State Fiscal Capacity and Tax Effort: Evidence for Indian States

Abstract

This study analyzes the tax effort of 17 Indian states as a means of creating fiscal space. Four individual state-level taxes—stamp duty and registration fees, state sales tax, state excise duty and motor vehicles tax—are studied as well as the total own-tax revenue of states. Stochastic frontier analysis (SFA) models have been estimated for each of the taxes and for own-tax revenue in order to obtain a measure of inefficiency in tax collection. The data used for the SFA models span the time period 2000–2001 to 2010–2011. The results of the estimation exercises point to technical inefficiency as being the primary reason for states being unable to achieve their potential for revenue collection. Possible reasons for this inefficiency are examined. The estimated tax effort points to large budgetary room that states potentially enjoy for the purpose of raising revenues from existing taxes. Rather disconcertingly, the article notes that the average tax effort seems to be declining over time. JEL Classification: H21, H71