Using the fixed and random effect panel regression models the paper tries to empirically examine the incentive effects of federal transfers on states’ own-revenue. Per capita resource transfers from the centre are found to be significant and negatively associated with states’ own-revenue, own-tax revenue and own-non-tax revenue in per capita terms, irrespective of choices of models or specification. This possibly indicates that central transfers have a dampening effect on states’ revenue efforts. Further, the incentive criterion for tax effort as used in the Finance Commission devolutions and in the Gadgil formula used by the Planning Commission is not reflected in the system, and it has failed to induce the desired, positive revenue pattern in states. The paper calls for assigning a higher weight to tax effort in the devolution formula and for more effective co-ordination among different channels in designing criteria and incentives.
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