The Finance Commission mechanism has not adequately resolved the vertical fiscal imbalance between the Union and States. Discuss with reference to the 15th Finance Commission's recommendations.

Vertical fiscal imbalance denotes the mismatch between the Union's dominant revenue powers under the Seventh Schedule and the States' larger expenditure responsibilities in health, education and agriculture. Article 280 makes the Finance Commission the constitutional corrective; yet States today spend roughly 60% of public expenditure while collecting a far smaller share of taxes [4], suggesting the mechanism has narrowed but not closed the gap.

Where the mechanism has worked

• Devolution retained at a high base: the 15th FC recommended 41% of the divisible pool to States, sustaining the sharp upward revision of the 14th FC [1].
• Equity-oriented horizontal formula: income distance, area, demographic performance and forest cover weights channel more resources to fiscally weaker States [1].
• Rules-based fiscal space: a 3% of GSDP fiscal deficit ceiling with an extra 0.5% tied to power-sector reform links borrowing headroom to performance [1].
• Revenue deficit grants and sector-specific grants cushioned States in the post-COVID years [1].

Where the imbalance persists

• Shrinking effective share: rising cesses and surcharges stay outside the divisible pool, so actual devolution falls below the headline 41% [1][3].
• Committed expenditure squeeze: salaries, pensions and interest absorb over half of States' revenue receipts, exceeding 60% in Kerala, Punjab, Himachal Pradesh, Tamil Nadu and Assam, crowding out capital outlay [1].
• Debt overhang: outstanding State liabilities near 28% of GSDP, with a majority of States above 30%, far past the FRBM Review Committee's 20% norm [1][2].
• Conditional, tied transfers: Centrally Sponsored Scheme co-financing and Article 293(3) borrowing consent dilute States' autonomy over their own priorities [3].
• Expiry of GST compensation in 2022 removed a key revenue cushion without a substitute [1].

The Finance Commission has managed the symptoms of imbalance through devolution and grants, but the asymmetry is structural and needs deeper reform. Protecting the divisible pool from cess-erosion, untying scheme transfers, and strengthening States' own tax capacity would help. The 16th Finance Commission (2026–31) offers the opportunity to make cooperative federalism fiscally real.