Answer

Introduction

Gross State Domestic Product (GSDP) represents the total value of all goods and services produced within a state’s boundaries over a specific period. As the sub-national equivalent of GDP, it serves as the primary indicator of a state’s economic health and size, increasingly utilized by the Finance Commission (FC) to calibrate the “Tax Effort” and “Income Distance” criteria in horizontal devolution.

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Rationale for GSDP in Tax Devolution

• Measuring Fiscal Capacity: GSDP acts as a proxy for the potential tax base available to a state, allowing the FC to assess how much revenue a state could ideally generate.
• Rewarding Tax Effort: Including the Tax-to-GSDP ratio rewards states that effectively mobilize their own revenue relative to their economic size, promoting fiscal responsibility.
  Eg: The “Tax and Fiscal Efforts” criterion (2.5% weight) incentivizes states to improve collection efficiency by benchmarking actual revenue against GSDP potential.
• Standardizing Economic Performance: It provides a uniform, objective metric to compare diverse states, moving away from subjective “backwardness” indices used in earlier commissions.
• Alignment with GST: In a post-GST era, GSDP helps track consumption and production trends, essential for determining the “destination-based” tax gains and losses of states.

Concerns for Equity

• Penalizing Low-Income States: A high weightage on GSDP-based “Tax Effort” can disadvantage poorer states with smaller formal economies that struggle to meet high tax-to-GSDP benchmarks.
• The Distance Paradox: While “Income Distance” seeks to help poorer states, the reliance on three-year GSDP averages can result in “rank-stability,” where bottom states remain trapped with limited growth incentives.
• Overlooking Informal Economies: GSDP often fails to capture the vast informal and subsistence sectors prevalent in backward regions, leading to an underestimation of their actual “fiscal disability.”

Concerns for Balanced Regional Development

• Widening the North-South Divide: Rewarding high GSDP growth can favor industrialized southern and western states, while northern states with high population pressures but lower GSDP per capita feel marginalized.
  Eg: Developed states like Tamil Nadu and Karnataka contribute significantly to the national GDP but often receive a diminishing share of the divisible pool due to the “Income Distance” penalty.
• Incentivizing “Race to the Bottom”: To keep GSDP growth high, states might prioritize capital-intensive urban centers over rural infrastructure, exacerbating intra-state regional imbalances.
• Erosion of Specificity: A singular focus on GSDP ignores unique regional challenges like topography or climate vulnerability that affect the “cost of service delivery.”
  Eg: Hilly states often have lower GSDP due to environmental constraints, requiring specialized grants beyond the standard GSDP-based horizontal formula.

Conclusion

The transition toward GSDP-linked devolution is a step toward “Cooperative and Competitive Federalism.” However, to ensure this does not facilitate a “digital or economic authoritarianism” of wealthy states, the 16th Finance Commission should consider reducing the weight of “Income Distance” while introducing a “Growth-Momentum” index. By balancing efficiency with a “Human Development Index” (HDI) overlay, India can ensure that its path to 2047 remains inclusive and regionally balanced.

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