Macroeconomic performance and tax revenue

Abstract

It is h1'pothesised that the ta-r revenues of a state economy would be sensitive to the nrucroeconomic performance of the state economy measured in terms of inflation and the growth of reaL income. The case of Gujarat state over the period 1980-81 to 1997-98 is consideredfor examining this hypothesis. The time trends of the state's tax revenue, GSDP and implicit deflator are esrimated and relatively high instabitiry of the growth of both nominal and real income in the state is brought out. The methodology used by the Tenth Finance Commission to estimate the buoyancy of the tax revenues of the states ignored the unit root problems in using the level variables with strong time trends. Since the Commission has also not testedfor cointegration of the regressions used, it has generated spurious correlations and meaningless estimates ofthe tax buoyancy for different states. In order to get a more realistic, acceptable and analytically usable estimate of the tax buoyancl in Gujarat, annual rates of growth in the variables are used in the regressions which amount to using the first dffirence in the double-log form. Moreover, the hypothesis of uniform marginal buoyancv of tax collection for inflation and real output growth is also tested for Guiarat. The argument about tax rebates and incentives contributing to the future growth of output and hence to the future tax collection is also examined. The data on Gujarat do not appear to support such causal links of the tux incentives and future growth of the economy. Very low tax buoyancy indicates serious problems with the tav administration and tax system in the state.