The Federal Structure of Indian Taxation

India’s tax system operates within a constitutional framework that divides fiscal powers between the central government and state governments. This division is laid out in the Seventh Schedule of the Constitution under Article 246, which specifies the Union List, State List, and Concurrent List. Taxes on the Union List (e.g., income tax, customs duty) are levied exclusively by the central government, while those on the State List (e.g., stamp duty, land revenue, vehicle tax) fall under state jurisdiction. The Concurrent List allows both levels to tax certain items, but central law prevails in case of conflict. This structured separation was designed to ensure both revenue adequacy for national priorities and fiscal autonomy for state-specific needs, but the interplay between state and central taxes has evolved significantly, especially after the landmark Goods and Services Tax (GST) reform in 2017.

Major Central Taxes

Income Tax

The central government collects income tax from individuals, Hindu Undivided Families (HUFs), firms, and corporations. Income tax is a direct tax, meaning it is levied directly on income earned. For individuals, tax rates follow a progressive slab structure, with the most recent changes in the 2023-24 budget introducing a new tax regime offering lower rates but fewer exemptions. In fiscal year 2022-23, income tax contributed roughly 30% of the central government’s gross tax revenue. The Central Board of Direct Taxes (CBDT) administers this tax, and taxpayers file annual returns through a largely digitized system. Official income tax portal.

Corporate Tax

Corporate tax is levied on the profits of companies registered in India. The base rate for domestic companies stands at 25% (for turnover up to ₹400 crore) and 30% for others, but a lower rate of 22% is available under the concessional regime introduced in 2019. Surcharges and cess (like the health and education cess of 4%) increase the effective rate. Corporate tax is a significant revenue source for the central government, accounting for about 24% of gross tax revenue in 2022-23.

Customs Duty

Customs duty is an indirect tax imposed on goods imported into India and, in some cases, on exports. It serves both revenue and protective functions, shielding domestic industries from foreign competition. The government periodically adjusts basic customs duty (BCD) rates to promote local manufacturing under the “Make in India” initiative. The Central Board of Indirect Taxes and Customs (CBIC) administers customs laws.

Excise Duty and Central Goods and Services Tax (CGST)

Before GST, excise duty was a major central tax on the manufacture of goods. Post-GST, most excise duties have been subsumed under the Central GST (CGST), which is the central component of the dual GST structure. However, excise duty still applies to a small set of products such as petroleum, liquor, and tobacco. CGST revenue is shared with states under the GST framework, making it a key part of the central-state tax interplay.

Major State Taxes

State Goods and Services Tax (SGST)

The SGST is the state-level counterpart of the CGST. Under the GST regime, both centre and state collect their respective shares on the same transaction base. For intra-state supplies, the total GST rate is split equally into CGST and SGST. States retain 100% of the SGST collected within their borders. The GST Council, a federal body, sets the rates and ensures uniformity across states, reducing the scope for tax competition.

Stamp Duty and Registration

Stamp duty is a state-level tax on the transfer of immovable property. Rates vary significantly across states, ranging from 4% to 8% of the property value. Registration fees are additional. This tax is a major source of state revenue, especially in property-driven economies. Some states have recently reduced stamp duty to boost real estate activity.

Land Revenue and Agricultural Tax

Land revenue is a tax on landholding, collected by state governments. Its contribution to total revenue has declined over the years, but it remains important for rural administration. Agricultural income is exempt from central income tax, but states have the power to tax it (though few exercise this fully). This creates a fiscal imbalance as agricultural incomes escape central taxation.

Vehicle Tax

Road tax or motor vehicle tax is a state levy on vehicles registered within the state. The rate varies by vehicle type and value, and some states offer concessions for electric vehicles. It is collected at the time of registration and annually in some jurisdictions.

State Excise and Other Taxes

State excise is levied on the production and sale of alcoholic liquor. This is a lucrative source of revenue, with many states deriving a significant share from liquor sales. Professional tax is another state-level levy on salaried persons and professionals, capped at ₹2,500 per annum per the Constitution.

The Goods and Services Tax (GST) – A Unifying Reform

The introduction of GST on July 1, 2017, represented the biggest overhaul of India’s indirect taxation system. It replaced a host of central and state taxes, including service tax, central excise, state VAT, entertainment tax, and luxury tax, among others. GST is a destination-based consumption tax, meaning the revenue accrues to the state where the goods or services are consumed, not produced.

How GST Works: CGST, SGST, and IGST

For intra-state transactions, the tax is split into CGST (central) and SGST (state). For inter-state transactions, the Integrated GST (IGST) is collected by the centre and then apportioned to the consuming state. This mechanism prevents cascading and ensures seamless credit flow across state borders. The GST system relies on a common IT platform, the GST Network (GSTN), for returns and invoice matching.

