The 16th Finance Commission (FC) is actively engaging with various stakeholders, including State governments, to gather inputs for its recommendations. The Union Government will also present its views during this consultation process.

India's federal structure, often described as cooperative federalism, strikes a balance between a strong Union and State governments with designated functions. It is a system that allows for continuous interaction and consultation between the two tiers of governance. K.C. Wheare aptly characterized India’s framework as quasi-federal, while the Supreme Court, in the landmark State of Rajasthan and Others vs Union of India (1977 AIR 1361), described the Constitution as "amphibian," functioning as federal during normal times and unitary in emergencies. Despite these nuances, the mandate under Article 280 of the Constitution to establish a Finance Commission every five years or earlier underscores a significant federal feature.

Article 280 outlines the FC's responsibilities, including:

Recommending the distribution of the Union’s tax revenues among States and determining each State’s share.
Suggesting grants to augment the Consolidated Fund of States for local bodies, disaster relief, and financial stability.
Advising any other matter referred by the President in the interest of sound finance.
Expanding Scope of Finance Commissions

Since the 11th Finance Commission, the Terms of Reference (ToR) have expanded significantly, turning the FC into an instrument for fiscal reforms. This has included conditions such as limiting revenue expenditures (11th FC), linking debt relief to the enactment of Fiscal Responsibility Acts (12th FC), and prescribing specific uses for local body grants (15th FC).

This expansion of the ToR has often led to dissatisfaction among States, particularly those governed by parties other than the ruling party at the Centre. For instance, the ToR of the 15th FC, including its shift to using the 2011 Census instead of the 1971 Census for population metrics, triggered protests. States that had successfully controlled population growth argued that they were being penalized for their efforts, as this change diminished their share in tax distribution.

^{15TH  FINANCE COMMISSION | PHOTO : WIKI COMMONS}
A New Direction for the 16th Finance Commission

The ToR for the 16th FC marks a departure from this trend. It remains closely aligned with the provisions of Article 280, avoiding mandates on population metrics or specific policy implementations. This offers the 16th FC greater flexibility compared to its predecessors since 2000.

However, the FC has hinted at concerns about Union finances being strained due to the higher tax devolution to States since the 14th FC. States, in turn, are likely to point to the rising share of surcharges and cesses, which are not part of the divisible pool, and the declining assistance for Centrally Sponsored Schemes as counterarguments.

Distribution Challenges and Kerala’s Position

A significant challenge for the 16th FC will be resolving disagreements among States over the criteria for distributing the devolved tax share. Wealthier States may argue for criteria reflecting their contributions to GDP, while less affluent States may push for a higher weightage on income distance.

For Kerala, these debates are particularly consequential. Despite being classified as a high per capita income State during the 15th FC, Kerala’s ranking has slipped, potentially allowing for a marginal increase in its tax share if the existing criteria are maintained. However, to secure a share comparable to what it received under the 14th FC (2.5%), Kerala must advocate for adjustments to the distribution formula.

Kerala’s Fiscal Challenges

Kerala’s financial position has been further complicated by the Union Finance Ministry’s decision to include borrowings by the Kerala Infrastructure Investment Fund Board (KIIFB) and a pension disbursement entity in the State’s debt calculations. This retrospective adjustment has significantly reduced Kerala’s borrowing limits, with an estimated ₹12,000 crore cut until 2025-26.

This has placed the State in a dilemma: either ensure welfare payments by creating liquidity, risking further borrowing restrictions or adhere to the borrowing cap and face fiscal constraints. The matter is now before the Supreme Court, which has suggested referring the issue of Union control over State borrowings to a Constitution Bench. However, a resolution may take years, possibly beyond the tenure of the current State government.

Timing and Fiscal Implications

Unlike previous Finance Commissions, whose awards coincided with the final year of Kerala’s government, the 16th FC’s recommendations will take effect from 2026-27, after the current government’s term ends. This deprives the administration of the fiscal flexibility enjoyed by its predecessors during their final year in office.

^{16TH FINANCE COMMISSION | PHOTO : WIKI COMMONS}
Conclusion

Kerala must approach the 16th FC with a strategic focus, emphasizing its fiscal vulnerabilities, cost disabilities, and unique challenges. The key question remains whether the 16th FC will balance the needs of higher-income States like Kerala with the demands of populous, low-income States. The outcome, expected by late 2025, will have significant implications for the State’s fiscal health and its ability to navigate emerging challenges.