Centre Freezes 41% Tax Share, Bets on ₹1.4 Lakh Crore Local Grants to Power Federal Push

The Union Budget for the Financial Year 2026-27 was presented by Finance Minister Nirmala Sitharaman in the Lok Sabha today (Sunday, 1 February 2026), setting the stage for Centre–State fiscal relations over the next five years. In a major announcement on federal finances, she said that the Government has accepted the 16th Finance Commission’s recommendation to retain the States’ vertical share of the divisible tax pool at 41 %, and has provided ₹1.4 lakh crore to States as Finance Commission Grants for FY 2026-27, to be channelled to Rural Local Bodies, Urban Local Bodies and Disaster Management mechanisms.

Vertical delegation of power refers to the share of the Centre’s divisible tax pool, major central taxes excluding the cesses and surcharges, that is collectively transferred to States; the 41 % figure means that out of every ₹100 in this pool, States together will continue to receive ₹41 while the Centre gains ₹59. This relies with the framework introduced by the 15th Finance Commission, which had reduced the earlier 42% share recommended by the 14th Commission to 41% to account for the reorganisation of the erstwhile State of Jammu & Kashmir into Union Territories funded directly by the Union Government.

Officials say locking in this 41% for the 2026–2031 award period offers States predictability in planning welfare and development expenditure, even as the Centre claims the need to preserve fiscal space for defence, debt servicing, infrastructure and centrally sponsored schemes.

The ₹1.4 lakh crore in Finance Commission Grants, over and above tax devolution, will be distributed under three major categories in 2026-27. Rural local body grants will support Panchayati Raj Institutions at village, block and district levels in providing local roads, drinking water, sanitation and other basic services, using a mix of tied and untied funds. Urban local body grants will go to municipalities, municipal corporations and nagar panchayats to improve water supply, sewerage, solid waste management and core urban infrastructure, usually linked to conditions like audited accounts and minimum property‑tax effort.

Disaster management grants will be based to State Disaster Response Funds under the Disaster Management Act, 2005, with Centre–State cost‑sharing on a ratio of 90:10 for North‑Eastern and Himalayan States and 75:25 for others, to ensure steady, rule‑based funding for preparedness, swift response and recovery.

The decision stops the long running discussion about the state’s share in the central taxes. During consultations with the 16th Finance Commission, most States had pressed for a raise to 50%, and at least one suggested 45%, arguing that their expenditure responsibilities and climate‑related pressures have grown steeper as the Centre adamantly relies on cesses and surcharges which is not included in the divisible pool.

Even as the Commission and the Centre seek to address grassroots needs through large, targeted grants to local bodies and disaster management,they have opted to continue within 41% choosing stability rather than expansion of States’ formal share. State governments are now expected to focus on the upcoming horizontal devolution formula, which will decide how the 41% will be divided among individual States based on criterias such as population, income distance, area, forest cover and tax effort to assess whether they emerge as gainers or losers in the new regime.

The 16th Finance Commission, chaired by economist and former NITI Aayog Vice‑Chairman Dr. Arvind Panagariya, submitted its report to President Droupadi Murmu on 17 November 2025. The government will lay the report before the President as per the Constitution of India article 281 and 281, detailing which recommendations have been accepted or modified, formally ushering in the 2026–2031 award cycle.

With the 41% devolution ratio held steady and ₹1.4 lakh crore set aside for local body and disaster grants in the first year, the Budget shows a balance between Central fiscal prudence and the constitutional promise of stronger States and empowered third‑tier institutions, even as unresolved questions around cesses, surcharges, horizontal sharing and implementation capacity at the local level ensure that the contest over India’s fiscal federalism is far from over.

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