Tax Efforts of Major North Indian States

Tax effort is a criterion used by the finance commissions for deciding the resource transfer from the union government to the states. However, there are many aspects of measuring tax efforts, which are useful for the planning of state finances, assessing their potential revenues and boosting overall economic growth (Garg et al 2017; Lotz and Mors 1967; Pessino and Finochietto 2010). Higher tax efforts help mobilise more resources for increasing public investments to add to the production capacity of states and improve delivery of public services, which are important functions of governments in modern welfare states (Boadway et al 1999; Boadway 1997). A few years back, a number of union and state taxes have been subsumed in the goods and services tax (GST). As a result, the legislative authority of states over revenues have been considerably diminished. Some studies show that the reduction of state autonomy in the sphere of taxation would reduce states’ own tax revenue (OTR) by around 17% (Suhag and Tiwari 2018).

Despite this limitation, the state governments have no choice but to increase tax collections on the one hand while also rationalising spending on the other in order to ensure ­better fiscal consolidation. This is because of the large debt burden accrued by the states due to the limited devolution of union government taxes and the inadequacy of the states’ OTR. To mobilise the full tax potential, the states must assess their tax potential (capacity) and tax effort. This is particularly true in the case of states like Uttar Pradesh (UP), Madhya Pradesh (mp), Bihar and Rajasthan, as these states are supposed to get benefited from the implementation of GST as well as from the Fifteenth Finance Commission recommendations. The finance commissions have ­always stressed the need to study the tax efforts of individual states under a federal form of government. Thus, tax efforts were ­always taken into consideration while devolving the fin­ances to the states. The first two
finance commissions recognised the need of “self-help.” The Gadgil Committee’s recommendations about the inclusion of the states’ tax efforts for the devolution of the financial resources of the union government were a ­major step in this direction. However, later, the Seventh Finance Commission recommended the linking of the tax efforts to the distribution of grants-in-aid to the states as they were generally provided without any fixed criterion. The Tenth Fin­ance Commission in its report suggested that the weightage given to tax efforts in the formula for distribution of transfers to states should be raised to 10%. However, the Fifteenth Finance Commission has again reduced the weightage to 2.5%.