Direct tax collection in India is heavily concentrated: a small number of states account for a large share of receipts, while many others contribute far less than their population or economic size would suggest. This concentration is often read along regional lines. That reading is incomplete. The underlying driver is not geography but the degree to which a state's economy is formalized and digitized - how much of its economic activity runs through salaried employment, registered enterprises, and traceable digital transactions rather than cash and informal arrangements. This piece sets out that pattern using data for FY 2024-25 and the preceding years, and considers what it implies for the 16th Finance Commission as it designs devolution and equalisation mechanisms.
The fiscal anomaly
The data
show that five states - Maharashtra, Karnataka, Delhi, Tamil Nadu, and Gujarat -
together contributed 76% of total direct tax collections in FY 2024-25, while
accounting for only around 27% of the country's population.
In other words, roughly
one-fourth of the population contributes three-fourths of direct tax revenue.
Figure 1 & 2: "27%
of people, 76% of tax"
(Click on the image to zoom)
A
services-digitalisation corridor
India's
direct tax map is best read not as a map of population, but as a map of
formalisation and digitalisation. The same five states that generate over
three-quarters of corporate and personal income tax collections house little
more than a quarter of the population.
What these
states share is not size but infrastructure for the formal economy: a
concentration of salaried employment in organised sectors, large corporate head
offices, filings related to ESOP income and capital gains on listed securities,
a deep gig and platform economy, and high levels of digital adoption.
This can be
described as a "services-digitalisation corridor" - a set of
economic geographies, running broadly from Ahmedabad through Mumbai to Delhi
and Bengaluru and on to Chennai, where the formal wage economy is densest,
digital payment penetration is highest, and the gap between GDP and taxable
economic activity is smallest.
Figure 3: Tax collection
intensity (Tax collected, FY 2024-25 / total population, 2011 Census)
(Click on the image to zoom)
States such as Uttar Pradesh
and Bihar together hold a little over a quarter of India's population but
contribute less than 3% to the direct tax corpus. This is not primarily a
function of lower income levels; it reflects the structure of the economy - a
larger share of income arising from agriculture, trading, and small-scale
business that sits outside self-assessment regimes by design, not by choice.
The policy message that follows
is straightforward: expanding the direct tax base is less a question of rates
or enforcement and more a question of formalisation.
Figure 4: Ratio of tax
collection to GSDP
(Click on the image to zoom)
Each
additional job created in the organised sector, each small trading firm that
adopts GST-compliant invoicing, each contractor who moves onto the books, is a
taxpayer at the edge of formalisation. The base widens as formalisation
spreads.
Direct tax collection tracks
formalisation and digital visibility rather than population or GDP alone. The
tax map is, in effect, a map of where the formal services economy is
concentrated.
Formalisation
trajectories: fast movers and slower starters
Looking at
the compound annual growth rate (CAGR) of direct tax collections for FY19–FY25
shows that formalisation is not fixed to any one place - it can spread over
time.
Telangana
recorded a 44% CAGR in direct tax collections over this period -
evidence of its emergence as a technology and pharmaceutical hub, marked by
large campuses, salaried workforces, and listed companies.
Haryana's 18%
CAGR reflects a related pattern: Gurugram's concentration of corporate
registered offices and high-salary employment is now visible in the tax data.
Together, these two states illustrate that formalisation can extend beyond its
original centres, and that direct tax growth tends to follow closely behind.
By contrast,
Bihar, Assam, Madhya Pradesh, Uttarakhand, and Andhra Pradesh recorded CAGRs at
or below zero over the same period - meaning their direct tax base is not just
small in absolute terms but static or shrinking.
Figure 5: CAGR of direct
taxes, FY 2019–25
(Click on the image to zoom)
This pattern
is not simply a proxy for state income levels - some of these states have
recorded reasonable GSDP growth over the same period. The more fundamental
issue is that growth in these states is often concentrated in agriculture,
informal construction activity, small-scale retail, and subsistence services - sectors
that sit largely outside the reach of income tax administration as currently
structured.
The distinction that matters
for tax policy is not which state is growing, but whether that growth is
occurring within organised, documented economic activity or within a large
informal sector that remains outside the income tax net.
Concentration over
time: the Lorenz curve
A single
summary statistic captures a broader shift: the Gini index for direct tax
concentration across states rose from 0.6342 in FY19 to 0.6506 in FY25.
Direct tax
collection has become more concentrated over the past six years. The FY25 curve
sits further from the line of equality than the FY19 curve, meaning that the
lower 60–70% of states (by tax contribution) now account for a smaller share of
the total than they did six years earlier, while the highest-contributing
cluster has pulled further ahead.
It is worth
being precise about what this concentration represents: it is not primarily
a story of already-wealthy states becoming wealthier in income terms. It is
better understood as growing divergence between formal and informal
segments of state economies.
