(Photo: iStockphoto )
(Photo: iStockphoto )

How tax efficiency varies across states

Study shows that some states are more efficient in generating tax revenues than others

In 2018-19, 52% of the revenue receipts of Indian states is estimated to have come from their own revenue, and the remaining 48% from transfers from the centre. State governments clearly rely heavily on their own revenue raising capabilities. However, a state’s ability to raise revenue varies sharply across India, shows a new study, authored by Sacchidananda Mukherjee, associate professor at the National Institute of Public Finance and Policy (NIPFP).

Mukherjee shows that, in addition to the size of the economy, a state’s tax base— the amount a government can raise through taxes—depends heavily on the structural composition of the economy.

For instance, the tax base is lower in states that have a larger share of manufacturing and mining or industrial firms, vis-à-vis states where agriculture is more important. And, in states where services are more important than agriculture, the tax base is higher. To show this, Mukherjee analyzes value-added tax (VAT) data for states between 2001 and 2016, when VAT was the most important source of revenue for states. Mukherjee also reveals that tax efficiency—that is, how effectively a state can tax its tax base—has a dynamic relationship with income levels. Tax efficiency initially increases with per-capita income of states, before reaching a plateau, following which any further rise in per capita income is associated with a fall in tax efficiency.

An analysis of states ranked on VAT efficiency shows that efficiency in relatively high-income states, such as Goa and Haryana, has been falling over the years and improving in low-income states such as Chhattisgarh and Odisha. Broadly, there was no sign of convergence in VAT efficiency across states. The authors argue that these findings are relevant for states even with the introduction of the goods and services tax (GST). To address these variations in tax efficiency, the authors suggest that states conduct in-depth assessments of their existing tax administration.

Also Read: Value Added Tax Efficiency across Indian States

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