16th Finance Commission Revamps Forest Formula: In a significant shift aimed at strengthening environmental conservation while balancing fiscal federalism, the 16th Finance Commission has overhauled the way forests are accounted for in the horizontal tax devolution formula. For the first time, open forests have been formally included in the calculation, with different weights assigned based on forest density. The move is designed to provide stronger incentives for states to not only protect dense forests but also expand overall forest cover and manage ecological risks more effectively.
The recommendations are part of the Commission’s report, which was submitted to Parliament on February 1, 2026, and will guide the sharing of central tax revenues among states in the coming years.
What Has Changed in the Forest Criterion?
Under the 15th Finance Commission, the forest criterion considered only dense and moderately dense forests while determining a state’s share of tax devolution. Open forests—despite covering large areas and playing a critical ecological role—were excluded from the formula.
The 16th Finance Commission has now corrected this by including open forests and assigning different weights to forest categories based on canopy density. This revision reflects a more nuanced understanding of forest ecosystems and their varying contributions to biodiversity, climate regulation, and livelihoods.
The forest criterion continues to carry an overall weightage of 10 per cent in the horizontal devolution formula, but the way this 10 per cent is calculated has been fundamentally reworked.
How Forests Are Now Classified and Weighted
The Commission has adopted standard forest density classifications used in India:
- Very Dense Forests (VDF): Canopy cover of 70 per cent and above
- Moderately Dense Forests (MDF): Canopy cover of 40–70 per cent
- Open Forests (OF): Canopy cover of 10–40 per cent
To calculate a weighted forest area, the Centre has assigned the following weights:
- 0.30 for Open Forests
- 0.65 for Moderately Dense Forests
- 1.00 for Very Dense Forests
According to the Commission, these weights are derived from the ratio of the mid-point canopy cover of each category to the mid-point of the Very Dense Forest category, ensuring a transparent and rational basis for differentiation.
Rewarding Not Just Area, But Growth in Forest Cover
A key innovation in the revised formula is that it does not stop at measuring the existing forest area. The Commission has also introduced a reward mechanism for growth in forest cover.
The forest variable is now calculated using two components:
- A state’s share in the total weighted forest area across all states
- A state’s share in the increase in weighted forest area over a defined base period
These two components are combined in an 80:20 ratio, respectively.
The growth in forest area is measured over the period 2015 to 2023, ensuring that states which have actively worked to expand forest cover in recent years are appropriately recognised.
“We have also introduced a small reward for an increase in the weighted forest area over a base period,” the report noted.
This approach is expected to encourage states to invest in afforestation, reforestation, and better forest management, rather than focusing only on preserving existing dense forests.
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Lower Minimum Area Threshold for States
Another notable adjustment relates to the minimum forest area share assigned to each state. In implementing the area criterion, the Commission has reduced the minimum area assigned to every state from 2 per cent to 1.5 per cent of the total area.
This change allows for a more proportionate distribution and avoids disproportionately benefiting states with very small forest areas simply due to a higher minimum floor.
Demographic Performance Metric Also Revised
Beyond forests, the 16th Finance Commission has also made an important change to the demographic performance variable in the devolution formula.
The earlier inverse Total Fertility Rate (TFR) metric has been replaced with the inverse population growth rate between 1971 and 2011, using the 2011 population as the reference point.
This shift is intended to better reflect long-term population control efforts by states, while aligning demographic incentives with historical data that is more stable and widely accepted.
Forest Fires Added to Disaster Risk Index
In another environment-focused reform, the Commission has explicitly included forest fires as one of the hazards in the updated Disaster Risk Index (DRI).
The DRI is used to allocate 30 per cent of funds under:
- The State Disaster Response Fund (SDRF), and
- The State Disaster Mitigation Fund (SDMF)
Forest fires now join nine other hazards considered in the index:
- Floods
- Droughts
- Cyclones
- Landslides
- Earthquakes
- Hailstorms
- Cold waves
- Cloudbursts
- Heatwaves and lightning
The inclusion reflects the growing frequency and intensity of forest fires in India, driven by climate change, prolonged dry spells, and human activity.
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Addressing Cost Disabilities in Hilly and Northeastern States
The Commission has reiterated that the forest-area criterion continues to serve as a partial proxy for cost disability, particularly for hilly and northeastern states, where providing infrastructure and public services is significantly more expensive than in the plains.
“In India’s special circumstances, the forest-area criterion also serves as a partial proxy for cost disability characterising the northeastern and hilly states,” the report observed.
The challenges faced by these states include:
- Difficult terrain increasing transportation costs
- Higher expenses in building roads, power infrastructure, and public facilities
- Relatively poor connectivity with the rest of the country, especially in the Northeast
The Commission pointed out that the 10 Northeastern and Himalayan (NEH) states accounted for 33.4 per cent of India’s dense forest area in 2021, while representing only 5.3 per cent of the national population. As a result, on a per capita basis, the forest-area criterion awards these states significantly higher revenues compared to others.
States’ Feedback Shaped the New Formula
The revised forest methodology was incorporated after representations and recommendations from multiple states, many of which argued that excluding open forests penalised regions making incremental progress in afforestation and ecological restoration.
By recognising different forest densities and rewarding growth, the Commission has attempted to strike a balance between environmental outcomes and fiscal equity.
Bigger Picture: Incentivising Green Growth
Taken together, the changes introduced by the 16th Finance Commission mark a clear policy shift. The revised formula aims to:
- Encourage conservation of existing dense forests
- Incentivise expansion of forest cover, including open forests
- Recognise the ecological and fiscal challenges faced by hilly and forest-rich states
- Strengthen disaster preparedness, especially in the context of forest fires
By linking fiscal transfers more closely to ecological performance and risk management, the Commission has sought to align environmental stewardship with financial incentives.
As climate risks intensify and ecological preservation becomes central to India’s development strategy, these changes signal a move towards a more environment-sensitive framework of cooperative federalism, where states are rewarded not just for what they have, but also for what they protect and grow.
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