Horizontal devolution

Also called: Horizontal distribution, Devolution criteria · Topic: Fiscal Federalism: Finance Commission, Devolution and Centre-State Finances · NCERT: Beyond NCERT

Meaning

Horizontal devolution is the way the Finance Commission splits the states' total share of central taxes among the individual states. It uses a weighted formula built on criteria such as income distance, population, area, forest, demographic performance and (from the 16th FC) contribution to GDP.

Formula: State's share = Σ (weight of criterion × state's share on that criterion)

It matters because it decides how many crores each state actually gets. It is also where the equity vs efficiency debate is fought: should money go to the states that need it most, or to the states that perform best?

Explanation

Two steps: vertical first, then horizontal

• Divisible pool: the part of the Centre's gross tax revenue that is shared with the states under Art. 270. It leaves out cesses, surcharges and the cost of collecting taxes.
• Step 1, vertical devolution: this decides how much of the divisible pool goes to all states taken together.
• 13th FC: 32%. 14th FC (2015-20): 42% [3].
• 15th FC (2021-26): 41%. The cut of 1 point happened because Jammu & Kashmir and Ladakh became Union Territories, which the Centre now funds directly [2].

• 16th FC (2026-31): kept at 41% [1].

• Step 2, horizontal devolution: this splits that combined share among the individual states. That split is this concept.

• The Finance Commission (set up under Art. 280 every five years) recommends both steps.

How the formula works

• For each criterion, every state gets a score share. This is its % out of 100 on that measure.
• Multiply each score share by the criterion's weight, then add the results.
• Worked example (made-up numbers, 16th FC weights):
• State X has these shares: income distance 12%, population 8%, demographic performance 4%, area 6%, forest 5%, GDP contribution 7%.
• Share = 0.425×12 + 0.175×8 + 0.10×4 + 0.10×6 + 0.10×5 + 0.10×7
• = 5.10 + 1.40 + 0.40 + 0.60 + 0.50 + 0.70 = 8.70% of the states' pool.
• If the states' pool is ₹10 lakh crore in a year, State X gets ₹87,000 crore.

The criteria and their weights (%)

Criterion	14th FC (2015-20)	15th FC (2021-26)	16th FC (2026-31)
Income distance	50	45	42.5
Population 1971	17.5	—	—
Population 2011	10	15	17.5
Area	15	15 (floor for small states)	10
Forest cover / forest and ecology	7.5	10	10
Demographic performance	—	12.5	10
Tax and fiscal effort	—	2.5	dropped
Contribution to GDP	—	—	10 (new)

• Income distance (the equalising core): a state gets a larger share when its per capita GSDP (Gross State Domestic Product ÷ population) is further below a benchmark.
• 15th FC benchmark: the distance from the highest-income state, using the average for 2016-17 to 2018-19 [2].
• 16th FC benchmark: the distance from the average of the top three large states, using 2018-19 to 2023-24 and leaving out 2020-21 [1].
• The top-three average stops one unusually rich state from pulling the benchmark up on its own. The COVID year is left out because incomes in that year were not normal.

• Example: the benchmark is ₹3,00,000. State A has ₹1,00,000, so its distance is ₹2,00,000. State B has ₹2,50,000, so its distance is ₹50,000. A's distance is 4 times B's, so A gets far more under this criterion.

• Population: this shows need, because more people means more schools, hospitals and rations to pay for. The 14th FC used 1971 population (17.5%) and 2011 population (10%). From the 15th FC onwards, only 2011 population is used.

• Demographic performance: this rewards states that controlled population growth.
• 15th FC: based on TFR (total fertility rate), which is the average number of children a woman has in her lifetime. A lower TFR gives a higher score [2].

• 16th FC: based on lower population growth between 1971 and 2011 [1].

• Area: this reflects cost disability. A bigger state spends more to deliver the same service, for example more roads and police stations. The 15th FC gave small states a floor (a minimum share). The 16th FC cut the weight to 10% [1].

• Forest: this pays states for keeping forests, because forests limit farming, mining and industry. The 16th FC combines the share of forest area with the increase in forest area (2015-23). It counts very dense, moderately dense and open forest [1].
• Tax and fiscal effort (15th FC only, 2.5%): average per capita own tax revenue ÷ average per capita GSDP, for 2016-17 to 2018-19 [2]. For example, ₹8,000 ÷ ₹1,00,000 = 8% tax effort. The 16th FC dropped this criterion.
• Contribution to GDP (16th FC, new, 10%): State share = √(GSDP of state) ÷ Σ √(GSDP of all states). It uses nominal GSDP averaged over 2018-19 to 2023-24, leaving out 2020-21 [1].
• Example: two states have GSDP of ₹100 and ₹25. Plain shares would be 80% and 20%. The square roots are 10 and 5, so the shares become 66.7% and 33.3%.
• The bigger economy is still rewarded, but by less.

