The 16th Finance Commission (16th FC) report that was tabled in Parliament along with the Union Budget on Sunday ignored most of Kerala's submissions related to the sharing of revenues between the Union and states, including an equal claim over the country's resources for the states and the scrapping of 'cesses and surcharges' imposed by the Centre.

On top of it, the 16th FC has put an end to the traditional benevolence of revenue deficit grants (RDGs), which are provided to states to eliminate their deficits. During the 15th FC period (2020-21 to 2025-26), Kerala received ₹53,137 crore as RDGs.

The Commission argued that RDGs breed dependence. "When States anticipate that shortfalls in their revenue account will be compensated through RDGs, the incentive to undertake difficult but necessary fiscal reforms such as rationalising subsidies, improving tax administration, or curbing revenue expenditures weakens. Over time, this softens fiscal discipline and embeds dependency rather than resilience," the report says.

No equal rights
Kerala and most other states wanted the divisible tax pool (income tax and excise duties) to be shared 50-50 between the Union and states.

The 16th FC, headed by NITI Aayog's first vice chairman Aravind Panagariya, however, has retained the 15th FC's vertical sharing formula of 41:59, 41 per cent of the divisible tax revenue to the states and the larger remaining chunk for the Union.

Kerala also wanted the cesses and surcharges imposed by the centre, which is not included in the divisible pool, to be abolished or capped or at least included in the divisible pool.

Centre's right to selfishness
The 16th FC acknowledged that the growing share of cesses and surcharges in the gross tax revenue (GTR) of the country was effectively shrinking the divisible pool. Yet, it refused to discourage the Centre from imposing more.

Under Article 270(1) of the Constitution, all the Union's tax revenues should be shared with states except cesses, surcharges, and taxes that flow to the Union Territories.

The report said that as a consequence of the Union increasingly resorting to cesses and surcharges to shore up its revenue, the share of divisible pool in the gross tax revenue of the country shrunk to 78.3 per cent. Therefore, in the place of the mandated 41 per cent, the Commission report noted that 37.6 per cent was the average devolution during the 15th FC term. This was lower than the average devolution (39.4 per cent) of the 14th FC period.

Even then, the Commission left the issue untouched saying that the imposition of cesses and surcharges was a right granted to the Union by the Constitution.

Kerala's slightly larger pie
Nonetheless, in horizontal devolution, or while apportioning the tax revenue among the 28 states in the country, the 16th FC has set apart a larger share for Kerala. If it was 1.925 per cent during the five years of the 15th FC, it will be 2.382 per cent during the 16th FC term (2026-27 to 2031-32), a 0.457 per cent increase.

This is same as the horizontal devolution during the 13th FC period (2010-11 to 2014-15). It was 2.50 per cent during the 14th FC period (2015-16 to 2019-20). Finance minister K N Balagopal was deeply dissatisfied with the horizontal devolution, too. He told reporters in Kollam that Kerala had sought a 2.7 per cent share.

Fiscal and family discipline
The 16th FC has introduced a new parameter in the horizontal devolution criteria: Contribution to GDP. This criterion recognises tax effort and fiscal discipline, and is given a weight of 10 per cent.

There were five other criteria: population, demographic performance, area, forest cover and 'per capita GSDP distance'.

'Per capita GSDP Distance' is the most dominant criterion and has been given a weightage of 42.5 per cent, slightly lower than the 15th FC weightage of 45 per cent. The poorer the state, the higher the devolution. States with relatively high GDP, like Kerala, will get a lower share under this parameter. The reason why Kerala had recommended only a 30 per cent weightage for this criterion.

'Population' has been accorded the second-highest weightage (17.5 per cent). Higher the population higher the tax share. Kerala does not disapprove of the criterion but resents the use of 2011 census as the base year to calculate the tax share.

From the 14th FC, commissions have relied on the 2011 census for their tax sharing calculations. This measure turns Kerala's population control achievement into a disadvantage. Because by 2011, Kerala had brought down its fertility rate to below replacement levels.

Therefore, Kerala has argued with finance commissions to keep the 1971 census as the base period, hoping it could get an even greater advantage. The 16th FC has also swatted aside this argument. Almost all other states are fine with the 2011 census, the report notes.

Cost of less babies
The last Commission, the 15th FC, had compensated states like Kerala that had controlled their population with a new criterion called 'Demographic Performance'. Lower the fertility rate higher the tax devolution. 12.5 per cent was the weightage given.

The 16th FC, however, has spotted a flaw in this criterion. It observes that declining total fertility rates (TFRs) meant a higher proportion of the aged, and therefore, a drag on the country's progress.

"The Commission found itself in sympathy with the view that as India travels on the growth path, it faces the risk of ageing before it becomes rich," the report says. So, it lowered the weightage of 'Demographic Performance' this time to 10 per cent. It even wants this criterion phased out over time. Kerala had recommended a weightage of 22.5 per cent for this parameter.

The other two parameters - area and forest cover - get a weightage of 10 per cent each. The highest horizontal share is for Uttar Pradesh (17.619 per cent), followed by Bihar (9.948) and Madhya Pradesh (7.347). Sikkim has the lowest share (0.335), followed by Goa (0.365), Nagaland (0.481) and Mizoram (0.564).