Grants-in-aid: statutory, discretionary, tied and untied

Detail

What grants-in-aid are

• Grants-in-aid are money the Centre gives to states on top of tax devolution.
• Tax devolution means the states' share of central taxes under Art. 270. States get it as a right and can spend it as they choose.

• A grant is a separate transfer. It is either statutory (given on the advice of the Finance Commission, FC) or discretionary (given for a specific purpose).

• Scale (15th FC, 2021-26): total FC grants were ₹10,33,062 crore over five years [3].

• Scale (16th FC, 2026-31): total FC grants are ₹9.47 lakh crore. The vertical devolution (the states' share of the divisible pool, meaning central taxes minus cesses and surcharges) stays at 41%, the same as under the 15th FC [2].

Route 1 — Art. 275(1): statutory grants

• What "statutory" means: the grant comes from the Constitution and the law, not from the Centre's choice in a given year.
• Charged on the Consolidated Fund of India (CFI). The CFI is the Union's main account, where all its revenue and borrowing go.
• "Charged" means Parliament can discuss these grants but does not vote on them.

• So the government of the day cannot hold them back through the budget vote.

• Who gets them: states "in need of assistance". Parliament decides the amount by law, on FC advice.

• Provisos (special conditions in the Article):
• grants for the welfare of Scheduled Tribes;

• grants to raise the administration of Scheduled Areas to the level of the rest of the state.

• Link to Art. 280: the FC recommends the principles for grants out of the CFI. Revenue deficit, local-body and disaster grants all follow this FC route.

Route 2 — Art. 282: discretionary grants

• The Union (or a state) can make grants for any public purpose. This holds even when the subject is outside its own law-making list.
• No FC advice is needed. The Centre decides through its ministries.
• It is the constitutional basis of centrally sponsored schemes (CSS) (§6). A CSS is a scheme the Centre designs and part-funds, and the state carries out, often with a matching state share.
• 15th FC on CSS: it asked for a minimum size below which a scheme should be phased out. This targets small schemes that use little of their money. It also asked for third-party evaluation of schemes within fixed time limits [3].

Route 3 — Art. 273: jute export duty grants

• These were grants to jute-producing states in place of their share of jute export duty (§2). They were temporary and are now only of historical interest.

Tied and untied grants

• Tied grant: the state must spend it on a named purpose, or only after meeting set conditions.

• Examples: local-body grants for water and sanitation, health grants, disaster funds.

• Untied grant: the recipient decides how to spend it.

• 16th FC example — one grant, half tied and half untied:

• Basic grants to local bodies: 50% untied; 50% tied to sanitation and solid waste management, or to water management [2].

• Entry-level conditions (16th FC, 2026-31). A state's local bodies get no grant unless the state has:

• formed its local bodies as the Constitution requires;
• published their provisional and audited accounts;

• set up its State Finance Commission (SFC) on time [2].

• Earlier conditions (15th FC): the state had to publish accounts, set a minimum floor rate for property tax, and set up SFCs by March 2024 [3].

How grants are classified in the Budget (Class 12)

• All grants to states count as Union revenue expenditure, even when they build assets such as roads or schools.
• Revenue expenditure is spending that creates no asset for the Union and does not reduce its liabilities.

• The asset belongs to the state, not the Union, so the Union books the spending as revenue expenditure.

• This is why the Union Budget shows "grants for creation of capital assets" separately.

• Formula: Effective revenue deficit = Revenue deficit − Grants for creation of capital assets
• Worked example:
• Union revenue expenditure = ₹40 lakh crore; revenue receipts = ₹35 lakh crore.
• Revenue deficit = 40 − 35 = ₹5 lakh crore.
• Of the grants to states, ₹3 lakh crore go to building assets.
• Effective revenue deficit = 5 − 3 = ₹2 lakh crore. This is the part of the deficit that went to pure consumption.

Revenue deficit grants (post-devolution)

• Definition: a grant to a state whose revenue expenditure is still more than its revenue receipts after tax devolution. It fills that gap after devolution.
• Formula: Revenue deficit grant = State revenue expenditure − (Own revenue + Tax devolution), when the result is positive.
• Worked example: a state spends ₹100, collects ₹55 on its own and gets ₹30 from devolution.
• Gap = 100 − (55 + 30) = ₹15. The FC gives a revenue deficit grant of ₹15.

• A state with a gap of zero or less gets nothing.

• 15th FC (2021-26):

• ₹2,94,514 crore to 17 states, to remove their revenue deficits [3]. (NCERT: about ₹2.94 lakh crore.)
• The grant tapered (grew smaller) each year.
• 2021-22 alone: ₹1,18,452 crore. It was paid in monthly instalments [4].

• The 17 states: Andhra Pradesh, Assam, Haryana, Himachal Pradesh, Karnataka, Kerala, Manipur, Meghalaya, Mizoram, Nagaland, Punjab, Rajasthan, Sikkim, Tamil Nadu, Tripura, Uttarakhand, West Bengal [4].

• Other 15th FC grants that were later dropped:

• Sector-specific grants: ₹1,29,987 crore across 8 sectors, for example agricultural reforms ₹45,000 crore, health ₹31,755 crore, PMGSY roads ₹27,539 crore and judiciary ₹10,425 crore [3].
• State-specific grants: ₹49,599 crore [3].
• Local bodies: ₹4,36,361 crore, including health grants of ₹70,051 crore [3].

