The Congress-ruled Karnataka is set to emerge as the biggest gainer of the 16th Finance Commission's horizontal devolution formula, while the BJP-led Madhya Pradesh will likely take the largest hit.
The Finance Commission, a constitutional body, recommends how tax revenues collected by the Central government should be distributed among the Centre and various states in the country. The Centre, however, is not legally bound to implement the suggestions made by the Commission.
The panel, established in 2023 and chaired by former Vice-Chairman of Niti Aayog Arvind Panagariya, submitted its report to the president in November 2025 after consultations with all states and union territories, many of which sought a higher share.
As per the new formula, Karnataka's share in the Centre's tax devolution was increased to 4.13% for 2026-31, compared to 3.65% under the 15th Finance Commission. This would imply an additional Rs 7,387 crore, increasing Karnataka's allocation to Rs 63,050 crore, in comparison to the Rs 55,663 crore Karnataka would have secured according to the previous formula.
The 10% weight for "contribution to Gross Domestic Product" in the devolution formula was a key element that spurred the shift.
This was used as a yardstick to gauge a state's economic performance and reward it for performing well.
Karnataka, with its sizable contribution to the national output via manufacturing, services, and technology, stands to reap unbalanced rewards due to this.
The Centre has decided to retain the share of states in a common pool of taxes for the 2026-31 period at 41%, Finance Minister Nirmala Sitharaman said in her Budget speech on Sunday, a move that drew criticism from some opposition leaders.
States' share of central taxes has been set at that range in the previous five years to account for the reorganisation of Jammu and Kashmir.
"We are disappointed that the Union Government has chosen to retain devolution at 41% without acknowledging the steadily increasing fiscal responsibilities of states," said Karnataka Chief Minister Siddaramaiah.
Although states' share has stayed high in percentage terms, their slice of total tax revenue has shrunk as cesses and surcharges have grown.
The central tax pool includes major levies shared with states such as income and corporate taxes, customs and excise duties and the goods and services tax, but excludes cesses and surcharges retained by the federal government.
Kerala trailed as the second-most prominent beneficiary, with its allocation increasing by Rs 6,975 crore and its share went up to 2.38% from 1.93%. Gujarat (Rs 4,228 crore) and Haryana (Rs 4,090 crore) also saw significant gains, due to their higher per capita incomes and considerable contribution to GDP.
Madhya Pradesh saw the least benefits, with its allocation reducing by Rs 7,677 crore to Rs 1.12 lakh crore. Its share in the Centre's divisible pool reduced to 7.35% from 7.85%, due to it not measuring up as well compared to the other states on the newly introduced efficiency metric.
The Finance Commission has recommended that the fiscal deficits of states should stay within the 3 per cent of Gross State Domestic Product (GSDP) limit during the award period 2026-27 to 2030-31, and that they should not go in for off-budget borrowings to ensure financial stability.
It also recommended that the Comptroller and Auditor General (CAG) include disclosures on off-budget borrowings in State Finance Accounts.
It has clarified that interest-free on-lending by the Centre to states under the Special Assistance to States for Capital Investment (SASCI) would continue to be outside this limit, as is the current practice.
The report has highlighted that in recent years, states have increasingly relied on market borrowings to finance their deficits.
