The 16th Finance Commission’s (FC) recommendations on vertical devolution have reignited an old but unresolved debate in Indian federalism: are States being fairly compensated for their constitutional responsibilities, or is the Centre steadily tightening its fiscal grip? By retaining the States’ share of the divisible pool at 41%, the Commission has opted for continuity. Yet, beneath this apparent stability lies a structural shift that increasingly disadvantages States — the steady erosion of the divisible pool itself.
What vertical devolution really means
Vertical devolution refers to the share of the Centre’s divisible pool of taxes that is transferred to States. At present, this share stands at 41%, a figure first recommended by the 15th Finance Commission and now retained by the 16th.
Crucially, the divisible pool does not include cesses, surcharges, or collection costs. This means the Centre determines not just how much revenue is collected, but how much of that revenue is actually shareable with States. As a result, the headline devolution percentage can remain unchanged even as States’ effective share declines.
The rise of cesses and surcharges
The core structural issue lies in the Centre’s increasing reliance on cesses and surcharges. Unlike standard taxes, these levies are not shareable with States.
Between 2013 and 2019, for every ₹100 collected by the Centre, roughly ₹93–95 came from taxes and duties forming part of the divisible pool, while only ₹5–7 came from cesses and surcharges. This balance has since shifted sharply. By 2021–22, the non-shareable component had risen to ₹13.5 per ₹100 collected. Even in 2025–26, it is projected to remain high at around ₹11.
The 16th FC itself acknowledges this trend. It notes that the non-shareable portion of revenues rose from 1.1% of GDP in 2011–12 to 2.2% of GDP by 2023–24, while the divisible pool barely increased from 9.1% to 9.4%. In other words, growth in central revenues has disproportionately occurred outside the pool shared with States.
What the numbers from Parliament show
Absolute collection data reinforce this picture. Central cess collections (excluding the GST compensation cess) rose from ₹44,688 crore in FY15 to ₹3.52 lakh crore in FY22, and are projected at over ₹2.5 lakh crore in FY26. Surcharges show a similar surge.
As a result, the share of the divisible pool in the Centre’s gross tax revenue has stayed below 90% for six consecutive years — a sharp contrast to the period between FY13 and FY18, when it consistently exceeded 93%.
States’ demands versus the Centre’s stance
Against this backdrop, it is unsurprising that States have demanded a higher share. As many as 18 States — cutting across regions and political affiliations — have sought an increase in vertical devolution to 50%. Others have argued for intermediate levels such as 45% or 48%.
The Centre, however, argued for “moderation in tax devolution”. The 16th FC chose to retain the status quo, positioning itself as a balancer between competing claims. But its reasoning reveals a clear tilt.
The Finance Commission’s justification
The Commission advances several arguments. First, it notes that the Constitution does not allow a cap on cesses and surcharges, and that these instruments give the Centre fiscal flexibility in emergencies such as war, pandemics, or natural disasters. Imposing limits, it argues, would be “imprudent”.
At the same time, the FC concedes that long-term dependence on these levies is undesirable, warning that the Centre may lose interest in standard taxation — a development harmful to States.
Second, it cites heightened external security challenges and defence requirements, alongside the Centre’s perceived effectiveness in infrastructure creation, to justify retaining greater fiscal space at the Union level.
Third, it claims that the existing distribution gives States “sufficient resources” to discharge their constitutional responsibilities.
Finally, the Commission places the onus of reform on political consensus, suggesting that the Centre should voluntarily shift revenue collection away from cesses and surcharges back into shareable taxes.
Why this raises deeper federal questions
This interpretation leaves several questions unresolved. Could the framers of the Constitution have anticipated such extensive use of non-shareable levies? By refusing to recommend even indicative limits, has the FC effectively ceded its mediating role between the Centre and the States?
The assertion that central infrastructure efficiency justifies higher central retention also ignores the fact that economically stronger States often contribute more but receive proportionally less. And if States truly have “sufficient” resources, the near-unanimous demand for a higher share becomes difficult to explain.
The deeper issue: rate versus base
The debate over whether 41% should be raised or lowered risks missing the central problem. Even a higher devolution rate delivers limited relief if the divisible pool itself keeps shrinking. As long as cesses and surcharges dominate revenue mobilisation, States’ fiscal autonomy will continue to erode, regardless of the headline percentage.
What to note for Prelims?
- Vertical devolution refers to tax sharing between Centre and States.
- Cesses and surcharges are excluded from the divisible pool.
- 16th Finance Commission retained vertical devolution at 41%.
What to note for Mains?
- Impact of rising cesses and surcharges on cooperative federalism.
- Limitations of Finance Commissions in restraining central fiscal power.
- Debate between headline devolution rates and the shrinking divisible pool.