The practical implication for
policy: the current trajectory does not, by itself, widen the geographic
base of direct taxation.
Compliance
mechanisms operating within the corridor - an expanded TDS regime, capital-gains
reporting, the Annual Information Statement, and related measures - are working
efficiently wherever formal incomes already exist. None of these instruments,
by design, reach into informal economic activity in places such as Bihar,
eastern Uttar Pradesh, or rural Madhya Pradesh, where the underlying gap widens
each year that growth occurs without accompanying formalisation.
Figure 6: Lorenz curve of
direct tax distribution, FY19 vs FY25
(Click on the image to zoom)
Four fiscal
archetypes
A
fiscal-digital alignment chart - plotting a digitalisation index against the
tax-to-GSDP ratio - is arguably the most policy-actionable view in this
analysis, because it moves past "why is there a gap" to "what
can be done about it." The answer differs across four broad clusters.
States in
the high-digitalisation, high-tax-yield quadrant have already become mature
fiscal hubs. For these, the priority is not to push further but to
institutionalise: build compliance infrastructure and reduce leakage in treaty
benefits and capital gains reporting. One large state sits just below this
group - highly digitised, but with some
extraction headroom still available.
A second,
emerging-formalisation cluster - including Telangana, Haryana, and Kerala - has reached meaningful levels of
digitalisation but has not yet converted this fully into tax yield, suggesting
the gains are still working their way through the system.
A third
cluster - an "industrial middle" that includes Gujarat, Tamil Nadu,
and Andhra Pradesh - shows moderate-to-high digitalisation alongside
comparatively low tax-to-GSDP ratios, consistent with a large presence of
proprietorship firms and trading enterprises where digital payments are common
but account-level transparency is limited.
A fourth,
catch-up cluster - including Uttar Pradesh, Bihar, Rajasthan, Madhya Pradesh,
Odisha, and the north-eastern states - shows low levels on both dimensions. For
this group, incremental compliance measures or nudges are unlikely to move the
needle, because the underlying preconditions for direct taxation - organised
employment and registered enterprise - are not yet present at scale.
Figure 7: Digitalisation
index vs tax-to-GSDP ratio
(Source: Digitalisation Index data from the State of India's
Digital Economy Report 2024)
(Click on the image to zoom)
The chart's
implicit message for the Finance Commission is that equalisation and devolution
design should account for tax administration capacity, not effort alone.
Expecting any state to match the tax-to-GSDP ratio of a mature fiscal hub
without first closing the formalisation gap sets an unrealistic benchmark.
India's direct tax geography
remains in motion, and decisions made over the next five years will shape
whether that motion moves toward convergence or further concentration.
The devolution
paradox
The Finance
Commission's horizontal devolution formula is designed specifically to offset
this kind of imbalance: states that collect more, and are more fiscally
efficient, receive proportionally less in devolved funds, while less prosperous
states receive more. There is nothing wrong with this design in principle. The
difficulty is that the gap it is meant to bridge is widening faster than
transfers alone can close it - because transfers address fiscal need, not
fiscal capacity. Additional allocations do not, by themselves, make an economy
more taxable.
The missing
instrument
The gap is
not primarily a case for more redistribution. It calls for investment -
distinct from redistribution - in the preconditions without which direct taxes
cannot be levied in the first place.
This
includes expanding digital payments infrastructure in tier-3 cities, supporting
GST compliance for micro-enterprises, and helping proprietorships and MSMEs
formalise.
These are
not welfare measures; they are supply-side fiscal investments that expand the
tax base over a ten-year horizon and, over time, ease the burden currently
concentrated on a small number of states. Every small enterprise that moves
from a cash-based to a formal footing - wherever it is located - is a taxpayer
in the making.
The Commission could
usefully frame formalisation not as a development outlay, but as fiscal
infrastructure.
An equation for where
India is heading
The 16th
Finance Commission inherits a direct tax geography that is more concentrated,
and more unevenly digitised, than that faced by any of its predecessors. It
also has access to a richer body of state-level data than before - on
formalisation, UPI transaction volumes, GST compliance rates, and AIS-based
income information - that can inform a devolution design aimed at expanding the
future tax base, not only redistributing the present one. States on the cusp of
formalisation do not need special dispensation; they need the enabling
conditions to complete that transition.
A
formula for the decade ahead
India's
direct tax landscape in 2035 will be shaped by decisions taken now. A
commission that looks only at the past can build a formula based on the past; a
commission that looks ahead can build a formula for the decade to come. The
16th Finance Commission has the opportunity to do both.
Disclaimer: The views expressed herein are solely those of the
author in a personal capacity and do not represent the official views or
position of the author's organisation.
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