India's Constitution creates a federal structure: the Union government collects certain taxes, state governments collect others, and the biggest taxes are shared. Managing this division fairly and efficiently is one of the most important, least understood parts of public finance. At the centre of it all is the Finance Commission.
What the Finance Commission does
The Finance Commission is a constitutional body set up every five years under Article 280. Its core job: recommend how the 'divisible pool' of central taxes should be split between the Centre and the states, and among the states themselves. It also recommends grants-in-aid to states that need extra support. The President appoints the Commission, which submits a report, and Parliament decides whether to accept its recommendations (it almost always does).
Think of the Finance Commission as the referee in fiscal federalism. It balances the Centre's needs (defence, interest payments, national programmes) against the states' needs (health, education, police, agriculture) and tries to ensure every state gets a fair share based on population, area, income distance (how poor the state is relative to others), forest cover, and other criteria.
Vertical devolution: the 41% figure
The most talked-about number in every Finance Commission report is the vertical devolution percentage: the share of the Centre's gross tax revenue (excluding cesses and surcharges, which are not shareable) that goes to the states. The 15th Finance Commission, which covers the period 2021-22 to 2025-26, recommended 41%. That means for every ₹100 the Centre collects in income tax, corporate tax, GST and customs (net of collection costs and excluding cesses), ₹41 is transferred to the states as their constitutional share.
This 41% is not a grant or loan — it is the states' entitlement, with no strings attached. States are free to spend it as they see fit. The percentage has risen over time (it was 32% in the 12th Finance Commission period, 42% in the 14th), reflecting a political and economic consensus that states need more resources to deliver services on the ground.
Horizontal devolution: dividing the pool among states
Once the vertical share is fixed, the Finance Commission must decide how to divide that 41% among the 28 states. This is horizontal devolution, and it is guided by a formula that weighs multiple factors:
- Population (using both 1971 and 2011 Census data, to balance rewarding population control with recognising current needs)
- Area (larger states have more infrastructure to maintain)
- Forest and ecology (states that preserve forests provide a public good)
- Income distance (poorer states get more to bridge the gap)
- Tax and fiscal effort (rewarding states that collect their own revenue efficiently)
The exact weights change with each Commission. The 15th Finance Commission gave significant weight to population (using a blend of 1971 and 2011 data) and income distance, ensuring that less-developed states like Bihar, Uttar Pradesh and Madhya Pradesh receive larger per-capita shares, while richer states like Maharashtra and Tamil Nadu receive less in proportion to population but still benefit from their larger tax base.
GST and the new layer: the GST Council
The introduction of GST in 2017 added a new constitutional actor: the GST Council, created under Article 279A. The Council is a joint forum of the Union and state finance ministers (the Union Finance Minister chairs it, and states collectively hold two-thirds voting weight). It sets GST rates, decides exemptions, and resolves disputes. Unlike the Finance Commission, which is a recommending body, the GST Council makes binding decisions on GST policy.
GST replaced a host of central and state taxes, and both Centre and states now collect GST in parallel (CGST and SGST). The design was meant to preserve states' fiscal autonomy while creating a single national market. In practice, states surrendered some taxing power in exchange for predictability and a promise of compensation (which ran into trouble during COVID-19). The GST Council is now the arena where federal tax bargaining happens continuously, not just once every five years.
Why this structure matters
Federalism is not a theoretical nicety — it is how public money reaches the hospital in your district, the school in your village, the police station in your town. States deliver most public services, but they do not raise enough revenue on their own. The Finance Commission's devolution formula and the GST Council's rate-setting are the mechanisms that make federalism financially viable.
For citizens, understanding this system means understanding that a 'central government policy' often depends on state implementation and state finances. A poorly funded state cannot deliver services, no matter how generous the Centre's scheme. The transfer system is the fiscal glue holding the Union together.
Fiscal federalism is not just about fairness between regions — it is about ensuring every citizen, in every state, has access to basic public goods. The Finance Commission is the quiet institution that makes that possible.
To see how much tax revenue your state receives from the divisible pool, and how central and state finances interact, explore the data dashboard on UnionOfTaxpayers.in.
Official sources
This explainer is based on official and primary sources. Always confirm figures and dates on these before acting:
Reviewed: October 2026. Tax rules change — verify the current financial year and assessment year before you rely on any figure.
This is general educational information for Indian taxpayers, not personalised tax, legal or financial advice. Union of Taxpayers is an independent platform and not a government body. Consider a qualified professional for your specific situation.
Not professional advice
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