Tax structure and economic growth in India: insights from ARDL model

Abstract

PurposeIn the academic debate, the tax–growth relationship is always a controversial one. This paper aims to investigate the relationship between tax structure and economic growth in India for the period 1980-2016. After controlling for total tax revenue share to GDP in the estimation model, the authors examine the long-run and short-run relationship between tax structure and growth in India.Design/methodology/approachAuto-regressive distributed lag (ARDL) model has been used in this study. This bound cointegration model has certain advantages to the traditional cointegration model. This study also applies the threshold cointegration test of Hansen and Seo (2002) for examining non-linearity in tax–growth nexus.FindingsThe analysis shows that income tax share, corporation tax share and excise tax share are harmful to growth in the long-run. While the custom share is enlarging the growth performance. Corporation tax share is also reducing growth in the short-run. Following the Pesaranet al.(2001) approach of ARDL bound testing, the authors find the existence of a long-run relationship between studied variables. However, this study does not find any existence of threshold effect in the tax–growth relationship for India.Practical implicationsBased on the empirical findings, the author suggests that the prime tax change, which has the potential to impact both long-run growth and short-run economic recovery is the reduction of corporate tax rate with sustainable revenue generation. It will definitely enlarge the foreign direct investment, saving and investment in India.Originality/valueThis study will be a contribution to the empirical literature by investigating “tax–growth” relationship in the Indian case. To the knowledge, this will be the first study to examine this relationship for India with a recent data set.