On November 17, 2025, the 16th Finance Commission (FC) of India submitted its report to the President, marking a significant moment in the ongoing dialogue about fiscal federalism and local governance in India. The Finance Commission, constituted every five years as mandated by Article 280 of the Indian Constitution, plays a crucial role in recommending how financial resources should be allocated between the Union and the States, and importantly, within States to local governments such as panchayats and municipalities. The latest report has generated considerable interest, particularly in how it addresses the vertical and horizontal distribution of resources for the next five-year period and the strengthening of local government finances.
Local governments in India—panchayats in rural areas and municipalities in urban settings—are the frontline providers of essential public services. Their responsibilities span a wide array of functions including drinking water supply, sanitation, public health, rural road maintenance, and upkeep of community assets. Despite their critical role, these local bodies often face a persistent mismatch between their expenditure responsibilities and their revenue-generating capacities. While the 73rd and 74th Constitutional Amendments empower State governments to devolve financial powers and responsibilities to local bodies, the reality on the ground is marked by significant variation across States and Union Territories.
One reason for this variation lies in the discretionary powers of State governments to assign revenue sources and functional duties to local governments. The Constitution’s 11th and 12th Schedules list numerous subjects for panchayats and municipalities respectively—29 broad subjects for panchayats and 18 for municipalities—but these lists are illustrative rather than exhaustive or binding. In practice, the assignment of functions and revenues is often imbalanced. State governments frequently allocate responsibilities to local bodies without granting them matching financial resources or administrative staff. This structural imbalance hampers the ability of local governments to deliver services effectively and manage development activities sustainably.
The issue is compounded by the nature of fiscal transfers. Local governments are expected to raise revenue through certain local taxes such as property tax, advertisement tax, and fees including market or toll charges. However, these sources often fall short of covering their expenditure needs, leaving local bodies heavily dependent on transfers from State and Union governments. To improve this situation, every State constitutionally establishes a State Finance Commission (SFC) every five years. These SFCs are tasked with recommending measures to enhance fiscal devolution to local governments, including sharing in the State’s revenue pool, assignment of revenue sources, and grants-in-aid (both conditional and unconditional). Despite over a hundred SFC reports submitted across various States, the implementation of their recommendations has been sporadic and inconsistent.
Given the limitations at the State level, local governments continue to rely heavily on fiscal transfers from the Union government, which are facilitated through the Union Finance Commission. Historically, six Union Finance Commissions have recommended transfers to local governments, but these were often ad hoc and did not systematically quantify the financial requirements of local bodies. The 13th Finance Commission marked a significant departure by recommending that grants to local governments be calculated as a fixed percentage share of the Union tax divisible pool. This formula-based approach had two major advantages: it neutralized the effect of inflation and allowed local governments to benefit from the growth in Union tax revenues.
However, this progress was short-lived. The 14th and 15th Finance Commissions reverted to recommending lump sum grants rather than continuing with the percentage-based formula. This back-and-forth created uncertainty and disrupted the continuity of fiscal planning at the local level. Another contentious issue has been the conditionality attached to grants. The Commissions split grants into basic (unconditional) and performance-based (conditional) components, aiming to incentivize reforms in local governance. Yet, each successive Commission introduced a different set of conditions for performance grants, often disregarding the reform agendas of their predecessors.
For example, the 13th Finance Commission set six conditions for performance grants, but most States struggled to meet them. The 14th Finance Commission dismissed these conditions entirely and proposed a new set of conditions. The 15th Finance Commission, in turn, came up with yet another distinct list of conditions. This lack of consistency has undermined the efficacy of conditional grants as a tool for local government reform and capacity building.
Amidst this backdrop, there has been a strong expectation that the 16th Finance Commission would take a more comprehensive and forward-looking approach. This includes conducting a detailed assessment of the resource requirements of approximately