Cabinet approves Terms of Reference for 16th Finance Commission

The Union Cabinet, chaired by Prime Minister Shri Narendra Modi, has granted approval for the Terms of Reference of the Sixteenth Finance Commission. These terms will be officially notified in the coming period. The recommendations of the 16th Finance Commission, once accepted by the government, are slated to apply for a duration of five years from April 1, 2026.

As per Article 280(1) of the Constitution, the establishment of a Finance Commission is outlined to provide recommendations on the distribution of net proceeds of taxes between the Union and the States. This includes the allocation of respective shares among the States, grants-in-aid, revenues of the States, and measures required to supplement the resources of the Panchayats during the award period.

The Fifteenth Finance Commission, formed on November 27, 2017, issued recommendations spanning a six-year period starting April 1, 2020, through its Interim and Final Reports. These recommendations remain in effect until the financial year 2025-26.

Terms of Reference for the Sixteenth Finance Commission:

The Finance Commission shall make recommendations as to the following matters, namely:

1. The distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them under Chapter I, Part XII of the Constitution and the allocation between the States of the respective shares of such proceeds;

2. The principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India and the sums to be paid to the States by way of grants-in-aid of their revenues under article 275 of the Constitution for the purposes other than those specified in the provisos to clause (1) of that article; and

3. The measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State.

The Commission will assess current funding structures for Disaster Management initiatives, specifically those outlined in the Disaster Management Act, 2005 (53 of 2005), and provide recommendations. The report, covering a five-year period from April 1, 2026, will be released by October 31, 2025.

Background:

The Fifteenth Finance Commission (15th FC), established on 27.11.2017, initially mandated to make recommendations for the five-year span of 2020-21 to 2024-25, saw an amendment to its Terms of Reference (ToR) on 29.11.2019. This modification required the commission to submit both a first report for the financial year 2020-21 and a final report covering an extended period from 2021-22 to 2025-26. Consequently, the 15th FC provided recommendations for a six-year period, spanning 2020-21 to 2025-26.

Despite the usual two-year timeframe for Finance Commission recommendations, the need for an extended reporting period led to the early constitution of the 16th Finance Commission. This move allows the 16th FC to assess the finances of the Union and States immediately preceding the recommendation period. Notably, historical instances, such as the Eleventh Finance Commission, were constituted six years after the Tenth Finance Commission, and the Fourteenth Finance Commission followed a similar pattern five years and two months after the Thirteenth Finance Commission.

The Advance Cell of the 16th FC was established in the Ministry of Finance on 21.11.2022 to oversee preliminary work before the formal constitution of the Commission. Subsequently, a Working Group led by the Finance Secretary and Secretary (Expenditure), including key officials, was formed to assist in crafting the ToRs. The consultative process involved seeking views and suggestions from State Governments and Union Territories (with legislature), which were thoroughly considered by the Group.

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