When Growth Pays but Population Collects: How the 16th Finance Commission Deepens India’s North–South Fiscal Divide

By R. Suryamurthy

The Sixteenth Finance Commission has not invented India’s North–South fiscal divide, but it has, perhaps more clearly than any of its predecessors, laid bare the political economy that sustains it: a system in which economically productive, demographically stabilised southern and western states finance a disproportionate share of the Union’s revenues, only to see redistribution still governed largely by population legacy and need-based metrics that increasingly reward scale rather than contribution, even as the Centre tightens its grip over the tax base itself.

The headline narrative—that Karnataka emerges as the biggest gainer from the 16th Finance Commission’s horizontal devolution formula—risks obscuring this deeper truth. Karnataka’s share of the divisible pool rises from 3.65 per cent to 4.13 per cent for the 2026–31 period, yielding an additional ₹7,387 crore.

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Kerala, Gujarat and Haryana also register gains, while Madhya Pradesh records the steepest relative loss. Yet these shifts, driven largely by the introduction of a 10 per cent weight for “contribution to Gross Domestic Product”, barely dent the structural imbalance between what the South contributes and what it ultimately receives back.

The Commission’s own data show why. Southern states—Tamil Nadu, Karnataka, Kerala, Telangana and Andhra Pradesh—together account for roughly 30 per cent of India’s GDP while housing just over 18 per cent of its population. In contrast, the populous northern and central states—Uttar Pradesh, Bihar, Madhya Pradesh, Rajasthan and Jharkhand—account for close to 43 per cent of the population but less than 30 per cent of national output.

This divergence has widened over the past decade as fertility rates fell sharply in the South while growth in services, manufacturing and formal employment remained spatially concentrated.

Yet horizontal devolution continues to lean heavily on demographic and redistributive logic. Population (2011) and demographic performance together still command a weight of 27.5 per cent in the formula, while income distance—designed to equalise fiscal capacity—retains a dominant 45 per cent weight. Against this, the much-discussed GDP contribution parameter, at 10 per cent, functions more as a symbolic concession to contributor states than as a decisive counterweight.

The result is visible in the return-on-contribution ratios. Southern states such as Karnataka and Tamil Nadu contribute between ₹1.50 and ₹2 to the Union exchequer for every ₹1 they receive back in devolution and grants. Kerala’s ratio is marginally better but still well below parity.

By contrast, several northern and central states receive ₹2 to ₹3 for every ₹1 they contribute, reflecting both lower tax bases and the continued emphasis on need-based redistribution. These ratios are not political claims; they emerge directly from comparing state-wise tax contribution estimates with Finance Commission devolution tables.

The 16th Finance Commission’s attempt to temper this imbalance through the GDP contribution metric is real but limited. Karnataka’s gain of ₹7,387 crore over five years, while politically salient, is economically modest when set against the scale of its contribution.

The state generates close to 9 per cent of national GDP and a significantly higher share of net direct taxes, yet its post-16FC share of the divisible pool remains just over 4 per cent. Even as the biggest “winner”, Karnataka continues to receive barely half a rupee for every rupee it sends to the Centre.

This asymmetry is sharpened further by the Centre’s expanding reliance on cesses and surcharges, a trend the Commission flags but does not resolve. Non-shareable levies now account for close to one-fifth of gross tax revenues, up from around a tenth a decade ago.

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Since these revenues sit outside the divisible pool, states—especially the high-contributing southern ones—see their effective share of national taxation shrink even as their formal devolution percentage remains unchanged at 41 per cent. In practical terms, the South pays more into a pool from which a growing share is never shared.

The federal tension becomes starker when expenditure responsibilities are layered onto this revenue picture. Southern states spend a higher proportion of their budgets on health, education, urban infrastructure and social protection, reflecting both demographic transition and higher citizen expectations.

They also tend to have stronger compliance with fiscal rules, lower debt ratios relative to GSDP, and better outcomes on most governance indicators. Yet the 16th Finance Commission’s recommendations on fiscal discipline—tight deficit caps, restrictions on off-budget borrowing, and enhanced audit scrutiny—apply uniformly, leaving little room for differentiated autonomy based on fiscal performance.

Meanwhile, poorer northern states continue to rely heavily on transfers to finance basic expenditure, with limited incentives—or capacity—to close the productivity gap. The Commission’s own projections acknowledge that inter-state income convergence remains slow, suggesting that decades of redistribution have not fundamentally altered the growth geography of the country.

What redistribution has done, however, is entrench political dependence on central transfers, while contributor states increasingly question the fairness of a system that penalises demographic success and rewards population weight.

This is where the North–South divide ceases to be merely economic and becomes constitutional. The framers envisaged Finance Commissions as instruments of balance—mechanisms that would allow poorer regions to catch up without permanently burdening richer ones.

What the 16th Finance Commission reflects instead is a federation under strain, where demographic arithmetic collides with economic geography, and where the political logic of representation increasingly overwhelms the economic logic of contribution.

The modest concessions made to southern states through the GDP contribution weight do not resolve this tension; they merely postpone it. As long as the divisible pool remains capped, cesses continue to proliferate, and redistribution remains anchored more in population than productivity, the South will continue to subsidise the North—not as a transitional necessity, but as a structural feature of India’s fiscal state.

In that context, Karnataka’s status as the largest gainer is not a vindication of federal fairness but a warning sign. When the most productive states are asked to celebrate marginal improvements in returns that still leave them deeply net negative, the question is no longer about tweaking formulas, but about whether India’s fiscal federalism can remain politically sustainable in a country where economic and demographic trajectories are pulling steadily apart.

This report is from 5Wh news service. NewsGram holds no responsibility for its content. 

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