Karnataka’s elevation as the single largest beneficiary of the new formula captures this contradiction with unusual clarity. Its share of the divisible pool rises from 3.65 per cent under the Fifteenth Finance Commission to 4.13 per cent for the 2026–31 award period, translating into an incremental gain of ₹7,387 crore and a cumulative devolution of about ₹63,050 crore. This gain is primarily driven by the introduction of a 10 per cent weight for “contribution to Gross Domestic Product”, a criterion that did not exist in this explicit form earlier and that disproportionately benefits states with large formal-sector footprints, high services intensity and deeper integration into national and global value chains.

Yet the headline gain obscures the more telling metric of Indian fiscal federalism: the return states receive for every rupee they contribute to the Union exchequer. Karnataka accounts for roughly 8.5–9 per cent of India’s GDP and between 12 and 14 per cent of net direct tax collections—driven by income tax, corporate tax and GST from services—yet its post-devolution share of central taxes remains barely above 4 per cent. Even after the 16th Finance Commission’s adjustment, most estimates suggest Karnataka receives between ₹0.50 and ₹0.55 for every ₹1 it contributes to the Centre, a ratio that improves only marginally from the sub-₹0.50 levels seen during parts of the Fifteenth Finance Commission period.

This imbalance is not unique to Karnataka. Gujarat, which contributes close to 8 per cent of GDP and around 10 per cent of central tax revenues, sees an additional ₹4,228 crore under the new formula, while Haryana gains ₹4,090 crore, yet both states remain structural net contributors, with return ratios well below unity. Kerala, whose share rises from 1.93 per cent to 2.38 per cent—adding ₹6,975 crore—benefits from a combination of higher per capita income scores and improved demographic indicators, but even here the state’s own tax effort and consumption-driven GST base far exceed what it ultimately receives back from the divisible pool.

By contrast, Madhya Pradesh illustrates the other side of the formula’s redistribution logic. Despite receiving an absolute allocation of around ₹1.12 lakh crore, its share of the divisible pool falls from 7.85 per cent to 7.35 per cent, cutting its entitlement by ₹7,677 crore relative to what it would have received under the earlier formula. The reduction reflects weaker scores on efficiency-linked metrics and the new GDP contribution criterion, signalling a clear departure from earlier Finance Commissions that placed heavier weight on income distance and population-based equity.

In isolation, such rebalancing can be defended as a corrective against moral hazard and chronic dependence. In aggregate, however, it raises uncomfortable questions about the future of fiscal equalisation in a country where inter-state income disparities remain wide and convergence has slowed. The per capita Gross State Domestic Product of the top five states is now more than 3.5 times that of the bottom five, a ratio that has barely narrowed over the past decade despite successive rounds of devolution.

The more consequential fault line, however, lies not within the horizontal formula but above it—at the level of vertical devolution and the shrinking divisible pool itself. The Centre’s decision to retain states’ share of net proceeds at 41 per cent for 2026–31 preserves continuity on paper, but masks a steady erosion in the share of total tax revenues that are actually shareable. Over the past ten years, the proportion of gross tax revenue raised through cesses and surcharges—none of which are devolved to states—has risen from around 9–10 per cent to well over 18–20 per cent in several years. As a result, while the divisible pool remains fixed at 41 per cent, the pool’s base has narrowed, reducing states’ effective claim on the Union’s overall tax take.

This structural shift matters because states today shoulder the bulk of expenditure responsibilities in sectors that are both politically salient and fiscally demanding. States account for roughly 60 per cent of total government spending on health, over 55 per cent on education, and the overwhelming share of capital outlays on urban infrastructure, transport and power distribution. Yet their own tax revenues average just 7–8 per cent of GSDP, compared with the Centre’s far higher revenue buoyancy and borrowing flexibility.

The 16th Finance Commission’s fiscal discipline framework further tightens this asymmetry. By mandating that state fiscal deficits remain within 3 per cent of GSDP throughout the award period and by explicitly discouraging off-budget borrowings—while simultaneously calling for enhanced disclosure by the Comptroller and Auditor General—the Commission reinforces a regime of constrained subnational autonomy. While interest-free on-lending under schemes such as the Special Assistance to States for Capital Investment remains outside the deficit ceiling, these flows are discretionary, conditional and centrally designed, effectively substituting rule-based transfers with negotiated dependence.

The Commission itself acknowledges that states have increasingly relied on market borrowings to finance deficits in recent years, with aggregate state debt now hovering around 28–30 per cent of GDP, but its prescription offers little room for counter-cyclical flexibility at the state level. In practice, this means that fiscally stronger states—those that generate more revenue for the Union—are also the ones most constrained in deploying their own balance sheets to respond to local economic shocks or developmental priorities.

Taken together, the numbers point to a deeper reconfiguration of Indian federalism. The 16th Finance Commission rewards contribution without restoring balance, incentivises efficiency without expanding autonomy, and tightens fiscal discipline without addressing the Centre’s growing dominance over the tax architecture. Contributor states are offered marginally higher shares within a capped pool, even as the Centre continues to ring-fence a growing portion of revenues through non-devolvable levies.

In that sense, Karnataka’s rise as the largest “gainer” is revealing not because it signals generosity, but because it exposes the limits of the current system. When a state that contributes close to a tenth of national output and far more than that in tax revenues is celebrated for clawing back an extra few thousand crore rupees over five years, the bar for federal equity has been set conspicuously low.

Unless future Finance Commissions confront the deeper imbalance between who raises revenues and who bears expenditure responsibility—by reining in the proliferation of cesses, expanding the divisible pool, or rethinking the architecture of shared taxation—India risks entrenching a model of federalism in which states are judged by performance, constrained by rules, and rewarded only at the margins, while the Centre steadily accumulates fiscal power. In that landscape, the question is no longer whether some states gain more than others, but whether the constitutional promise of cooperative federalism can survive a system where paying more increasingly guarantees getting less back. (IPA Service)