This paper models the perverse impact of increased devolution of funds from higher to lower level governments on tax revenues collected by the latter, an issue largely ignored by the extant literature. We theoretically model the cost of taxation and use this and the ratio of transfers that augment the local wage rate to those that do not to explain tax collected at the village level using a unique data set for India and permit mutual endogeneity of tax collected and transfers. The cost of tax collection and the ratio of transfers that augment the local wage rate (to those that do not) have significant negative effects on tax collection, thus validating the conclusions of the theoretical model. These results are particularly relevant to India where it has been presumed that fiscal devolution would lead to increased public expenditure and that such expenditures would be consistent with the preferences of the local population.