Fiscal federalism: the Finance Commission and GST

India collects most of its tax at the centre and spends most of it in the states, so the machinery that moves money between the two is not an administrative detail — it is where the federal bargain is actually struck. Two constitutional bodies do that work and they are built on opposite principles. The Finance Commission is temporary, expert and advisory: it is appointed, it reports, it dissolves, and the Union is free in law to decline what it recommends. The GST Council is permanent, political and decisional: the Union sits in it alongside every state and the outcome is produced by a weighted vote. A third channel, larger than either in discretionary terms, has no constitutional body at all.

Channel one: the Finance Commission

Article 280 requires the President to constitute a Finance Commission every fifth year, or earlier if needed, with a chairperson and four other members. Its mandated business is to recommend three things: the distribution between the Union and the states of the net proceeds of taxes that are divisible between them, the allocation of the states’ share among the states themselves, and the principles that should govern grants-in-aid to the states out of the Consolidated Fund of India. Since the seventy-third and seventy-fourth amendments it also has to recommend measures to augment a state’s consolidated fund so the state can supplement the resources of its panchayats and municipalities — the third tier whose constitutional position is set out in the brief on local government.

Two features do most of the analytical work. First, the recommendations are advisory. Article 281 requires the Union to lay every Finance Commission report before each House of Parliament together with an explanatory memorandum of the action taken on it — which is an obligation to explain a refusal, not a prohibition on refusing. In practice the tax-devolution recommendation has been accepted by successive governments; grant recommendations have a more mixed record. Second, the commission is reconstituted from scratch each cycle with fresh terms of reference written by the Union. Because the terms of reference set the questions, who writes them is itself a federal issue, and states have made it one.

The headline output is the vertical share — the percentage of the divisible pool that goes to the states as a class. The Fourteenth Finance Commission set it at 42 per cent for 2015-20, the largest single increase in the instrument’s history. The Fifteenth set it at 41 per cent for 2021-26, the one-point reduction reflecting the conversion of Jammu and Kashmir into union territories, which moved that population out of the pool of states being shared among. The Sixteenth Finance Commission (constituted in December 2023) had its report tabled in Parliament on 1 February 2026 for the five years 2026-27 to 2030-31. It kept the vertical share at 41%. On the horizontal split it gave the largest weight to income distance (42.5%), raised the weight of 2011 population to 17.5%, cut area to 10%, held demographic performance and forest cover at 10% each, dropped the tax-and-fiscal-effort criterion and introduced a new criterion, contribution to GDP, at 10%. It recommended Rs 9.47 lakh crore of grants over the period — for rural and urban local bodies and disaster management — and discontinued the Fifteenth Commission’s revenue-deficit, sector-specific and state-specific grants, per the annexure to PRS Legislative Research’s budget analysis. The 2026-27 Budget estimates were drawn on that basis: tax devolution of Rs 15,26,255 crore, Finance Commission grants of Rs 1,29,397 crore (15% below the 2025-26 revised estimate) and no post-devolution revenue-deficit grants (PRS).

What sits outside the divisible pool

The vertical share is a percentage of something, and the something is defined narrowly. Article 270 makes the net proceeds of Union taxes and duties shareable, but expressly excludes surcharges and cesses levied for specific purposes. A rupee raised as a cess is a rupee the states do not divide. This is the single most consequential piece of plumbing in Indian fiscal federalism, because it means the Union can raise revenue in a form that is legally its own without amending the devolution formula at all. Whatever one thinks of the merits, the arithmetic is not in dispute: the share is fixed by the commission, and the base it applies to is fixed by how the Union chooses to label the levy.

Channel two: the GST Council

The Constitution (One Hundred and First Amendment) Act, 2016 did something the Indian federal structure had not done before: it took a whole field of taxation out of the exclusive columns of the Seventh Schedule and made it concurrent. Article 246A gives the Union and every state legislature power to make laws on goods and services tax. Article 269A puts inter-state supply under a central levy that is then apportioned. And Article 279A creates the GST Council to keep a single national tax coherent across thirty-odd separate taxing authorities. The tax came into force on 1 July 2017.

The Council’s composition and voting rules are the interesting part. The Union Finance Minister chairs it; the Union Minister of State in charge of revenue or finance sits on it; and each state nominates its finance or taxation minister, or another minister, as its member. A decision needs a majority of not less than three-quarters of the weighted votes of the members present and voting. Within that, the Union’s vote counts for one-third of the votes cast and all the states’ votes together count for the remaining two-thirds. The design is symmetrical in its blocking power: the Union cannot carry a decision alone, and the states cannot carry one over the Union’s objection either.

