Finance Commissions and the Case for the Himalayan States

Finance Commissions must compensate states facing ecological disadvantages, writes Subhash Chandra Garg.

Finance Commissions are set up every five years primarily to determine the states’ collective share of central taxes (vertical devolution) and how it should be distributed amongst them (horizontal devolution).

(Photo: Aroop Mishra/The Quint)

Over a hundred public-spirited, retired public servants have come together under the aegis of the Constitutional Conduct Group (CCG) to seek financial empowerment for the ecologically sensitive states in India's Himalayan belt. In a written memorandum to the Sixteenth Finance Commission (FC) on 3 November 2025, the CCG has sought recognition for the climatic and public services' contribution of the four Himalayan states to the nation and compensation to these states for the said services.

Finance Commissions are set up every five years primarily to determine the states’ collective share of central taxes (vertical devolution) and how it should be distributed amongst them (horizontal devolution).

The CCG memorandum might be a bit late, given that the 16th FC is due to submit its report by 30 November. But the issues raised therein are extremely important as it makes a strong case for a larger share of the Himalayan states in horizontal devolution.

What is the case and, how or in what form should the FCs compensate such states?

Population and Poverty Primary Determinant

Though FCs have used a plethora of factors (referred to as 'weights') to determine specific share of each state in the past, two factors— population and poverty—have been the primary weights. This resulted in a bulk of the devolution being directed to the populous and poor states of the Hindi heartland.

The first and second FCs assigned 80 percent weight to population and 20 percent to the relative tax collections of states.

The fourth FC constructed a ‘relative economic backwardness’ index, assigning 20 percent weight to it while keeping the 80 percent weight of the population unchanged.

The sixth FC redefined economic backwardness in terms of the state’s per capita income distance from the highest income state and assigned it 25 percent weight, reducing population weight to 75 percent.

The poverty factor kept strengthening, thereafter. The eighth FC raised the poverty factor’s weight to 75 percent, reducing the population weight to 25 percent. Until the ninth FC, poverty and population determined almost 100 percent of horizontal devolution.

The tenth FC reduced the population’s weight to 20 percent with the poverty factor (per capita income distance), weight kept at 60 percent. Weight of population (1971) varied thereafter: 10 percnt in the 11th, 40 percent in 12th, 25 percent in the 13th and 17.5 percent in the 14th.

The 14th FC assigned 10 percent additional weight to population of 2011. The 15th FC assigned 15 percent weight to 2011 population and introduced demographic performance weight to 12.5 percent to take care of states with better population control.

Many states started highlighting their disadvantaged position (large areas, under-developed infrastructure, mountainous regions, forest areas etc) which imposed severe cost disabilities on them.

The area and infrastructure were recognised first with the tenth FC, which assigned five percent weight to each. The area’s weight increased thereafter. The 14th FC assigned 7.5 percent weight to forest cover. The 15th gave 10 percent to forest and ecology.

Himalayan States Have a Strong Case

India has ten Himalayan and mountainous states (including Jammu & Kashmir, temporarily a Union Territory). In addition to the four states (Himanchal, Uttarakhand, Kashmir, and Sikkim) mentioned in the CCG memorandum, there are six such states in the North-east (Arunachal Pradesh, Nagaland, Mizoram, Manipur, Tripura, and Meghalaya).

These states have too little agricultural and industrial production which adversely impact their tax revenues. On the contrary, they maintain difficult terrains and provide major natural and ecological services (forest cover, water and eco-tourism) as classical public goods, which impose considerable costs on them. This double whammy of lower tax revenues and higher costs has to be spread to the entire country.

Meanwhile, some mainland states (like Chhattisgarh and Jharkhand) with large regions and certain others (like Madhya Pradesh, Odisha, Maharashtra and Karnataka) with significant pockets of mountains/hills and forest cover also face similar cost disabilities. FCs must compensate these states.

Merge Population and Poverty

Large populous states in the northern and central plains of India (Uttar Pradesh, Bihar, Madhya Pradesh, Odisha, Rajasthan etc) also house most of India’s poor.

The population first and poverty later model, with 75 percent to 100 percent of weight, ensured that these states got a disproportionately high share of horizontal devolution. These states also receive substantial central resources for poverty alleviation through centrally sponsored schemes (CSSs) and other mechanisms.

Yet, these states have made no perceptible gains in poverty reduction. The quality of governance and administration is also no better in these states.

In fact, states without significant FC resource allocations have done better in population control and poverty alleviation. It is, therefore, advisable to junk poverty-weight completely.

The principal rationale of resource transfers through the FCs is to provide adequate fiscal resources to the states to raise people’s standard of living to a national average. Population is an excellent proxy for determining expenditure requirement of providing public services to raise the standard of life. Population, therefore, can be the principal factor for allocating a divisible pool of resources.

Merging poverty factor with population weight, not more than 60 percent of the divisible pool of central taxes can be assigned to it by FCs.

States with Forest and Oher Ecolgical Disabilities

The CCG memorandum referred to the Himachal CM’s proposal for the creation of a Rs 50,000 crore Fund for incentivising mountainous states. The memo asked for raising the forest and ecological services weight to 20 percent (from 10 percent).

The FCs are not meant for establishing and have never created any "fund" for any specific purpose. They used to recommend specific grants but that practice has also fallen out of use by now. Even when the 15th FC recommended some grants, these were not accepted by the government.

The case of the Himalayan and North-eastern states on account of forest cover and ecological consideration is primarily that of geographical and environmental cost disabilities, along with some other justified claims.

The tribal areas also suffer from severe cost disabilities. Some other geographical areas like the deserts in Rajasthan and the mangroves in Sundarbans, also suffer from large cost disabilities.

All these geographically and environmentally cost disadvantaged areas of India can be clubbed together, and an appropriate area and terrain cost disability index can be constructed to suitably compensate concerned states. FCs can allocate the remaining 40 percent of the devolution based on this index.

But have we already missed the 16th FC bus? The CCG memorandum of 3 November is quite late in the day. Further, the background of the 16th FC's constitution and composition does not inspire much confidence that it would be undertaking any basic restructuring of central devolution on vertical or horizontal axes.

There might, nonetheless, be some tinkering of the weight of forest and ecology services.

The CCG memorandum, however, would better serve its purpose by initiating a debate in the country about fundamental restructuring of central tax devolution to nudge resources towards states with significant geographical and environmental cost disabilities away from populous poor states.

(Subhash Chandra Garg is the Chief Policy Advisor, SUBHANJALI, and Former Finance and Economic Affairs Secretary, Government of India. He's the author of many books, including 'The $10 Trillion Dream Dented, 'We Also Make Policy', and 'Explanation and Commentary on Budget 2025-26'. This is an opinion piece. The views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)