Preserve The Fiscal Union, Make States More Fiscally Competitive

The concern over fiscal asymmetries and the dissatisfaction of certain Indian states with the current devolution formula is understandable. Yet, the remedy offered by Dr. C. Rangarajan, an idea to allow Indian states to levy personal income tax, risks dismantling core pillars of India’s fiscal architecture, and making states more lazy.

This opinion will offer a counterview — however not with the depth and width of financial expertise or institutional experience, or economic wisdom of Dr. Rangarajan, but with the same nationalist intent and an unwavering belief that the solution must lie within the constitutional framework that binds us. Sovereign taxation is not just a financial lever but a constitutional construct that upholds the unity of a diverse federation. Diluting this foundational principle may not correct imbalance but instead institutionalise fragmentation.

Income tax on individuals is perhaps the most potent expression of sovereign authority. Its centralisation in India’s constitutional design was deliberate. The need for uniformity, administrative efficiency, and a shared sense of fiscal responsibility demanded that the Union alone exercise this power. To now argue that subnational units should enter this terrain because of growing grievances that states have with the Union, risks opening a Pandora’s box of jurisdictional disputes, compliance burdens, and governance inefficiencies.

Comparisons with federal systems such as the United States may seem attractive but they overlook the deeply different trajectories and institutional ecosystems. India’s federal evolution, socio-political diversity, and economic asymmetry are distinct in both complexity and character. The Republic of India is not yet, nor do we want to be, United States of India.

Indian tax culture is still maturing, is complex and complicated, compliance remains uneven, and personal income tax payer base is low. We need to solve for that first. Introducing state-level income taxes in such a landscape is likely to create a labyrinth of overlapping jurisdictions, discourage interstate citizens mobility, and deepen regional inequities. Even the idea of capping aggregate tax liabilities or ensuring non-duplication would be difficult to implement effectively, especially in an environment where fiscal policy is often inseparable from political contestation.

It is important to acknowledge that the GST Council already provides a functioning forum for cooperative fiscal governance. In addition, there is the Finance Commission. Despite initial friction, negotiation fatigue, and political divergence, the Council has evolved into a platform where the Union and states engage constructively, on GST. Its journey has not been without obstacles but its continued relevance demonstrates that India’s democratic institutions can sustain the complexities of collaborative federalism.

The Constitution of India provides clarity not just on power-sharing but on responsibility-sharing. The division into Union, State, and Concurrent Lists is a constitutional grammar that enables coordinated governance. Any move to decentralise personal income taxation must therefore be judged not just on its economic rationale but on its constitutional ramifications. In moments of fiscal strain, the solution is not to erode national prerogatives but to work through constitutional instruments that can be recalibrated. The income-distance criterion can be rationalised. The growing prevalence of cesses and surcharges, which fall outside the divisible pool, can be reviewed. States can be given greater flexibility in expenditure design, without fragmenting the revenue base.

Unlike the Union, which is subject to continuous scrutiny from global investors, credit rating agencies, and multilateral institutions, states operate largely within a domestic political economy with weaker market discipline. Many of them do not exhibit the necessary level of fiscal self-regulation. This structural gap in accountability makes the prospect of devolving sovereign tax instruments not only premature but potentially destabilising.

Even from the standpoint of macroeconomic stability, fragmenting income taxation might impair the Reserve Bank of India’s capacity to manage fiscal and monetary coordination across tiers of government. The RBI relies on a consolidated view of general government finances to manage liquidity, assess risk, and maintain investor confidence. A differentiated, state-specific income tax system would cloud revenue visibility, introduce compliance asymmetries, and reduce the predictability of subnational borrowing. 

The resulting fiscal opacity could increase the cost of capital, particularly for weaker states. At a time when India seeks to deepen its bond markets, and still is engaged in deepening its debt markets, and enhance investor trust, any move towards such fiscal disaggregation would be strategically unwise.

More importantly, we must not conflate underperformance with unfairness. Any suggestion that states that have failed to build competitive ecosystems or developmental capabilities should be compensated through new taxation powers is dismissive of the nation’s collective aspirations. India cannot afford to become a fiscal federation where certain states evade hard reforms while demanding greater fiscal latitude. Several states continue to rely heavily on regressive and volatile revenue sources such as alcohol rather than building long-term enablers like infrastructure and enterprise support. Several have indulged in fiscally unsound measures—loan waivers, pension changes, and indiscriminate subsidies—without credible funding backstops.

To entrench such a model by granting personal income tax powers would send the wrong signal. It would normalise and reward inertia instead of innovation. The moment has come for each state to compete seriously for capital, talent, and ideas. They must build ecosystems that attract investment, nurture employment, and deliver public goods with efficiency. Fiscal autonomy must be earned through demonstrable capability and credibility, not granted as a compensatory mechanism. There is room to design fiscal incentives that recognise good governance. Performance-linked grants, outcome-based allocations, and enhanced spending autonomy can achieve this balance without diluting the core principles of sovereign authority.

Asymmetric taxation rights, if granted, would also risk turning India into a federation of unequal taxpayers. Dual-speed sovereignty of this nature would fracture the fiscal unity that has held India together since Independence. No citizen should face materially different tax treatment purely based on geography. Once sovereign taxation is disaggregated, it is politically and administratively difficult to reverse. Such decisions must not be driven by present discontent or lack of economic discussions, but weighed against the enduring coherence of the Republic.

Perhaps what is not said aloud, even by the expert voices, who have contributed to our nation-building, is the hunger for open and intellectually honest debate on matters of political economy is unquenched, and deserves more. After all, Viksit Bharat cannot afford any policy having less exposure to diversity of — ideas, engagement and critique – before they crystallise into prescriptions. The future of India’s economic federalism must lie in responsible devolution, rigorous accountability, and deepening the spirit of constitutional cooperation, all hopefully with much debate and rigour of intellectual honesty.

But then, fragmenting sovereign taxation is a strategic misstep that India must avoid.