Paper: GS – III, Subject: Economy, Topic: Growth and Development, Issue: Recognising States’ GSDP in Tax Devolution.
Context:
The central government transfers to states in India, focusing on the criteria used to determine these transfers. The Gross State Domestic Product (GSDP) share is a more meaningful indicator of a state’s contribution to central taxes than current methods, which rely heavily on factors like income distance and population.
Key Highlights:
Key Concerns with Current Central Transfers:
- Erosion of Fiscal Autonomy: States face reduced fiscal autonomy due to the implementation of GST and increasing dominance of Centrally Sponsored Schemes (CSS).
- Revenue Losses: GST rate cuts lead to revenue losses for states.
- Unshared Revenue: The Centre’s growing reliance on cesses and surcharges, which are not shared with states, is a concern.
- Declining Devolution Shares: High-performing states experience declining devolution shares.
- Prioritization of Equity over Efficiency: Finance Commissions (FCs) have historically favored equity over efficiency, relying on debatable criteria like income distance and population.
- Regional Disparities: Significant regional disparities persist in expenditure needs and fiscal capacity across states.
GSDP as a Proxy for State-Level Tax Accrual:
- GSDP Represents the Tax Base: While the Centre levies direct taxes, GSDP represents the underlying tax base within each state.
- Assumption: If tax administration efficiency is uniform and the ratio of direct tax revenue to GSDP doesn’t vary significantly, a state’s share in national GSDP can approximate its contribution to central tax revenues.
- GST Attribution: GST is destination-based, making its attribution across states relatively uncontroversial.
- Empirical Evidence:
- Correlation between states’ GSDP and direct tax collections (2023-24 data): 0.75
- Correlation between states’ GSDP and GST collections (2023-24 data): 0.91
- Conclusion: GSDP share is a meaningful indicator of the accrual of central taxes at the state level.
Analysis of Current Transfer System:
- 15th FC Recommendations: The Centre devolved 41% of its gross tax revenues to states (2020-21 to 2024-25), along with grants-in-aid and CSS.
- Total Transfers: Amounted to ₹75.12 lakh crore.
- Largest Recipients: Uttar Pradesh (15.81%), Bihar (8.65%), and West Bengal (6.96%).
- Tax Collection Shares: These states accounted for only 4.6%, 0.67%, and 3.99% of combined direct tax and GST collections, respectively.
- Largest Contributors: Maharashtra contributed the highest share of tax collections (40.3%) but received only 6.64% of total transfers.
- Other Contributors: Karnataka and Tamil Nadu contributed 12.65% and 7.61%, receiving 3.9% and 4.66%, respectively.
- Low Transfer Shares: Haryana, Himachal Pradesh, and Uttarakhand received low shares of transfers despite contributing 5.39%, 0.43%, and 0.81%, respectively.
- Correlations:
- 15th FC’s devolution shares show a high correlation (0.99) with actual transfers.
- Weak correlation (0.24) with tax collection shares.
- GSDP shares display a high correlation with tax collections (0.81) and a moderate correlation with devolution shares (0.58).
- Exceptions: In Haryana, Karnataka, and Maharashtra, GSDP share is less than tax collection share, likely due to the concentration of registered offices of multi-state firms. In Tamil Nadu, GSDP share exceeds tax collections, reflecting production activity whose tax payments are recorded elsewhere
Impact of a GSDP-Based Formula:
- Gainers: If transfers were distributed purely based on GSDP shares, nine of the 20 major states would gain.
- Largest Beneficiaries: Maharashtra, Gujarat, Karnataka, and Tamil Nadu.
- Largest Reductions: Uttar Pradesh, Bihar, and Madhya Pradesh.
- Overall Impact: Gains and losses would be moderate, as GSDP shares differ less sharply from tax collection shares than current devolution outcomes.
While equity remains central to India’s fiscal federalism, GSDP is a robust indicator of economic contribution and tax accrual capacity. Incorporating it more meaningfully into devolution formulas can improve fairness, efficiency, and trust between the Centre and States. A calibrated approach—balancing redistribution with contribution—offers the most sustainable path forward.
Source: (The Hindu)
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