A Shift in Centre-State Financial Dynamics
Centre’s Proposal to Cut States’ Share in Central Taxes from 2026: A Financial Turning Point: The Union government has proposed a reduction in the states’ share of central taxes from 41% to 40%, starting from the 2026–27 fiscal year. While the drop appears modest, even a 1% cut could translate to a ₹3.5 lakh crore annual loss for states, significantly impacting their ability to finance social welfare programs and development projects. This proposal is expected to be reviewed by the Finance Commission headed by Arvind Panagariya, which will submit its report by October 31, 2025.
Why Is the Centre Considering This Change?
The Centre cites its rising expenditure burden and a projected fiscal deficit of 4.8% of GDP in 2024–25 as the main reasons for the proposed revision. In contrast, states are expected to maintain a deficit of 3.2%. Historically, the share of central taxes allocated to states grew from 20% in 1980 to 41% today, but post-pandemic pressures, coupled with increased global uncertainties, have prompted the Centre to reassess its financial commitments. Moreover, cesses and surcharges, which form over 15% of the Centre’s tax revenue, are not shared with states, increasing the financial asymmetry.
How Could This Impact State Finances?
With over 60% of public expenditure handled by state governments—particularly in health, education, and welfare—any cut in central transfers could trigger a financial crunch. Many states, especially Tamil Nadu, Kerala, and West Bengal, heavily rely on central devolution and may need to scale back schemes or shift resources. Adding to the strain, the GST framework has already reduced states’ autonomy in raising taxes independently, leaving limited fiscal room for adjustment.
Freebies Under Scrutiny
A key aspect of the proposal is the Centre’s intent to link revenue-deficit grants to fiscal responsibility, discouraging populist measures like loan waivers or cash incentives. The move is aimed at promoting budget discipline at the state level, but critics argue it may violate the principles of federal autonomy. If implemented, states offering such freebies could face cuts in central assistance, raising concerns about the Centre influencing state policy choices through financial leverage.
Federal Tensions Likely to Rise
Although Finance Commission recommendations are advisory, they often shape major budget decisions and intergovernmental financial relations. With several opposition-led states already at odds with the Centre over resource allocation, this proposal is likely to deepen the divide. The final decision will depend on the framing of the Commission’s report, the Cabinet’s endorsement, and Parliamentary approval, especially amid rising political debates around fiscal control and decentralization.
Static GK Snapshot
Centre’s Proposal to Cut States’ Share in Central Taxes from 2026:
| Topic | Details |
| Proposed Change | Reduce states’ share of central taxes from 41% to 40% |
| Effective Year | 2026–27 Fiscal Year |
| Finance Commission Head | Arvind Panagariya |
| Centre’s Fiscal Deficit (2024–25) | 4.8% of GDP |
| States’ Fiscal Deficit (2024–25) | 3.2% of GDP |
| Estimated Revenue Impact | ₹3.5 lakh crore gain for Centre from 1% reduction |
| Key State Spending Areas | Health, education, social welfare |
| GST’s Impact on States | Reduced tax independence for state governments |
| Revenue Deficit Grant Decline | From ₹1.18 trillion (2021–22) to ₹137 billion (2025–26) |
| Controversial Clause | States offering freebies may lose grant eligibility |
