India’s system of sharing central tax revenues with States is once again under scrutiny. With the recommendations of the 16th Finance Commission yet to be tabled, debates around fairness, fiscal autonomy, and efficiency in Centre–State transfers have intensified. At the core lies a fundamental question: are States receiving a fair return relative to their economic and tax contributions?
How Centre–State transfers are structured
The sharing of the Centre’s gross tax revenues with States is guided by successive Finance Commissions, constitutional bodies that determine both the overall divisible pool and the formula for distributing it among States. In addition to tax devolution, States receive resources through grants-in-aid and centrally sponsored schemes (CSS), which are often tied to specific policy objectives of the Centre.
Under the 15th Finance Commission, 41% of gross tax revenues were devolved to States between 2020-21 and 2024-25. According to the Ministry of Finance, total transfers during this period amounted to ₹75.12 lakh crore, a substantial fiscal flow shaping State-level public spending.
Why the existing framework is being questioned
Several structural concerns have converged to make central transfers politically and economically contentious. The introduction of the Goods and Services Tax has significantly reduced States’ independent taxation powers, while GST rate cuts have eroded their revenue base. Simultaneously, the growing use of cesses and surcharges by the Centre — which are not shareable with States — has narrowed the divisible pool.
Another source of discontent is the increasing dominance of CSS, which limits States’ flexibility to allocate funds according to local priorities. High-performing States argue that this combination of factors has weakened fiscal federalism and undermined their autonomy.
Tax collection versus actual tax contribution
States such as Maharashtra, Karnataka and Tamil Nadu frequently point out that they contribute disproportionately to central tax revenues but receive relatively modest shares through devolution. This claim is often countered by noting that direct tax data reflect the place of collection rather than where income is actually generated.
Large firms operate across multiple States, yet pay taxes where their registered offices are located. Labour migration, multi-location employment, and the absence of granular inter-State transaction data further distort State-wise tax attribution. As a result, PAN-based jurisdictional data is an imperfect measure of economic contribution.
Why GSDP offers a more reliable proxy
Gross State Domestic Product (GSDP) captures the underlying economic activity within a State and therefore represents a more stable proxy for the accrual of central taxes. If tax administration efficiency is broadly similar across States, a State’s share in national GSDP can approximate its contribution to direct tax revenues.
Empirical evidence reinforces this argument. For 2023-24, the correlation between States’ GSDP and direct tax collections stood at 0.75, while the correlation with GST collections was even higher at 0.91. This reflects the destination-based nature of GST and the close link between production, consumption, and tax accrual.
What recent transfer data reveals
Between 2020-21 and 2024-25, Uttar Pradesh received the largest share of total transfers (15.81%), followed by Bihar (8.65%) and West Bengal (6.96%). Yet, these States accounted for only a small fraction of combined direct tax and GST collections.
In contrast, Maharashtra contributed over 40% of total tax collections but received just 6.64% of transfers. Karnataka and Tamil Nadu displayed similar asymmetries. The correlation between the 15th Finance Commission’s devolution shares and actual transfers was nearly perfect (0.99), but their correlation with tax collections was weak (0.24). GSDP shares, by comparison, showed a strong link with tax collections (0.81) and a moderate alignment with devolution outcomes (0.58).
Who gains and who loses under a GSDP-based formula
If central transfers were allocated purely on the basis of GSDP, nine of the 20 major States would gain. Maharashtra, Gujarat, Karnataka and Tamil Nadu would see the largest increases, while Uttar Pradesh, Bihar and Madhya Pradesh would face reductions. Importantly, these shifts would be moderate, as GSDP shares diverge less sharply from tax contributions than current devolution outcomes.
Such a formula would better acknowledge States’ roles in generating national income while retaining scope for redistribution to address regional disparities.
What to note for Prelims?
- Finance Commissions recommend tax devolution formulas and shares.
- 41% tax devolution was recommended by the 15th Finance Commission.
- GST is destination-based; direct taxes are collected at the point of registration.
- GSDP is a proxy for State-level economic activity and tax base.
What to note for Mains?
- Equity–efficiency trade-off in Finance Commission formulas.
- Impact of GST and cesses on State fiscal autonomy.
- Limitations of PAN-based tax attribution.
- GSDP as a compromise indicator balancing contribution and redistribution.
The debate over tax devolution is ultimately about trust in India’s fiscal federal framework. A greater role for GSDP in transfer formulas could strengthen both the perceived fairness and the long-term credibility of Centre–State financial relations.
