The 41% Question, Fiscal Federalism, Cesses, and the Battle Over India’s Divisible Pool
On Wednesday, February 11, 2026, Union Finance Minister Nirmala Sitharaman rose in the Lok Sabha to deliver her reply to the debate on the Union Budget. The chamber was, as is customary on such occasions, restive. Opposition members had spent the preceding days levelling a charge that has become a perennial feature of India’s fiscal discourse: that the Centre was short-changing the States by failing to transfer the mandated 41 per cent share of the divisible pool of taxes, as recommended by the 15th Finance Commission.
The Finance Minister’s response was unequivocal. “I assure you, it is 41 per cent that we have transferred to the States. We have not reduced any State’s divisible tax.” She backed her assertion with data: the Comptroller and Auditor General’s audit of the Centre’s finances, she noted, confirmed that the devolution made by the Centre from 2018-19 to 2022-23 “exactly matches” the 15th Finance Commission’s recommendations. The total resources to be transferred to the States in 2026-27, including both devolution and centralised sponsored scheme funds, is estimated at ₹254.44 lakh crore—an increase of ₹2.7 lakh crore over the previous year.
Yet the Opposition’s charge, and the Finance Minister’s defence, operate on different registers of calculation. The Opposition points to the Centre’s increasing reliance on cesses and surcharges, which are collected as part of gross tax revenue but are excluded from the divisible pool that must be shared with the States. The Finance Minister responds that the 41 per cent target is being met on the divisible pool that remains after these exclusions. Both statements are, in their own terms, accurate. Both avoid the underlying constitutional and political question: whether the current architecture of tax devolution, which permits the Centre to unilaterally determine the composition of the divisible pool, remains consistent with the constitutional vision of cooperative federalism.
This is not a technical dispute about accounting methodologies. It is a fundamental contest over the distribution of fiscal power in India’s federal system. The States, regardless of which parties govern them, have long complained that the Centre’s expanding use of cesses and surcharges—which now account for a significant and growing share of gross tax revenue—effectively reduces the divisible pool and thereby diminishes the States’ constitutionally guaranteed share of central taxes. The Centre responds that cesses and surcharges are collected for specific purposes—health, education, roads—and that the revenues are ultimately spent in the States, on schools and hospitals and infrastructure.
The dispute resists easy resolution because it is built into the constitutional architecture. The Constitution confers upon Parliament the power to levy cesses and surcharges, and explicitly excludes them from the divisible pool. The Finance Commission, whose mandate is to recommend the distribution of the divisible pool, has no authority over the composition of that pool. The States, which must rely on the Commission’s recommendations for their share of central taxes, have no mechanism to prevent the Centre from altering the pool’s composition through its choice of taxation instruments.
This is not a new problem, but it is an accelerating one. The 16th Finance Commission, whose recommendations will govern the five-year period beginning April 2026, must grapple with a fiscal landscape in which the divisible pool constitutes a diminishing share of gross tax revenue. The Opposition’s charge that the Centre is “shrinking” the divisible pool may be rhetorically overstated, but it captures a genuine structural trend. The Finance Minister’s defence that the 41 per cent target is being met on the reduced pool does not address the underlying grievance: that the base on which the 41 per cent is calculated is itself a product of central discretion.
The Constitutional Architecture: Divisible Pool, Cesses, and the Limits of Commission Mandate
Article 270 of the Constitution provides that taxes collected by the Union shall be distributed between the Union and the States in accordance with the recommendations of the Finance Commission. However, Article 271 confers upon Parliament the power to increase any of the duties or taxes referred to in Article 269 and 270 by a surcharge for purposes of the Union, and the proceeds of any such surcharge “shall not be shared with the States.” Similarly, cesses—taxes levied for specific purposes—are collected under separate statutory authority and are excluded from the divisible pool.
This constitutional design reflects a deliberate compromise. The framers recognised that the Union would require exclusive revenue sources to meet its national responsibilities, including defence, foreign affairs, and macroeconomic stabilisation. They also recognised that the States, which bear primary responsibility for delivering essential services such as health, education, and infrastructure, would require adequate and predictable financial resources. The Finance Commission was established as the constitutional mechanism to mediate between these competing claims, recommending the proportion of the divisible pool to be transferred to the States and the principles of distribution among them.
The compromise, however, contained an internal instability. The Commission’s mandate extends only to the divisible pool; it has no authority over the composition of that pool. The Centre, by choosing to finance its expenditures through cesses and surcharges rather than through taxes that enter the divisible pool, can unilaterally reduce the resources subject to Commission recommendation. This is not a violation of constitutional text; it is an exercise of constitutional authority. But it is a exercise that shifts the balance of fiscal power from the cooperative federalism envisioned by the Constitution’s framers toward a more centralised, discretionary model.
