concerns are raised with respect to health and education indicators. Southern states contend that having invested consistently in human development, they now receive relatively fewer resources compared to states that lag behind on these parameters. This, they argue, discourages good governance and long-term planning.

Further, southern states maintain that they are effectively being penalised for economic development. They point out that many of them rank among the highest in per-capita income. In 2023, Telangana ranked first, Karnataka second, Tamil Nadu fourth and Kerala sixth in per-capita income. Despite contributing significantly to the national tax pool, these states claim they receive a comparatively smaller share of central transfers.

Consequently, southern states have called for greater weight to state-specific factors and performance-based criteria, arguing that the current framework redistributes resources in ways that undermine fiscal equity and cooperative federalism.