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How tax efficiency varies across states
June, 10th 2019

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 center. State governments clearly rely heavily on their own revenue raising capabilities. However, a state’s ability to raise revenues varies sharply across India, shows a new study, authored by Sacchidananda Mukherjee of 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. While in states where services are more important than agriculture, the tax base is higher. To show all this, Mukherjee analyzes value-add 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, how effectively state can tax their 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 reveals 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. And to address these variations in tax efficiency, the authors argue that states need to conduct in-depth assessments of their existing tax administration.

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