Equity vs efficiency: what pushes shares up or down

• Equity criteria (based on need and cost): income distance, area, forest, and population.

• Aim: every state should be able to give similar public services at similar tax rates.

• Efficiency criteria (based on reward): demographic performance, tax effort, and contribution to GDP.

• Aim: a state should not lose money for doing well.

• Trend: efficiency weights went from 15% (15th FC: 12.5 + 2.5) to 20% (16th FC: 10 + 10). Income distance fell from 45% to 42.5%.

• Result: richer, well-performing states gain a little, and poorer states lose a little.

In India

• Institution: the Finance Commission under Art. 280. The 16th FC report was placed in Parliament on 1 February 2026 and covers 2026-27 to 2030-31 [1].
• Shares of the states' pool (%), 15th FC → 16th FC:

State	15th FC	16th FC	Change (points)
Uttar Pradesh	17.94	17.62	−0.32
Bihar	10.06	9.95	−0.11
Madhya Pradesh	7.85	7.35	−0.50
Maharashtra	6.32	6.44	+0.12
Karnataka	3.65	4.13	+0.48
Gujarat	3.48	3.76	+0.28
Kerala	1.93	2.38	+0.45

• Under the 16th FC, the highest share goes to Uttar Pradesh (17.62%) and the lowest to Sikkim (0.34%) [1].
• Kerala's share rises by about 23% compared with its old share, and Karnataka's by about 13%. Three changes drove this: the new GDP criterion, less weight on income distance, and less weight on area.
• The 16th FC also stopped revenue deficit grants, sector-specific grants and state-specific grants [1]. So the horizontal formula now decides almost all of a state's equalising transfers.
• Political context: Karnataka and Kerala protested in Delhi in February 2024 over falling devolution shares. This was part of the "north-south" debate: richer southern states pay more tax than they get back.

Don't confuse with

• Vertical devolution: this is the size of the whole cake for all states together (41% under the 15th and 16th FCs). Horizontal devolution is how that cake is cut among the states.
• Grants-in-aid (Art. 275): these are separate transfers, outside tax sharing. Horizontal devolution splits the tax share under Art. 270.
• Population 2011 vs demographic performance: the population criterion pays states with more people (need). Demographic performance pays states that slowed population growth (reward). A state can score high on one and low on the other.
• Income distance vs contribution to GDP: income distance gives more to poorer states (equity). Contribution to GDP gives more to bigger economies (efficiency), softened by a square root.

Prelims Hooks

• The highest-weight criterion in every recent FC is income distance: 50 → 45 → 42.5%.
• Contribution to GDP (10%) is new in the 16th FC. It equals √GSDP of the state ÷ Σ√GSDP of all states [1].
• Tax and fiscal effort (2.5%) appeared only in the 15th FC. The 16th FC dropped it.
• Demographic performance is TFR-based in the 15th FC (12.5%) [2] and based on 1971-2011 population growth in the 16th FC (10%) [1].
• 1971 population was last used by the 14th FC (17.5%). The 15th and 16th FCs use only 2011 population.
• Trap: Art. 280 sets up the FC. Art. 270 covers the sharing of taxes. Art. 275 covers grants-in-aid, which are not part of tax devolution.

Mains Points

• Equity vs efficiency:
• Income distance and area protect horizontal equity, so a citizen in Bihar can get services similar to one in Karnataka.
• But heavy equalisation can punish states that perform well and weaken their own tax effort. This is a moral hazard problem (a state that knows it will be helped anyway has less reason to try).

• The 16th FC's square-root GDP criterion is a middle path: it rewards output but limits the gain for the largest economies.

• Demography and federal trust:

• Moving from 1971 to 2011 population data cut the shares of southern states, which controlled population early.
• Demographic performance compensates them, but its weight fell from 12.5% to 10%.

• The pending Census and delimitation (redrawing constituencies by population) will raise both fiscal and political representation questions.

• Formula now carries the full load:

• With revenue deficit grants ended under the 16th FC [1], the horizontal formula does almost all the equalising.
• The growth of cesses and surcharges outside the divisible pool shrinks what is shared. This deepens the north-south debate, and the forest criterion's shift to counting forest increase shows the formula also being used as a green fiscal incentive.

Related concepts

• Income distance criterion
• Demographic performance criterion
• Tax effort criterion

Read more

• Horizontal devolution: the formula and the equity vs efficiency debate