The compensation arrangement that made the bargain politically possible was time-limited by construction. States were guaranteed a protected revenue growth rate for five years from the introduction of the tax, funded by a compensation cess, and that five-year window closed on 30 June 2022. The cess itself continued past that date to service borrowings raised on the states’ behalf during the pandemic years. With the September 2025 rate rationalisation the cess was removed from most goods; the Union’s note on the reforms kept existing GST and compensation-cess rates only on cigarettes and other specified tobacco products until the loans and interest raised against the cess are fully discharged. The end of guaranteed compensation is the reason state finance ministers’ arithmetic changed sharply in 2022, and it is the background to most of what is argued about in the Council now.

A further point of law matters for how the Council is described. The Supreme Court held in 2022 that the Council’s recommendations are recommendatory and do not bind the Union and the states, both of which legislate under Article 246A in their own right. In practice the Council has operated by consensus far more often than by recorded vote, so the binding-or-not question surfaces rarely; when it does, it surfaces in the courts.

The two bodies compared

	Finance Commission	GST Council
Constitutional basis	Article 280	Article 279A, inserted by the 101st Amendment
Existence	Reconstituted every five years, then dissolves	Permanent
Who sits	A chairperson and four members appointed by the President	The Union Finance Minister, a Union minister of state, and a minister from every state
How it decides	Deliberation, then a report	A vote, three-quarters weighted majority
Force of the output	Advisory; Union must table an action-taken memorandum	Recommendatory in law, near-binding in practice
What it governs	The split of the divisible pool and grants-in-aid	Rates, exemptions, thresholds and the design of GST

The third channel, which has no body

Beyond formula-based devolution and the GST framework sits the discretionary layer: centrally sponsored schemes. These are Union-designed programmes delivered by states, funded in a stated ratio between the two, and conditional on the state following the Union’s design. They are how much of the social-policy apparatus described in the welfare state dossier actually reaches a household. They are also outside both constitutional bodies. No commission recommends them and no council votes on them; they are decided by the Union executive and appear in the demands for grants that the Ministry of Finance puts before Parliament. Any account of Indian fiscal federalism that stops at the Finance Commission’s percentage is describing the transparent part of the system and skipping the discretionary one.

Live in 2026: levies, cash management and the next Council meeting

Three developments since mid-2026 sit on the Union-state seam. First, Parliament passed the Mines and Minerals (Development and Regulation) Amendment Bill, 2026 in the Monsoon Session (20 July-13 August 2026). It bars state governments from imposing specified taxes, cesses or levies on mineral rights or mineral-bearing lands except in accordance with restrictions the central government prescribes, and deems unpaid dues of such state levies from before its commencement invalid while not requiring refunds of amounts already collected, per PRS’s August 2026 review and the Bill text. It is a direct instance of the Union legislating on the boundary of state taxing power. Second, an RBI-constituted Advisory Committee on Ways and Means Advances to State Governments reported on 29 September 2026, recommending that the aggregate limit on states’ short-term advances rise from Rs 61,008 crore to Rs 67,839 crore with annual revision, and that the days a state may stay in overdraft be cut; it recorded that 19 states used the special drawing facility, 11 ways-and-means advances and 10 overdraft in 2025-26. Third, the GST Council, last convened in September 2025, had its 57th meeting scheduled for 8 October 2026 after two postponements (see the brief on India’s fiscal stance).

Settled, and contested

Settled: the constitutional text, the composition of both bodies, the voting rule, the exclusion of cesses and surcharges from the divisible pool, and the dates. All of that is readable in the primaries below.

Contested, and held by identifiable camps rather than by everyone: whether the growth of cesses and surcharges has hollowed out devolution in substance while leaving the headline share intact; whether the horizontal formula — which weighs population, income distance, area, demographic performance and forest cover differently in each cycle, and from 2026 adds contribution to GDP — rewards need or penalises performance, an argument the southern states make in one direction and the populous northern states in another; whether the GST Council’s consensus convention is a federal achievement or a device that makes dissent invisible; and whether a permanent successor to the Finance Commission would be an improvement on reconstituting one every five years. IndiaStand states the positions and attributes them. It does not recommend a settlement, and this brief contains no forecast of what any commission will recommend.

Maintained topic brief. Analysis by IndiaStand — sourced to the constitutional text and to the two bodies’ own publications, with the range of positions attributed and no recommendation made.