The growth of cesses and surcharges is not a recent phenomenon, but it has accelerated markedly over the past decade. The share of gross tax revenue constituted by cesses and surcharges has increased from approximately 10 per cent in 2010-11 to over 20 per cent in some recent years. This expansion reflects both the Centre’s need for additional revenue and its preference for instruments that afford it greater discretion over expenditure. Unlike shared taxes, which flow to the States according to Commission-determined formulae, cess revenues are appropriated by Parliament and allocated through central sector and centrally sponsored schemes, over which the Centre retains significant control.
The States’ Grievance: Shrinking Pool, Growing Dependence
The States’ grievance is not merely that their share of the divisible pool is calculated on a shrinking base; it is that the entire trajectory of Union-State financial relations is shifting away from the constitutional model of tax sharing and toward a model of discretionary transfers and conditional grants.
Under the constitutional model, States receive their share of central taxes as an entitlement, determined by objective criteria and distributed through a transparent, Commission-determined formula. These unconditional transfers respect State autonomy, allowing elected State governments to allocate resources according to their own priorities and the specific needs of their constituencies. They are the fiscal expression of cooperative federalism: the Union raises revenue efficiently through its superior tax collection infrastructure, and the States receive a predictable, constitutionally guaranteed share to fund the services for which they are responsible.
Under the emerging model, an increasing proportion of central transfers to States takes the form of centrally sponsored schemes and other conditional grants, which come with detailed central guidelines, matching funding requirements, and extensive reporting obligations. These transfers give the Centre considerable influence over State-level policy priorities and expenditure patterns. They also introduce uncertainty and unpredictability into State finances, as scheme funding is subject to annual budgetary allocations rather than constitutionally guaranteed entitlements.
The Finance Minister’s assertion that “cesses and surcharges are collected for a particular purpose such as health cess, education cess, road cess” and that “these do not benefit the Centre, they go to the States in terms of building schools, hospitals, roads in the States” does not fully address this grievance. The States’ complaint is not that the revenues are not spent within their territories; it is that the terms and conditions of that spending are determined by the Centre, through centrally sponsored schemes and other conditional transfer mechanisms, rather than by the States themselves through their own budgetary processes.
A rupee transferred as tax devolution is a rupee over which the State legislature exercises full budgetary authority. A rupee transferred as a centrally sponsored scheme grant is a rupee over which the State’s discretion is substantially constrained by central guidelines, matching requirements, and reporting obligations. The shift from the former to the latter, however justified on grounds of national priorities and uniform standards, represents a real transfer of fiscal power from the States to the Centre.
The Finance Commission’s Dilemma: Mandate Without Authority
The 16th Finance Commission, whose interim report was tabled on February 1, 2026, and whose final recommendations will govern the five-year period from 2026-27 to 2030-31, confronts a structural dilemma. Its constitutional mandate is to recommend the distribution of the divisible pool among the States. It has no authority over the composition of that pool, which is determined by the Centre’s choices among taxation instruments.
The Commission can, and presumably will, continue to recommend that the Centre transfer 41 per cent of the divisible pool to the States. It can refine the horizontal distribution criteria to better reflect contemporary realities of population, income, area, forest cover, and demographic performance. It can recommend incentives for States that achieve superior outcomes in tax effort, fiscal management, and social development.
What the Commission cannot do, within its existing constitutional mandate, is prevent the Centre from reducing the divisible pool by increasing its reliance on cesses and surcharges. It cannot compel the Centre to bring these levies within the sharing framework. It cannot adjust its devolution recommendations to compensate States for the erosion of the divisible pool. The Commission’s authority extends only to the distribution of what the Centre chooses to place in the divisible pool; it has no authority over the Centre’s choice of what to place there.
This is not a criticism of the Commission or its members, who are distinguished economists and public administrators operating within constitutional constraints they did not design. It is a criticism of the constitutional architecture itself—an architecture that has permitted, over seven decades, a steady accretion of fiscal power to the Centre at the expense of the States, and that now confronts the 16th Finance Commission with a mandate that is substantial in form but limited in substance.
The Way Forward: Constitutional Reform or Fiscal Restraint?
The growing divergence between the constitutional promise of cooperative federalism and the fiscal reality of centralised discretion admits two possible responses.
The first is constitutional reform. Article 270 could be amended to bring specified cesses and surcharges within the divisible pool, either entirely or in part. Article 271’s provision that surcharge proceeds “shall not be shared with the States” could be qualified to permit sharing above a certain threshold. The Finance Commission’s mandate could be expanded to encompass recommendations on the overall composition of Union revenues, not merely the distribution of the divisible pool.
