Inter-State Tax Effort-A Comment

A Comment G Thimmaiah IN a recent article1 K N Reddy has used some indices of tax efforts to highlight the relative tax efforts of the different states. The purpose of this note is to point out certain methodological mis-interpretations and to indicate an alternative approach which is better suited for the purpose. This note will also attempt to show the reasons for the failure of the Finance Commissions to take into account the relative tax efforts of the stares while determining the grants-in-aid to the states, Reddy has used 'Frank-Bird' indices and multivariate regression analysis to estimate the relative tax efforts of the states. Besides, he has also compared he elasticity of the states' tax revenue and marginal tax ratios. He has rightly concluded that "Frank-Bird' indices are very crude indicators of relative tax efforts of the states as they ultimately boil down to the ratio of states' tax revenue to states' income. For the same reason he has maintained that income-elasticity of tax revenue is an inadequate index of relative tax efforts of the states. Therefore, he has used the methodology adopted by Charles Montrie Kenneth J Fedor and Harlan Davis.2 These three authors have used what is now known as the 'Aggregate Regression Approach' to measure the relative tax performance of the Latin American countries which are members of the Alliance for Progress, They have used both univariate and bivariate regression analysis and the elasticity of tax revenue and marginal tax ratios to find out the relative self-reliance of these countries. They have regressed the ratio of total taxation of the Central government to the GNP on per capita income and also on the ratio of foreign trade to GNP, the ratio of total revenue of the Central government on per capita income and on the ratio of foreign trade to GNP, and the total revenue of all levels of government on per capita income. They have compared these results with the ex post elasticity (buoyancy) of the tax revenue and the marginal tax ratios.