Revised GDP tests devolution fairness

The promise of performance-based allocation is credible, but the methods are not tuned to fiscal equity.

The recent revision of India’s GDP series by the Ministry of Statistics and Programme Implementation (MOSPI), adopting 2022-23 as the new base year, marks one of the most significant methodological upgrades in the country’s national accounts framework in over a decade. While such revisions intend to improve statistical accuracy and better reflect structural changes in the economy, their implications extend beyond measurement. In particular, they assume critical importance given the 16th Finance Commission’s decision to assign a 10% weight to states’ Gross State Domestic Product (GSDP) in the tax devolution formula.

At first glance, including GSDP as a criterion represents a logical and progressive step. By incorporating economic contribution into the devolution formula, the Finance Commission acknowledges the role of states as engines of growth, production, and tax mobilisation. This introduces an element of performance-based allocation into what has been a predominantly redistributive framework. However, the criterion’s effectiveness depends on the reliability and comparability of the underlying GDP estimates – an issue complicated by MOSPI’s revised methodology.

The new GDP series introduces several substantive methodological changes. These include the expanded use of administrative data sources such as GST records, corporate filings (MCA-21), and PFMS data, along with integrating regular surveys like the Periodic Labour Force Survey (PLFS), to improve measurement of the household sector.

Adopting double deflation in key sectors such as manufacturing and agriculture, and integrating Supply and Use Tables (SUT) to reconcile production and expenditure estimates, aim to enhance the robustness and internal consistency of GDP estimates.

Importantly, the revised methodology seeks to better capture emerging and previously underrepresented areas of economic activity, including the digital economy. At a conceptual level, these changes bring India’s national accounts closer to international best practices. However, these improvements also introduce new challenges when GDP is used as a basis for fiscal transfers.

The increased reliance on administrative and formal-sector data, particularly GST and corporate filings, means that states with higher levels of formalisation and stronger compliance systems are likely to see a greater increase in measured GSDP. Conversely, states with significant informal economies, where economic activity is less fully captured in such datasets, may not experience comparable gains in measured output, even with similar underlying economic conditions.

This creates a structural asymmetry in the measurement of economic activity across states. While the revised methodology improves overall accuracy, it may also re-rank states in terms of measured economic size and growth, not solely due to real economic changes but due to differences in data capture. In a system where GSDP carries explicit weight in tax devolution, such shifts can have direct fiscal consequences.

Even a modest change in relative GSDP shares can influence the allocation of thousands of crores of rupees in central tax revenues. For states with limited fiscal space, these changes can affect expenditure priorities, development programmes, and long-term planning. The issue is, therefore, not merely statistical but fundamentally linked to fiscal equity.

Complementary indicators

The interaction between GSDP contribution and the traditional income distance criterion further complicates the framework. Income distance, which carries substantial weight, is designed to favour poorer states by allocating higher transfers to those with lower per capita income. The introduction of GSDP as a performance-based parameter creates a counterbalancing force that rewards larger or more productive economies. This dual structure can generate tensions, particularly if methodological changes amplify measured performance without corresponding changes in real economic capacity.

From a policy perspective, this raises a critical question: can GDP, in its revised form, serve as a stable and equitable basis for fiscal transfers? The answer lies not in rejecting GDP, but in recognising its evolving nature and incorporating safeguards. The 16th Finance Commission has addressed short-term volatility by using multi-year averages of per capita GSDP in computing income distance. However, given recent methodological changes, greater transparency in state-level adjustments remains essential to distinguish real performance from statistical effects. There is also merit in complementing GSDP with additional indicators of fiscal capacity, such as own tax revenue effort, sectoral composition, and fiscal sustainability metrics.

The inclusion of GSDP reflects an important evolution in India’s fiscal federalism, recognising economic dynamism alongside redistribution. Its effectiveness, however, depends on the robustness and consistent application of the measurement framework. Ensuring that devolution reflects real economic differences rather than artefacts of measurement will be essential to maintaining fairness and credibility.

(The writer is an associate professor at the Department of Economics, Christ University)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.