Union Budget 2026-27 Maintains States' Tax Share at 41% Following Finance Commission Advice
In a significant development for fiscal federalism, the Union Budget for 2026-27 has proposed to continue allocating 41% of the central government's divisible pool of taxes to states for the five-year period commencing from FY27. This decision aligns precisely with the recommendations put forth by the Sixteenth Finance Commission (SFC), which is chaired by noted economist Arvind Panagariya.
Budget Speech Confirms Acceptance of Commission's Report
Presenting the budget in Parliament on 1 February, Finance Minister Nirmala Sitharaman confirmed that the government has accepted the SFC's recommendation to keep the vertical devolution ratio unchanged. She informed lawmakers that the commission submitted its comprehensive report to the President on 17 November 2025, and the administration has moved forward with its key suggestion regarding tax distribution.
"As recommended by the commission, I have proposed ₹1.4 lakh crore to the states for the year 2026-27 as finance commission grants. These allocations specifically include crucial rural and urban local body grants alongside essential disaster management grants," Minister Sitharaman stated during her address.
Background and Economic Context of the Decision
This move was widely anticipated, with reports as early as June 2025 indicating the government's inclination to maintain the 41% share. Given that the Indian economy is projected to grow at approximately 7% annually over the medium term, states are expected to witness a substantial increase in their share in absolute monetary terms as central revenues expand correspondingly.
The Sixteenth Finance Commission, being a constitutional body, holds the mandate to recommend the distribution of tax revenues between the Centre and states for the period spanning from 1 April 2026 to 31 March 2031. The horizontal sharing methodology for the 41% pool—which excludes cesses and surcharges—is determined based on several critical factors:
- Population metrics and demographic considerations
- Income distance and economic disparities
- Regional development status and infrastructure needs
- States' own tax efforts and revenue generation capabilities
Shift in Fiscal Consolidation Framework Emphasized
In her budget speech, Finance Minister Sitharaman also outlined a pivotal shift in the Centre's fiscal consolidation strategy. The government is moving away from primarily targeting the fiscal deficit as a percentage of GDP toward focusing more intently on reducing the Centre's debt-to-GDP ratio.
"The government has been delivering on its fiscal consolidation commitments consistently without compromising on essential social needs and welfare programs," the minister emphasized, highlighting the balanced approach adopted by the administration.
Debt-to-GDP Targets and Fiscal Deficit Achievements
Elaborating on the new fiscal management standards introduced in Budget 2025-26, Sitharaman recalled that the central government aims to achieve a debt-to-GDP ratio of 50%, with a permissible variation of plus or minus one percentage point, by the fiscal year 2030-31. In alignment with this ambitious target, the debt-to-GDP ratio is estimated at 55.6% of GDP in the budget estimate for FY27. This marks a slight improvement from the 56.1% of GDP recorded in the revised estimate for the preceding year, 2025-26.
Furthermore, the government has successfully met its commitment, originally made in FY22, to bring the fiscal deficit below 4.5% of GDP by 2025-26. The revised estimates for 2025-26 peg the fiscal deficit at 4.4% of GDP, demonstrating disciplined fiscal management.
"In line with the new fiscal prudence path centered on debt consolidation, the fiscal deficit in the Budget Estimate for 2026-27 is projected to be 4.3% of GDP," Sitharaman announced, underscoring the continued trajectory toward greater fiscal stability and responsible economic governance.
