Why Kerala gains on paper but loses fiscally under 16th Finance Commission
Higher inter se share offers no relief as withdrawn revenue deficit grants, growing reliance on surcharges and cesses cut into state's inflows from tax devolution
The 16th Finance Commission’s decision to retain 41 per cent of the divisible pool of Union taxes for devolution to states in 2026-31 has triggered concerns in Kerala. A study by the Kochi-based Centre for Socio-economic and Environmental Studies (CSES) says the unchanged headline figure hides a substantial fall in actual fiscal transfers to the state.
In its response to the Finance Commission award, the CSES said the decision to maintain the vertical share at 41 per cent amounts to a status quo approach that does not address the longstanding concerns of states regarding the shrinking divisible pool.
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The organisation pointed out that Union taxes and duties, excluding cesses and surcharges, constitute the divisible pool, and that the increasing reliance on cesses and surcharges has steadily reduced the shareable revenue available to the states.
The 16th Finance Commission has discontinued post devolution revenue deficit grants, under which Kerala had received Rs 37,814 crore during the previous award period. State and sector-specific grants have also been withdrawn.
“Irrespective of the ruling front in power, most states and a number of public finance experts have raised a demand to cap the quantum of cesses and surcharges to halt further shrinkage of divisible poll,” it said.
Cess and surcharge
The CSES further stated that the 16th FC “did not heed to the demands of the states to enhance the share or to enrich the divisible pool either by capping the cesses and surcharges or including non-tax revenue to the divisible pool”.
According to the analysis, dividends and profits of the Union government have increased sharply in recent years, from around Rs 1 lakh crore in 2023 to an estimated Rs 3.25 lakh crore in the current year, i.e., 2026.
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At the same time, GST rate reductions undertaken by the Centre have further reduced the size of the divisible pool, with the impact of these decisions being borne primarily by the states.
Kerala's share up, but...
On inter se distribution, Kerala’s share in tax devolution has increased from 1.925 per cent under the 15th FC to 2.382 per cent under the 16th, an increase of about 0.457 percentage points. However, the CSES, said this marginal rise does not translate into a net gain for the state due to the elimination of key grants.
Why Kerala stands to lose under 16th FC
♦ Divisible pool shrinks due to cesses and surcharges
♦ Revenue deficit and specific-purpose grants withdrawn
♦ Local body grants ignore Kerala’s decentralisation achievements
♦ Population projections skew rural grant allocations
♦ Kerala’s share of disaster management funds is down
The 16th FC has discontinued post-devolution revenue deficit grants, under which Kerala had received Rs 37,814 crore during the previous award period. State and sector-specific grants have also been withdrawn. Kerala had received Rs 2,412 crore under these heads during the 15th FC cycle.
M Gopakumar, researcher and CSES fellow, endorsed the assessment in the organisation’s response. “Retaining the vertical share at 41 per cent without addressing the steady shrinkage of the divisible pool and the withdrawal of compensatory grants effectively weakens the fiscal capacity of states like Kerala,” he told The Federal.
Specific-purpose grants
The analysis also highlighted the discontinuation of specific-purpose grants across states. During the previous FC period, aggregate specific-purpose grants to states amounted to more than Rs 1.22 lakh crore. The 16th FC has declined to continue these transfers, further reducing the overall volume of the commission transfers to states.
Local body grants have emerged as another area where Kerala faces a disadvantage under the new award.
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The inter se share of Kerala in grants for rural local bodies shall be 0.76 per cent, whereas the share in grants for urban local bodies shall be 5.73 per cent. In effect, the rural local bodies in Kerala shall get only Rs 3,308 crore, whereas the urban local bodies shall get Rs 16,683 crore during 2026-2031.
Ninety per cent weightage is given to the population in the devolution the FC grants to local bodies. The remaining 10 per cent is for area in the case of rural local bodies and own resource mobilisation in the case of urban local bodies.
No weightage is given to the decentralisation index. Thus, the significant devolution of powers and functions to local bodies in Kerala and the efficiency of local governance are not considered in the Finance Commission grants to local bodies. Kerala loses significantly on account of this.
Population projections
The 16th FC has taken into consideration the projections made by the Technical Group on Population Projections, Ministry of Health and Family Welfare (2020) to determine inter se shares in rural and urban local body grants.
As per the projection, the rural population in Kerala is 63,51,000 and the urban population is 2,99,12,000. These projections have been taken mechanically for ascertaining the inter se shares in local body grants without considering the fact that ‘urban population’ by definition is not all residents of urban local bodies.
The significant devolution of powers and functions to local bodies in Kerala and efficiency of local governance are not considered in the Finance Commission grants to local bodies. Kerala losses significantly on account of this.
The urban population is calculated based on Census figures which categorises census towns as urban areas. Many of the census towns in Kerala are grama panchayats. As a result of this misclassification, the rural local bodies in Kerala sustained a heavy loss.
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The previous FC provided Rs 6,344 crore for rural local and Rs 3,242 crore for urban local bodies. “The scenario, therefore, has reversed,” reads the CSES analysis.
Disaster management funds
The decline in Kerala’s share of disaster management funds is another area of concern. Under the 16th FC, the state has been allocated Rs 2,580 crore for disaster related funds over the award period, including allocations to the State Disaster Response Fund and the State Disaster Mitigation Fund. Its share has declined from 1.4 per cent under the previous FC to 1.2 per cent under the current award.
Former Kerala Finance Minister TM Thomas Isaac placed the FC recommendations within the wider context of declining central support to states.
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“Central assistance to states under various heads has been reduced by Rs 2 lakh crore in 2025–26. Moreover, allocations in the 2026–27 Budget are Rs 59,456 crore lower than last year’s Budget Estimates. This reduction has come in a year when GST revenues have declined and 40 per cent of the liability under the employment-guarantee scheme has been pushed onto the states,” he said in a social media post.
Overall slump in transfers
Critics of the Union government conclude that while the 16th FC has formally retained the 41 per cent devolution rate, the withdrawal of revenue deficit grants, the discontinuation of specific purpose grants and the failure to address the shrinking divisible pool have resulted in an effective decline in total transfers to states.
From Kerala’s perspective, they say, the recommendations amount to a significant fiscal setback rather than a neutral continuation of existing arrangements.
