The central government shares its gross tax revenues with States based on the recommendations of successive Finance Commissions (FCs), which determine both the overall share to States and the formula for tax devolution. The Centre also transfers resources through grants-in aid and centrally sponsored schemes (CSS).
While the recommendations of 15 FCs have been implemented, those of the 16th FC have yet to be tabled in Parliament. Central transfers have become a subject of intense debate. Key concerns include the erosion of the fiscal autonomy of States following the implementation of Goods and Services Tax (GST), revenue losses arising from GST rate cuts, the increasing dominance of CSS that constraint State-level spending flexibility, the Centre’s growing cesses and surcharges that are not shared with States, and declining devolution shares of high-performing States.
Moreover, most FCs have prioritised equity over efficiency, having relied heavily on debatable criteria such as income distance and population, and frequently altered the weights assigned to these variables. Significant regional disparities also persist across States in expenditure needs and fiscal capacity.
Tax collection versus tax contribution States such as Karnataka, Maharashtra and Tamil Nadu argue that they contribute disproportionately to central tax revenues but receive relatively smaller shares through tax devolution. This claim, however, is often contested on the grounds that direct tax figures reflect the location of collections rather than the actual place where income is generated. Individuals and companies may pay taxes in locations different from where economic activity occurs.
For example, automobile manufacturers in Tamil Nadu may sell vehicles across India, but their tax payments are recorded in the State where their registered office is located. Similarly, plantation companies in Kerala earn profits nationwide, though taxes are paid in Kerala.
Therefore, jurisdiction based on PAN data fails to accurately capture State-wise contributions to direct taxes. This is due to the presence of multi-State firms, labour migration, temporary or multi-location work arrangements, and the absence of detailed data on inter-State transactions among associated enterprises. Therefore, an indirect and more reliable proxy is needed to estimate the accrual of central taxes at the State level.
GSDP as proxy for State-level tax accrual Although the Centre levies direct taxes, Gross State Domestic Product (GSDP) represents the underlying tax base within each State. If tax administration efficiency is broadly uniform across States and the ratio of direct tax revenue to GSDP does not vary significantly, a State’s share in national GSDP can reasonably approximate its contribution to central tax revenues.
Since the GST is destination-based and the principal source of indirect taxation, its attribution across States is relatively uncontroversial. Empirical evidence supports this approach. Using 2023-24 data, the correlation between States’ GSDP and direct tax collections is 0.
75, while the correlation between GSDP and GST collections is as high as 0. 91.
This strong relationship suggests that GSDP share is a meaningful indicator of the accrual of central taxes at the State level. From 2020-21 to 2024-25, the Centre devolved 41% of its gross tax revenues to States in line with the 15th FC’s recommendations, along with additional transfers through grants-in-aid and CSS.
According to the Ministry of Finance (Rajya Sabha Unstarred Question No. 236, dated December 2, 2025), total transfers during this five-year period amounted to ₹ 75. 12 lakh crore (see Table).
Uttar Pradesh received the largest share of transfers (15. 81%), followed by Bihar (8.
65%), and West Bengal (6. 96%). However, these States accounted for only 4.
6%, 0. 67% and 3. 99%, respectively, of combined direct tax and GST collections.
In contrast, Maharashtra contributed the highest share of tax collections (40. 3%), but received only 6.
64% of total transfers. Karnataka and Tamil Nadu contributed 12.
65% and 7. 61%, while receiving 3.
9% and 4. 66%, respectively.
Haryana (1. 1%), Himachal Pradesh (1. 58%) and Uttarakhand (1.
65%) received low shares of transfers, despite contributing 5. 39%, 0. 43% and 0.
81%, respectively. The 15th FC’s devolution shares show an almost perfect correlation (0. 99) with actual transfers over the five-year period, but a weak correlation (0.
24) with tax collection shares. By contrast, GSDP shares display a high correlation with tax collections (0.
81) and a moderate correlation with devolution shares (0. 58). This suggests that GSDP strikes a balance between efficiency, by reflecting tax contributions, and equity, by allowing redistribution.
Only in Haryana, Karnataka and Maharashtra, the GSDP share is less than tax collection share, likely due to the concentrations of registered offices of multi-State firms. In Tamil Nadu, GSDP share exceeds tax collections, reflecting production activity whose tax payments are recorded elsewhere.
Gainers, losers under a GSDP-based formula If total central transfers were distributed purely on the basis of GSDP shares, nine of the 20 major States would gain. Maharashtra, Gujarat, Karnataka and Tamil Nadu would benefit the most, while Uttar Pradesh, Bihar and Madhya Pradesh would experience the largest reductions. Importantly, these gains and losses would be moderate, as GSDP shares differ less sharply from tax collection shares than current devolution outcomes.
A higher weight for GSDP share would better reflect the accrual of central tax revenues, acknowledge the contributions of States to national income, and improve the perceived fairness and the credibility of India’s inter-governmental fiscal transfer system. K. R.
Shanmugam is Economic Consultant, Government of Tamil Nadu, and former Director, Madras School of Economics. Sankarganesh Karuppiah is an IRS officer. The views expressed are personal.