The GST Council – A Coordination Mechanism

The GST Council is a constitutional body (Article 279A) comprising the Union Finance Minister and state Finance Ministers. It decides on tax rates, exemptions, and administrative rules. The Council’s recommendations have near-binding authority, making it a key forum for central-state cooperation on fiscal matters. Since inception, the Council has held over 50 meetings, adjusting rates and procedures to address economic and taxpayer concerns. GST Council official site.

Impact on State Autonomy and Revenue

GST reduced states’ freedom to set their own indirect tax rates, but it simplified the system and broadened the tax base. To compensate states for revenue losses in the transition, the central government guaranteed compensation for five years (ending June 2022). The pandemic severely impacted GST collections, leading to borrowing arrangements through a special window. Post-compensation, states now rely on growing SGST revenues and continue to seek greater flexibility within the GST framework.

Direct Taxes: Central Dominance

Direct taxes such as income tax and corporate tax remain exclusively under central jurisdiction. The central government collects these taxes and then shares a portion with states through the Finance Commission’s tax devolution formula. Currently, 41% of the centre’s divisible tax pool (GST compensation cess excluded) is devolved to states. This vertical sharing is a critical element of the interplay, as state budgets heavily depend on transfers. Horizontal devolution among states is based on criteria like population, income distance, and demographic performance.

Because direct taxes are progressive and buoyant, the centre’s control over them gives it tools to manage aggregate demand and redistribution. However, states often argue that their revenue-raising capacity is limited to inelastic sources like stamp duty and excise on alcohol, making them dependent on central transfers. The Finance Commission periodically reviews the devolution formula to address fiscal imbalances.

Challenges in the Interplay

Revenue Imbalance (Vertical Fiscal Imbalance)

The central government collects about 65% of total tax revenue but incurs only about 45% of total expenditure (including transfers to states). States, on the other hand, are responsible for key social services like education, health, and infrastructure but lack the tax base to fully fund them. This vertical fiscal imbalance requires large transfers from centre to states. Delays in these transfers or changes in devolution percentages create uncertainty for state planning.

Tax Competition Among States

Even within GST, states have some discretion on certain items (like petrol and alcohol) and on non-GST taxes. Some states lower stamp duty or offer tax incentives to attract investment, leading to a race to the bottom. This competition can erode the overall tax base and create inefficiencies. The GST Council tries to minimize such competition by standardizing rates.

Compliance Burden for Businesses

Despite GST, businesses still deal with multiple tax authorities – central for income tax and customs, state for SGST and local taxes, and both for GST. Compliance costs are high, especially for small and medium enterprises. Frequent changes in GST return forms and rules add to the complexity. The government is working on a simplified single-return system (the GST return 2.0) but implementation is ongoing.

GST Compensation and Transition Issues

The end of the compensation guarantee in June 2022 left some states worried about revenue shortfalls. Though GST collections have been growing (averaging over ₹1.5 lakh crore per month in 2023-24), some states still face gaps. The centre has extended compensation for certain years through special loans. Additionally, pending input tax credit refunds and audits create friction between state tax departments and taxpayers.

Recent Reforms and Future Directions

Simplified Tax Regime for Individuals

The central government introduced a new income tax regime in 2020, offering lower tax rates for individuals who forgo most deductions and exemptions. The regime was made the default from 2023-24. This simplifies tax calculation and aims to increase voluntary compliance. States have also been encouraged to rationalize their professional tax slabs.

GST Rate Rationalization

The GST Council has been working on reducing the multiplicity of rates. Currently, there are four main categories: 5%, 12%, 18%, and 28%. A Committee of Officers has recommended merging the 12% and 18% rates into a single 17% or 16% slab, which would simplify compliance and reduce “rate war” anomalies. A final decision is pending.

Digitalization and Tax Administration

Both central and state tax authorities are investing in technology. The Income Tax Department’s e-filing portal was upgraded in 2023 with improved functionality. The GST Network continues to add features like automated return filing and real-time invoice upload. States are digitizing stamp duty registration and vehicle tax collection. This reduces leakages and taxpayer hassles.

State-Level Reforms

Some states are reforming their own tax structures. For instance, a few states have voluntarily reduced stamp duty rates to moderate levels. Maharashtra and Karnataka have introduced online property registration systems. Others are considering subsuming small taxes like electricity duty and luxury tax into GST to streamline administration.

Conclusion

The interplay between state and central taxes in India reflects the country’s federal character – a balance between national uniformity and regional diversity. While the GST has harmonized indirect taxation, direct taxes remain a central preserve, necessitating robust revenue-sharing mechanisms. Challenges like vertical imbalance, tax competition, and compliance costs persist, but ongoing reforms in rate rationalization, digitalization, and fiscal coordination point toward a more efficient and equitable system. Understanding this interplay is essential for policy analysts, businesses, and citizens alike, as it shapes India’s economic trajectory. World Bank overview of India’s fiscal federalism. RBI’s analysis of state finances.