These reforms would be politically difficult. They would require not only the cooperation of the Centre—which is unlikely to voluntarily surrender fiscal discretion—but also the consent of a majority of States and, for constitutional amendments affecting federal provisions, ratification by at least half the State legislatures. They would also require a fundamental renegotiation of the Union-State fiscal compact, with uncertain consequences for the stability and predictability of the entire system.
The second is fiscal restraint. The Centre could, without constitutional amendment, voluntarily moderate its reliance on cesses and surcharges and bring a greater proportion of its revenues within the divisible pool. It could rationalise the proliferating cess levies, merging those that have become permanent features of the tax landscape into the basic tax rates and subjecting the merged proceeds to sharing. It could cap the share of gross tax revenue constituted by cesses and surcharges, either through self-imposed fiscal rules or through consultation with the Finance Commission.
This path is also politically difficult. Cesses and surcharges are convenient instruments from the Centre’s perspective: they generate revenue without triggering devolution obligations, they afford greater discretion over expenditure, and they can be presented to the public as benefiting specific, popular purposes. Voluntarily relinquishing these advantages would require a commitment to cooperative federalism that has not, to date, been consistently demonstrated.
The Finance Minister’s assertion that “the Constitution gives the Centre the authority to collect cesses and surcharges” is, of course, correct. The question is not whether the Centre possesses this authority but how it chooses to exercise it. A constitutional power can be exercised in a manner that strengthens cooperative federalism or in a manner that weakens it. The same revenue can be raised through shared taxes that respect State autonomy or through cesses and surcharges that enhance central discretion. The choice between these instruments is a choice about the kind of federalism India will inhabit.
Conclusion: The Long View and the Immediate Dispute
The Finance Minister’s statement that the Union Budget has been “prepared as the first Budget in the second quarter of the 12th century” and “covers a lot of issues from 2026 to 2050” invites reflection on the long arc of India’s constitutional development. Over the next quarter-century, the country’s fiscal institutions will be tested by profound challenges: the fiscal implications of an ageing population, the investment requirements of the green transition, the financing of infrastructure for a projected population of 1.6 billion, and the continued integration of the Indian economy into global markets.
These challenges will require robust, resilient, and cooperative federal institutions—not a Centre perpetually at odds with States over the distribution of revenues, not a Finance Commission whose constitutional mandate is steadily eroded by extra-constitutional fiscal practices, not a system in which the States’ constitutionally guaranteed share of central taxes is progressively diluted by the Centre’s choice of taxation instruments.
The immediate dispute over the 41 per cent devolution target and the growing share of cesses and surcharges is, in this longer perspective, a symptom of a deeper institutional strain. It reflects a federal fiscal system that has evolved, through decades of centralised discretion and State acquiescence, far from the cooperative model envisioned by the Constitution’s framers. It reflects a Finance Commission whose constitutional authority has been steadily circumscribed by extra-constitutional fiscal practices. And it reflects a set of State governments that, regardless of party, have found their constitutional entitlements progressively diluted and their fiscal autonomy progressively constrained.
The Finance Minister’s assurance that the 41 per cent target is being met on the divisible pool is accurate, as far as it goes. But it does not address the underlying grievance: that the divisible pool itself is shrinking, that the States’ constitutionally guaranteed share is calculated on a diminishing base, and that the constitutional vision of cooperative federalism is being steadily displaced by a model of centralised discretion and conditional transfers. Until that grievance is addressed—whether through constitutional reform, fiscal restraint, or a combination of both—the battle over the 41 per cent will continue, session after session, Commission after Commission, Budget after Budget.
Q&A Section
Q1: What is the constitutional basis for the States’ claim to a share of central taxes, and how do cesses and surcharges circumvent this arrangement?
A1: Article 270 of the Constitution mandates that taxes collected by the Union shall be distributed between the Union and States according to Finance Commission recommendations. However, Article 271 empowers Parliament to levy surcharges for Union purposes, the proceeds of which “shall not be shared with the States.” Cesses—taxes levied for specific purposes under separate statutory authority—are similarly excluded from the divisible pool. This constitutional design creates a structural vulnerability: the Centre can unilaterally reduce the divisible pool by financing its expenditures through cesses and surcharges rather than through taxes that enter the sharing framework. The States’ claim to 41 per cent of the divisible pool (as recommended by the 15th Finance Commission) is calculated only on the pool that remains after these exclusions. If the Centre increases its reliance on cesses and surcharges, the absolute size of the divisible pool shrinks, and the 41 per cent transfer, while proportionally compliant, represents a smaller share of gross tax revenue. The Finance Minister’s assurance that the 41 per cent target is being met on the divisible pool does not address this compositional shift.
Q2: What is the distinction between tax devolution (divisible pool transfers) and centrally sponsored scheme transfers, and why does this distinction matter for State autonomy?
