The Finance Commission of India is a constitutional body established under Article 280 of the Constitution of India to maintain financial harmony between the Union and the States. It is one of the most important institutions supporting India’s federal structure. Through its recommendations, the Finance Commission seeks to promote fiscal federalism, balanced regional development, and equitable distribution of national resources.

The Finance Commission is constituted by the President of India after every five years.

India is a Union of 28 States. We have a federal Constitution having two types of Governments—

(1) Union Government and,

(2) State Governments

The Union Government has its own Sources of Income and similarly State Governments have their own Sources of Income. Some Taxes such as Income Tax, Corporate Tax i.e. Income Tax on Companies, Custom Duty etc are imposed and collected by the Union Government only. Some taxes such as VAT on five petroleum items ( crude oil, petrol, diesel, CNG and Aviation Turbine Fuel ), Excise duty on liquor for human consumption, etc are imposed & collected by States. We have started a GST system w.e.f. 1-7-2017 and under this we have clubbed more than 18 indirect taxes under one tax - the Goods & Service Tax (GST). GST is shared by the union and the state governments.

Income Tax, Corporation Tax , Custom Duty etc. are imposed by the Union Government and collected by the Union Government but they are shared with the states as per the recommendations of the Finance Commission.

The Finance Commission defines the financial relations between the Centre, the States and among the states. The Finance Commission is at the Centre of Fiscal Federalism. Its core responsibility is to evaluate the state of finances of the Union and the State Governments, recommend the sharing of taxes between them and it lays down the principles to determine the distribution of these taxes between Centre & States & among the states.

The First Finance Commission was formed on 2nd November, 1951 by the President. Till date, 16 Finance Commissions have been formed. The Sixteenth Finance Commission is the current Finance Commission of India for the period from 1 April 2026 to 31 March 2031.

The Commission is chaired by Arvind Panagariya. Its full-time members are Annie George Mathew, Manoj Panda and Soumya Kanti Ghosh. Mr T Rabi Sankar serves as the part-time member.

The 14th Finance Commission recommended an increase in share of the States in the Centre’s tax revenue from 32% to 42%. This was indeed the single largest increase ever recommended by a Finance Commission. Higher allocation to States was recommended to reassure them that the States need not to worry due to implementation of GST.

Functions of the Finance Commission:

1. Vertical Devolution - The Finance Commission recommends how the tax revenue collected by the Central Government should be divided between the Centre and the States. This sharing of revenue between the two levels of government is known as Vertical Devolution.

2. Horizontal Devolution - After deciding the share of all States together, the Commission recommends how this amount should be distributed among the individual States. Factors such as population, area, income level, forest cover, and tax effort are considered while allocating funds.

3. Grants-in-Aid - The Commission recommends Grants-in-Aid, which are financial assistance provided by the Central Government to States that need additional funds.

4. Strengthening Local Governments - The Finance Commission recommends measures to improve the financial position of Panchayats and Municipalities.

5. Other Financial Matters - The President of India may refer any other financial issue to the Finance Commission. The Commission then advises the President on matters related to sound financial management, fiscal stability, public debt, disaster management funding, and other financial concerns.

The recommendations of the Finance Commission are advisory in nature and therefore not binding on the Union Government.

Tenure:

The Chairperson and members of the Finance Commission are appointed by the President and have the tenure of 5 years.

State Finance Commission (Article 243 I)

Our Constitution talks about the establishment of a State Finance Commission for each State. The Governor of a State constitutes the State Finance Commission after every 5 years. The Chairperson and members of the State Finance Commission are appointed by the Governor for a tenure of 5 years. The main functions of State Finance Commission are—

(1) (a) To recommend distribution of the state taxes to panchayats.

(b) The determination of taxes which can be imposed by the Panchayats and,

(c) Grant-in-Aid to the Panchayats by the State Government.

(2) Measures needed to improve the financial position of Panchayats.

(3) Any other matter referred to the Finance Commission by the State Governor in the interest of Sound Finance of Panchayats.

Note: Article 243 (Y) of the Constitution further provides that the State Finance Commissions shall make similar recommendations for Municipalities.

16th Finance Commission Recommendations (2026–31) –

The 16th Finance Commission Report, tabled on 1 February 2026 for 2026–31, retained 41% vertical devolution of central taxes (excluding cesses and surcharges). For horizontal devolution, it uses income distance, 2011 population, demographic performance (1971–2011 population growth), forest cover (including increase in forest area), and contribution to GDP. It recommended ₹9.47 lakh crore as Grants-in-Aid, mainly for Urban and Rural Local Bodies and disaster management, while discontinuing revenue deficit, sector-specific, and state-specific grants. It increased the share of grants for Urban Local Bodies to 45% in view of rising urbanisation. For disaster management, it recommended a ₹2.04 lakh crore corpus, inclusion of heatwaves and lightning as notified national disasters, and upgradation of the National Disaster Management Information System (NDMIS).