Centre–State Fiscal Transfers -

Background: Centre–State Transfers

Central tax revenues are shared with States based on Finance Commission (FC) recommendations.
Transfers occur through tax devolution, grants-in-aid, and Centrally Sponsored Schemes (CSS).
The 15th Finance Commission recommendations are in force; 16th FC report is pending.
Debates focus on fiscal autonomy erosion after GST implementation.
Concerns include GST revenue losses, rising cesses and surcharges, and CSS spending rigidity.
High-performing States allege declining devolution shares despite strong revenue contributions.
FCs historically prioritised equity over efficiency, using income distance and population criteria.

Tax Collection versus Economic Contribution

States like Maharashtra, Karnataka, Tamil Nadu argue they contribute more than they receive.
Direct tax data reflect place of collection, not place of income generation.
Multi-State firms pay taxes where registered offices are located, distorting State attribution.
Labour migration and multi-location operations further weaken PAN-based tax attribution.
Hence, direct tax figures are unreliable for estimating State-wise tax contribution.

GSDP as a Proxy for Tax Accrual

Gross State Domestic Product (GSDP) represents the underlying tax base of a State.
Assuming uniform tax efficiency, GSDP share approximates tax accrual capacity.
GST, being destination-based, poses fewer attribution concerns.
Empirical evidence supports GSDP relevance.
In 2023–24, correlation between GSDP and direct taxes was 0.75.
Correlation between GSDP and GST collections was higher at 0.91.

Transfer Outcomes under Current System

From 2020–21 to 2024–25, States received 41% of gross tax revenues.
Total transfers amounted to ₹75.12 lakh crore.
Uttar Pradesh, Bihar, West Bengal received high transfers despite low tax shares.
Maharashtra, Karnataka, Tamil Nadu contributed heavily but received modest transfers.
Devolution shares correlated 0.99 with actual transfers, but only 0.24 with tax collections.
GSDP share showed 0.81 correlation with tax collections and 0.58 with devolution.

Implications of a GSDP-Based Formula

Pure GSDP-based transfers would benefit Maharashtra, Gujarat, Karnataka, Tamil Nadu.
Uttar Pradesh, Bihar, Madhya Pradesh would face moderate reductions.
GSDP balances efficiency and equity, improving fairness and system credibility.
Higher GSDP weight acknowledges State contributions to national income.

Centre–State Fiscal Transfers