A2: Tax devolution is an unconditional transfer: States receive their share of central taxes as a constitutional entitlement, determined by objective Finance Commission criteria, with no conditions attached to its utilisation. State legislatures exercise full budgetary authority over these funds, allocating them according to their own priorities. Centrally sponsored schemes are conditional transfers: funds are provided for specific purposes, with detailed central guidelines on implementation, matching funding requirements from State budgets, and extensive reporting and audit obligations. The distinction matters because it represents a transfer of fiscal power from States to the Centre. A rupee transferred as devolution is controlled by the elected State government; a rupee transferred as a centrally sponsored scheme grant is controlled, in significant part, by central ministries and their guidelines. The Finance Minister’s assertion that cess proceeds “go to the States in terms of building schools, hospitals, roads” is accurate, but it elides this distinction: the question is not whether the money is spent in the States, but who decides how it is spent. The shift from devolution to conditional grants, enabled by the growing share of cesses and surcharges, represents a progressive centralisation of fiscal decision-making.
Q3: What is the “structural dilemma” confronting the 16th Finance Commission, and why is it unable to address the States’ grievance directly?
A3: The 16th Finance Commission confronts a dilemma rooted in the disjunction between its mandate and its authority. Its constitutional mandate under Article 280 is to recommend the distribution of the divisible pool of central taxes among the States. It has no authority over the composition of that pool—over what share of gross tax revenue is placed in the divisible pool and what share is collected through cesses and surcharges and thus excluded from sharing. The Commission can recommend that the Centre transfer 41 per cent (or any other percentage) of the divisible pool; it can refine the horizontal distribution criteria; it can recommend incentives for fiscal performance. But it cannot prevent the Centre from reducing the divisible pool by increasing its reliance on non-sharable levies. It cannot compel the Centre to bring cesses and surcharges within the sharing framework. It cannot adjust its devolution recommendations to compensate States for the erosion of the divisible pool. This is not a failure of the Commission or its members but a limitation of the constitutional architecture itself. The Commission’s mandate is substantial in form but limited in substance; it can distribute what the Centre chooses to place in the divisible pool, but it cannot influence that choice.
Q4: What are the two possible responses to the growing divergence between the constitutional promise of cooperative federalism and the fiscal reality of centralised discretion?
A4: The article identifies two distinct pathways, each with its own political and institutional challenges:
1. Constitutional reform: Amend Articles 270 and 271 to bring specified cesses and surcharges within the divisible pool, either entirely or in part; qualify Article 271’s prohibition on sharing surcharge proceeds; expand the Finance Commission’s mandate to encompass recommendations on the overall composition of Union revenues. This path requires extraordinary political consensus: constitutional amendments affecting federal provisions require not only parliamentary super-majorities but also ratification by at least half the State legislatures. The Centre is unlikely to voluntarily surrender fiscal discretion.
2. Fiscal restraint: Without constitutional amendment, the Centre could voluntarily moderate its reliance on cesses and surcharges, bring a greater proportion of revenues within the divisible pool, rationalise proliferating cess levies into basic tax rates, and cap the share of gross tax revenue constituted by non-sharable levies. This path is also politically difficult because cesses and surcharges are convenient instruments: they generate revenue without devolution obligations, afford greater expenditure discretion, and can be presented as benefiting specific popular purposes. Voluntary restraint requires a commitment to cooperative federalism not consistently demonstrated.
The choice between these paths—or the choice to continue the current trajectory—will determine the future shape of India’s federal fiscal architecture.
Q5: What is the significance of the Finance Minister’s framing of the 2026-27 Budget as “the first Budget in the second quarter of the 12th century” covering “issues from 2026 to 2050”?
A5: This framing is significant for several reasons. First, it signals a deliberate shift in budgetary philosophy from annual or short-term fiscal management to long-term strategic planning. The Budget is presented not merely as a statement of immediate revenue and expenditure but as a blueprint for India’s development trajectory over the next quarter-century. Second, it contextualises the current dispute over tax devolution within a broader temporal horizon. The Finance Minister implicitly argues that the immediate distributional conflicts between Centre and States must be understood within the framework of long-term national development goals. Third, it acknowledges the 16th Finance Commission’s five-year mandate (2026-31) as the first instalment of this longer journey, with subsequent Commissions addressing subsequent phases. Fourth, it invites reflection on the adequacy of existing fiscal institutions—including the Finance Commission itself—to address challenges that extend far beyond their five-year cycles. An institution designed for quinquennial recommendations is now being asked to inform planning that extends to 2050. Whether the constitutional architecture can accommodate this expanded temporal ambition, or whether it requires fundamental reform, is a question the framing raises but does not answer. The phrase is thus simultaneously a statement of intent, an assertion of legitimacy, and an invitation to constitutional imagination.
