GSDP share as criterion for central-State transfers

Why in the News?

With the recommendations of the Sixteenth Finance Commission yet to be tabled in Parliament, debates around fairness in Centre–State fiscal transfers have intensified. An opinion piece by K.R. Shanmugam argues for using Gross State Domestic Product (GSDP) share as a key criterion for determining central transfers, to better reflect States’ actual contribution to national tax revenues.

Background

Under Article 280 of the Constitution, Finance Commissions recommend:

• The share of States in central taxes
• The formula for inter-State distribution
  

Over time, central transfers occur through:

• Tax devolution
• Grants-in-aid
• Centrally Sponsored Schemes (CSS)
  

Post-GST, States have raised concerns over:

• Loss of fiscal autonomy
• Revenue erosion due to GST rate cuts
• Rising cesses and surcharges are not shareable with States
• Declining shares for economically high-performing States

Traditionally, Finance Commissions have prioritised equity using criteria such as:

• Income distance
• Population
• Area often at the cost of efficiency and contribution recognition.

Features 

Tax Contribution vs Tax Collection

• Direct tax data is based on the place of collection, not the place of income generation.

Due to:

• Multi-State firms
• Centralised registered offices
• Labour migration direct tax figures misrepresent the state-wise contribution.
  

GSDP as a Proxy

• GSDP reflects the economic base from which taxes arise.
• If tax administration efficiency is broadly uniform:
  • A State’s share in national GSDP ≈ its contribution to central taxes.
• GST, being destination-based, is already better aligned with consumption geography.

Empirical Evidence

Correlation (2023–24 data):

• GSDP & Direct taxes: 0.75
• GSDP & GST: 0.91

Over 2020–25:

• Devolution shares correlate strongly with transfers (0.99),
• But weakly with tax contribution (0.24).

GSDP shows:

• High correlation with tax contribution (0.81)
• Moderate correlation with devolution (0.58).
  

Equity–Efficiency Balance

• GSDP shares differ less sharply than tax collection shares.
• This makes redistribution less disruptive, while improving fairness.

Challenges in the Existing System

Perceived Injustice

• States like Maharashtra, Karnataka, and Tamil Nadu argue they receive less than their contribution.

Over-reliance on Redistributive Criteria

• Income, distance, and population may disincentivise growth.

Regional Disparities

• Wide variation in fiscal capacity and expenditure needs.

Trust Deficit

• Declining credibility of inter-governmental fiscal arrangements.

Way Forward

Introduce GSDP as a Formal Criterion

• Assign a significant weight to GSDP in the devolution formula.

Balanced Formula Design

• Combine:
• GSDP (efficiency & contribution)
• Income distance (equity)
• Demographic and geographic needs

Rationalise CSS

• Increase untied transfers to restore State flexibility.

Transparency in Tax Attribution

• Improve data on inter-State value creation and income generation.

Rebuild Cooperative Federalism

• Ensure high-performing States feel rewarded, not penalised.

Conclusion

Using GSDP share as a criterion for central transfers offers a pragmatic middle path between equity and efficiency. It better reflects the economic contribution of States, improves perceptions of fairness, and strengthens the credibility of India’s fiscal federal architecture. As India aspires to sustain high growth, rewarding economic performance while protecting redistribution goals will be crucial for cooperative and competitive federalism alike.