Could India’s Next Big Economic Threat Come From Within? Unpacking the Emerging Inter-State Trade Wars
India's unified market model faces rising internal risk as states compete aggressively with tax incentives and policy tweaks, sparking trade tensions. Explore GST disparities and inter-state tax battles.
NewsSutra
India’s promise of a unified national market, underpinned by the Goods and Services Tax (GST), is facing an unforeseen internal disruption: rising inter-state trade tensions, driven by competitive tax incentives, preferential policies, and revenue-sharing disputes among states. These escalating conflicts—over investment subsidies, GST rebates, and input credit mechanisms—may not only destabilize federal fiscal harmony but also threaten India’s economic integration, undermining the very foundations of “One Nation, One Market.”
1. Punjab, UP, MP: State Incentive Wars on the Rise
Economic activists and industrialists have observed a notable trend: companies shifting bases from established states like Punjab to more attractive regimes in Madhya Pradesh and Uttar Pradesh, lured by better incentives and streamlined approvals. In Ludhiana, textile and manufacturing leaders cited Madhya Pradesh’s incentive packages—capital subsidies up to 40%, lower land costs, and power subsidies—as reasons for relocation (turn0news23).
Similarly, Uttar Pradesh has implemented sector-specific subsidies and investment comfort letters that make it a competitive rival to established hubs (turn0news13). These regional policy tactics, while welcome for investors, can be viewed as economic “beggar-thy-neighbor” games that distort an otherwise unified market.
2. GST & IGST: The Uneven Playing Field
GST was introduced to eliminate inter-state taxation disparities, supplanting older systems like octroi, VAT, and surplus entry taxes (turn0search6). Ideally, the Integrated GST (IGST) ensures tax-on-consumption benefits the importing state and enables input tax credits across states (turn0search3). Yet, divergent state-level enforcement often results in inconsistent credit practices and refund delays.
This system complexity disproportionately affects small traders and multi-state businesses, who report confusion and compliance burdens—especially after Karnataka’s controversial use of UPI data to issue GST notices to small enterprises without clarifying methodology (turn0news16).
Crucially, under GST, states lose entitlement to central sales tax earned on inter-state goods movement. This disrupts incentive schemes tied to older tax regimes: companies can earn substantial VAT-based incentives under intra-state arrangements, but gain little under GST due to consumption-based attribution. As a result, firms face significant variation depending on state policies—even for identical transaction volumes (turn0search5).
3. Divergence of Economic Opportunities Across States
Despite GST and unified trade mechanisms, economic disparities across states have persisted—and in some cases widened. Advanced states like Gujarat, Maharashtra, Karnataka, and Tamil Nadu continue to attract over 85% of industrial investment, per data published between 2018 and 2022 (turn0search2). Less-industrialised states remain excluded from economic convergence, even as poorer states benefit more from tax devolution formulas (turn0reddit31).
These disparities are fueled by tailored incentives like Andhra Pradesh’s new electronics manufacturing policy offering capital and interest subsidies (turn0search28). While effective at state level, such incentives create friction when they direct investment flows toward specific states, leaving others disadvantaged.
4. Fiscal Federalism and the GST Compensation Controversy
Under GST, states are protected for five years by a compensation mechanism overseen by the GST Council. Post-2022, the fund is no longer guaranteed, and the central government continues to collect cess until 2026 to service residual obligations (turn0search2). Meanwhile, unresolved IGST settlements and GST tribunal delays add complexity to revenue-sharing: states continue to demand greater adjudication powers over small taxpayer assessments, threatening unified compliance (turn0search8).
The 15th Finance Commission has also come under pressure from states like Bihar and West Bengal to revisit the fiscal deficit criteria and revise revenue sharing formulas to better reflect regional needs and fiscal imbalances (turn0search33).
5. What’s at Stake: Risks to the Unified Market Model
5.1 Fragmented Compliance
Businesses operating across states must follow different documentation practices and tax refund timelines, raising compliance costs and hampering scale.
5.2 Incentive Arbitrage
Companies can leverage state-specific deals, which creates uneven competition, distorts industrial location decisions, and encourages lobbying for tax breaks.
5.3 Runaway Fiscal Competition
States under pressure to attract jobs and capital may engage in subsidy races—sacrificing long-term fiscal discipline for short-term investor appeal.
5.4 Policy Uncertainty
Unilateral changes by states in industrial policy can discourage risk-averse investors, fearing sudden regime shifts or preferential deals that shift capital flows unexpectedly.
6. Voices from Experts and Sector Leaders
Economists have long warned that India’s state-level economic competition—though healthy in theory—often descends into wasteful rivalries, including skewed incentives that justify relocations but fracture federal intent (turn0search11). Trade chambers and industrial leaders echo concern that GST’s promise of a single market is being undermined from within by uneven policy landscapes.
Business associations in high-outflow states have lamented not just industrial migration, but policy unpredictability and the lack of coordination at insistence of clarifying IGST audits and appeal structures (turn0search9).
7. Policy Options to Prevent Trade Fragmentation
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Uniform, transparent incentive frameworks: Creating national standards for subsidy eligibility to reduce cross-state disparity.
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Strengthened GST tribunal architecture: Enables appeals and uniform interpretation of IGST-related disputes (turn0search8).
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Performance-based fiscal grants: Rewarding efficient states and encouraging convergence without undercutting federal stability (turn0reddit34).
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Labor mobility facilitation: Improved interstate labor portability in recognition, language training, and employment portability can smooth regional wage disparities.
Additionally, expanding federal investment in lagging states through dedicated SEZs or eco-tax zones can promote convergence while reducing incentive sprawl.
8. The Way Forward: Preserving Unity Across Diversity
India faces a delicate balancing act: preserve creative state-level economic experiments while maintaining a cohesive national market. Without greater coordination—via GST Council consensus, Finance Commission frameworks, and central mediation—the risk intensifies that states’ incentive wars turn into economic fragmentation.
For policymakers, sustaining tax uniformity, equitable devolution, and competitive neutrality across state boundaries is essential. A successful approach will build on state strengths without allowing shifting subsidy regimes to corrode market unity.
Final Takeaway
India’s next economic frontier may not lie in international trade wars, but in inter-state policy competition. As states pursue distinct incentive strategies to attract investment, the hard-won unity of the GST-enabled national economy is under threat. Without reforms to harmonize tax incentives, clarify GST dispute resolution, and foster equitable federal cooperation, the country risks sacrificing integration for inter-state advantage.
Addressing this challenge is more than economic housekeeping—it is pivotal to preserving India’s original vision of a unified, scalable, and equitable marketplace across 28 states and 8 Union Territories.
