Budget 2026: States' Tax Share Held at 41%, Centre Accepts 16th FC Report

Union Budget 2026: Continuity in Fiscal Federalism

In a key announcement during the Union Budget 2026 presentation, Finance Minister Nirmala Sitharaman confirmed that the government has accepted the 16th Finance Commission's recommendation to maintain the vertical share of tax devolution to states at 41 percent. This decision ensures continuity in the fiscal architecture governing Centre-state financial relations for the five-year period from 2026 to 2031. Alongside this, the Finance Minister allocated Rs 1.4 lakh crore in grants to states for the financial year 2026-27, reinforcing the Centre's commitment to supporting state-level finances.

The Core Recommendation: A 41% Share

The 41 percent figure represents the portion of the Centre's divisible tax pool that will be transferred to all states and union territories. This divisible pool includes major central taxes like income tax and Goods and Services Tax (GST), but excludes cesses and surcharges, a long-standing point of contention for states. By accepting this recommendation, the government has opted for stability, carrying forward the same percentage that was in effect under the 15th Finance Commission's term.

This move provides states with a predictable revenue stream, allowing them to better plan their expenditures on social schemes, infrastructure projects, and other developmental activities. For the central government, maintaining the status quo helps in managing its own fiscal consolidation path without major disruptions.

Historical Perspective on Devolution

The decision to retain the 41 percent share follows a period of significant change. The 14th Finance Commission (2015-2020), led by former RBI Governor Y.V. Reddy, had recommended a substantial increase in the states' share from 32 percent to 42 percent. The 15th Finance Commission (2020-2026) adjusted this to 41 percent to account for the newly formed union territories of Jammu & Kashmir and Ladakh, which would receive funds directly from the Centre. The 16th Finance Commission, chaired by former NITI Aayog Vice-Chairman Arvind Panagariya, has endorsed this level, signaling a consensus on the current balance of fiscal resources.

Grants-in-Aid: The Rs 1.4 Lakh Crore Allocation

Beyond the tax devolution, the Union Budget has allocated a substantial Rs 1.4 lakh crore as Finance Commission grants for FY 2026-27. These grants are crucial transfers that supplement the states' revenues and are often tied to specific objectives. As stated by the Finance Minister, this allocation includes:

• Grants for Rural and Urban Local Bodies: To strengthen grassroots governance and fund local infrastructure and services.
• Disaster Management Grants: To enhance the financial capacity of states to respond to natural calamities, in line with the Disaster Management Act, 2005.

These grants play a vital role in addressing specific needs and ensuring that funds reach the last mile for critical services.

Metric	Union Budget 2026 Provision
Vertical Devolution (States' Share)	41% of the divisible tax pool
Finance Commission Grants (FY 2026-27)	Rs 1.4 lakh crore
Period Covered by 16th FC Report	April 1, 2026, to March 31, 2031

Unchanged Dynamics and State Concerns

While the 41 percent share provides stability, it does not address the demands from several states for a higher devolution, with some advocating for a 50 percent share. The primary concern remains the increasing use of cesses and surcharges by the Centre. Since these are not part of the divisible pool, states do not get a share, effectively reducing the total revenue transferred to them from the gross tax collections.

Furthermore, the budget announcement confirms the vertical devolution, but the detailed report containing the formula for horizontal distribution—how the 41 percent pool is divided among the states—has not yet been made public. This formula, which historically uses criteria like population, area, income distance, and demographic performance, is often a source of friction between states, particularly between southern states and their northern counterparts over the weightage given to population.

Market and Economic Impact

The acceptance of the Finance Commission's recommendation is a positive signal for fiscal stability and policy predictability. For the bond markets, it removes a key uncertainty regarding the Centre's fiscal position. For states, it provides a clear basis for their own budget preparations. The continuity ensures that there are no sudden shocks to state finances, which is crucial for maintaining public investment and social spending momentum across the country.

Conclusion: A Path of Stability

The Union Budget 2026 has set a clear and stable path for Centre-state financial relations for the next five years by accepting the 16th Finance Commission's headline recommendation. The decision to maintain the 41 percent tax share, coupled with a significant grant allocation, balances the needs of both the Centre and the states. The full implications, however, will become clearer once the commission's detailed report, particularly the criteria for horizontal distribution, is tabled in Parliament and made public.