16th FC (2026-31): a narrower grant system

• Discontinued: revenue deficit grants, sector-specific grants and state-specific grants [2].

• Stated reason: such grants "create adverse incentive". They push states to "be profligate" (overspend) instead of fixing the root causes of their deficits [5].

• Total recommended: ₹9.47 lakh crore [2].

• Local bodies: ₹7.91 lakh crore (§9) [2]:
• Rural: ₹4.35 lakh crore, made up of a basic grant of ₹3.48 lakh crore (80%) and a performance grant of ₹87,048 crore (20%).

• Urban: ₹3.56 lakh crore, made up of:

  • basic grant: ₹2.32 lakh crore;
  • performance grant: ₹58,032 crore;
  • Special Infrastructure Component: ₹56,100 crore, for wastewater systems in cities with 10-40 lakh people;
  • Urbanisation Premium: ₹10,000 crore, one-time money for villages that merge into towns and for a rural-to-urban transition policy.

• Disaster management: ₹1,55,916 crore (about ₹1.56 lakh crore). This is the Centre's share of a ₹2,04,401 crore corpus (total fund) for SDRF/SDMF (State Disaster Response Fund and State Disaster Mitigation Fund) [2].

• Cost sharing (Centre:State): 90:10 in north-eastern and Himalayan states; 75:25 in all other states [2].

• The earlier 15th FC corpus was about ₹1,60,000 crore, with a Centre share of ₹1,20,000 crore. It used the same sharing pattern [3].

• Budget 2026-27: the Government provided ₹1.4 lakh crore of FC grants.

• Rules that go with the grants: the fiscal deficit limit for states is 3% of GSDP (Gross State Domestic Product, the total output of a state). Off-budget borrowing must stop and be brought onto state budgets [5].

The debate

• The case against gap-filling:
• Gap-filling creates moral hazard. This means a party takes more risk because someone else bears the cost.

• A state that overspends gets a bigger grant, so its reason to raise its own revenue or cut waste becomes weaker.

• The case against withdrawing grants suddenly:

• It strains fiscally weak states that relied on these grants, such as Punjab, Himachal Pradesh, Kerala, West Bengal and the NE states (verify current).

• Case — Himachal Pradesh:

  • It received ₹3,257 crore (1.3% of GSDP) in revenue deficit grants in 2025-26.
  • All of this is lost in 2026-27.
  • Total central grants to the state are estimated to fall by 48% in 2026-27 compared with 2025-26 revised estimates [5].

• The trade-off: tied and performance grants reward reform, while untied grants respect state autonomy. The 16th FC's 50:50 basic grant tries to balance the two.

Prelims Hooks

• Art. 275(1) statutory grants are charged on the CFI and are not voted. They go to states "in need of assistance", on FC advice.
• Art. 282 discretionary grants can be for "any public purpose", even outside the Union's legislative field. They are the basis of centrally sponsored schemes and need no FC advice.
• The provisos to Art. 275(1) cover grants for Scheduled Tribe welfare and Scheduled Area administration.
• Effective revenue deficit = Revenue deficit − Grants for creation of capital assets. All grants to states are Union revenue expenditure.
• 15th FC: revenue deficit grants of ₹2,94,514 crore went to 17 states (2021-26). Total FC grants were ₹10,33,062 crore.
• 16th FC (2026-31): total grants ₹9.47 lakh crore = local bodies ₹7.91 lakh crore + disaster ₹1.56 lakh crore. Revenue deficit, sector-specific and state-specific grants were discontinued.
• 16th FC basic grants to local bodies: 50% untied, 50% tied (sanitation/waste or water).
• SDRF/SDMF Centre:State sharing: 90:10 for NE and Himalayan states, 75:25 for others. The 16th FC corpus is ₹2,04,401 crore.
• Trap: vertical devolution is 41% under both the 15th and 16th FCs. What changed in 2026-31 is the grant structure, not the tax share.
• Trap: a local body gets no FC grant unless its State Finance Commission was set up on time and its accounts were published.

Mains Points

• Moral hazard vs equalisation:
• Revenue deficit grants reward states with large deficits. The 16th FC says they "create adverse incentive".
• Stopping them suddenly can hit states that cannot raise much revenue themselves. Himachal Pradesh loses 1.3% of its GSDP and sees a 48% drop in central grants in 2026-27.

• A phased glide path is a middle route: taper the grants, but tie them to a plan for fiscal correction.

• Formula vs discretion:

• As FC grants (Art. 275) shrink, a larger share of transfers can move to Art. 282 CSS grants. These are tied, decided by the Centre and come with matching-share conditions.

• This reduces cooperative federalism and state autonomy. The 15th FC asked for scheme thresholds and third-party evaluation to limit this.

• Strengthening the third tier:

• About 84% of 16th FC grants (₹7.91 of ₹9.47 lakh crore) go to local bodies, with entry conditions (SFCs, audited accounts) and performance grants.

• This supports the 73rd and 74th Amendments. But states that fail the conditions lose money, and their citizens bear the cost.

• Accounting honesty:

• Asset-creating grants are booked as Union revenue expenditure, so the revenue deficit overstates how much the Union spends on consumption.
• The effective revenue deficit gives a more accurate measure for FRBM targets.