Taxable Capacity, Tax Efforts and Structural Break: Do the Child States Follow Their Respective Parents?

Abstract

The present article makes an attempt to test the hypothesis whether smaller states have better fiscal efficiency in terms of own tax revenue collections or not. This has been tested by taking the case of three states Uttar Pradesh, Madhya Pradesh and Bihar with their child states Uttarakhand, Chhattisgarh and Jharkhand, respectively. For this purpose tax buoyancy, tax capacity and efforts, and structural break models—Chow test (with known break points) and Quandt likelihood ratio (QLR) test (with unknown break points), to see the impact of value added tax (VAT) on own tax revenue (OTR)—have been estimated. Log-log regression model was adopted for both calculating tax buoyancies and taxable capacity of each parent and child state. However, we did not find any conclusive evidence that child states have better tax buoyancy or tax efforts. On the basis of our observations, we concluded that the size of the state is not a major determinant affecting revenue efficiency of the state. Other supplementary policies like efficient tax administration, developed industrial sector, reduced exemptions and concessions, broad-based and effective tax rates are equally important. JEL Classification: H11, H21, H71, R50