Intergovernmental Transfers and Tax Collection in India: Does the Composition of Transfers Matter?

This study examines whether the impact of intergovernmental transfers on tax effort of Indian states depends on the composition of transfers (conditional vis-a-vis unconditional). It also tests the asymmetry hypothesis, which states that subnational governments respond to increases in transfers differently from losses. The evidence suggests that tax collections, including both indirect and direct taxes, are inversely related to unconditional transfers irrespective of whether they are increasing or decreasing. Imposition of conditions on transfers has prevented the Indian states from substituting such transfers for tax collection (direct tax collection is an exception). Direct tax collection responds most sensitively to transfers.