Vertical devolution

Also called: Vertical tax devolution · Topic: Fiscal Federalism: Finance Commission, Devolution and Centre-State Finances · NCERT: Beyond NCERT

Meaning

Vertical devolution is the share of the Centre's divisible pool of taxes that goes to all states together, as recommended by the Finance Commission (FC). The divisible pool is the part of central taxes that must be shared with states, after removing cesses, surcharges and the cost of collection.

• Formula:
• Divisible pool = Gross Tax Revenue (GTR) − cesses and surcharges − cost of collection
• States' devolution = Vertical share (%) × Divisible pool

It matters because the Union collects most of the tax money, while the states do most of the spending (health, police, agriculture, schools). Vertical devolution is the main tool for closing this gap.

Explanation

How it works

• Vertical fiscal imbalance: this is the gap between what states earn and what they must spend. Vertical devolution corrects it.
• The FC does this job under Art. 280(3)(a). This clause asks it to split the net proceeds of shareable taxes:
• between the Union and the states. This is the vertical split, and it decides the size of the whole cake for states.

• among the states. This is the horizontal split, and it decides each state's slice.

• Net proceeds: the tax collected minus the cost of collection.

• The FC sets a new share every five years. That is one reason it is called the "balancing wheel of fiscal federalism".
• The money is untied. States can spend their devolved share on anything they choose. Scheme grants are different: they are tied to a fixed purpose.

What is left out of the pool

• Cess: a tax charged for a stated purpose, such as the Health and Education Cess.
• Surcharge: an extra tax charged on top of a tax, such as on high incomes.
• The Centre keeps 100% of both. They are not part of the divisible pool [2].
• Worked example (illustrative numbers):
• Centre's GTR = ₹100
• Cesses and surcharges = ₹15. Cost of collection = ₹1.
• Divisible pool = 100 − 15 − 1 = ₹84
• States get 41% × 84 = ₹34.4
• So a "41%" share is only about 34% of GTR.

What makes the real share rise or fall

• The headline share (%) set by the FC. For example, it went from 32% to 42% under the 14th FC.
• The size of the divisible pool. This is the hidden factor:
• The Centre raises more through cesses and surcharges → the divisible pool shrinks.

• The pool shrinks → states get less money, even though the "41%" does not change.

• Real data: the 41% share worked out to only 32% of the Centre's GTR in 2024-25 (Budget Estimates) [3].

• Growth of all central taxes. Since the 80th Amendment (2000), states share in the whole pool. So when total collections grow, their share grows too.

In India

• Art. 280: the President sets up the FC every five years, or earlier if needed. It has a chairman and four other members. Their qualifications are laid down in the FC (Miscellaneous Provisions) Act 1951.
• Art. 281: the report is laid before both Houses of Parliament with an explanatory memorandum. This is a note from the government saying which recommendations it accepts and why it rejects any others.
• Advisory, not binding: in law, the Union does not have to follow the FC. But by convention, the Union has always accepted the devolution share the FC recommends.
• Early FCs (1st to 9th): only certain taxes were shared, mainly income tax and Union excise duties.
• 10th FC (K.C. Pant, 1995-2000): its "alternative scheme" gave states 29% of all central taxes. The 80th Amendment (2000) rewrote Art. 270 to make this law.
• Timeline of the vertical share:

FC	Chair	Period	States' share
11th	A.M. Khusro	2000-05	29.5%
12th	C. Rangarajan	2005-10	30.5%
13th	Vijay Kelkar	2010-15	32%
14th	Y.V. Reddy	2015-20	42%
15th	N.K. Singh	2020-21 and 2021-26	41%
16th	Arvind Panagariya	2026-31	41%

• 14th FC: its jump from 32% to 42% was the largest single rise. The 42% was recommended by majority decision [4].
• 15th FC: it cut the share by 1 percentage point, to 41%. That 1% covers the needs of the new Union Territories of Jammu & Kashmir and Ladakh (created in 2019). UTs are funded by the Centre.
• 16th FC (2026-31):
• It was constituted on 31 December 2023.
• Its report went to the President on 17 November 2025 [1].
• It was tabled in Parliament on 1 February 2026, together with Budget 2026-27 [2].
• It kept the vertical share at 41% [2], and the government accepted this [1].

Don't confuse with

• Horizontal devolution: vertical devolution decides how much goes to all states together. Horizontal devolution decides how that amount is divided among states. The 16th FC used criteria such as population (2011 Census), income distance and demographic performance.
• Gross Tax Revenue (GTR): the 41% is a share of the divisible pool, not of GTR. In 2024-25 (BE), it came to only about 32% of GTR [3].
• Grants-in-aid (Art. 275): these are paid from the Consolidated Fund of India, based on principles the FC lays down under Art. 280(3)(b). They are separate from tax devolution. Example: the 16th FC's ₹9.47 lakh crore of grants for local bodies and disaster management over 2026-31 [2].
• Centrally sponsored schemes: these are tied transfers that must be spent on a fixed purpose. Tax devolution is untied money.

Prelims Hooks

• The divisible pool leaves out cesses, surcharges and the cost of collection. Trap: "states get 41% of all central tax revenue" is wrong.
• Highest vertical share ever: 42%, by the 14th FC (Y.V. Reddy, 2015-20), up from 32% under the 13th FC (Vijay Kelkar).
• 15th FC (N.K. Singh) cut the share to 41% because of the new UTs of J&K and Ladakh.
• 10th FC (K.C. Pant) gave the "alternative scheme" of 29% of all central taxes. It became law through the 80th Amendment (2000), which rewrote Art. 270.
• 16th FC: chair Arvind Panagariya; period 2026-31; vertical share 41%; report submitted 17 Nov 2025 [1]; tabled 1 Feb 2026 [2].
• FC advice is not binding (Art. 281). By convention, the Union has always accepted the devolution share.

Mains Points

• "41%" on paper, about 32% in practice:
• Cesses and surcharges grew from 2.3% of GTR in 1980-81 to 15% in 2019-20 [5].
• They stayed above 15% of GTR between 2020-21 and 2022-23 [3].
• As a result, states got only about 32% of GTR (2024-25 BE) [3].

• Possible reforms: put a cap on cesses and surcharges, or bring them into the divisible pool once they cross a set limit.

• The 50% demand versus the Centre's needs:

• Many states want the vertical share raised to 50%.
• The Centre says it needs money for defence, interest payments, central schemes and fiscal space (room in the budget for new spending or emergencies).

• The 16th FC chose stability at 41% [2]. This leaves the states' demand unmet.

• Untied money versus tied money (GS-II, Centre-state relations):

• The 14th FC's jump to 42% was a structural shift towards untied transfers, which supports cooperative federalism.
• But the Centre then made more use of centrally sponsored schemes, which are tied to fixed purposes.
• So states did not gain as much real freedom to spend as the headline share suggests.

Read more

• The Finance Commission and vertical devolution