ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846
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Measurement of Taxable Capacities of States by Ninth Finance Commission

Measurement of Taxable Capacities of States by Ninth Finance Commission EFFORTS to measure relative efficiency of the lax performance of various units in a federal structure are always beset with a number of conceptual as well as estimation problems. However, as some indicator of tax performance is needed to decide the' procedure for federal transfers, such efforts are generally unavoidable. Against this background, the responsibilities of the Finance Commission in India are indeed difficult requiring it to balance a number of opposing economic criteria and the interests of the central and state governments. The reports of earlier Finance Commissions have thus attracted a number of comments, ranging from the gently suggestive to the highly critical. Bearing those past experiences in mind, none probably expects the present commission to submit a report which meets everyone's expectations. But it would probably not be unfair to expect'that with a longer professional and administrative experience to back it, the approach of this commission would be more reasoned than that of its predecessors. However, the exercise done by the commission towards measurement of taxable capacity and tax efforts of different states, as reported in its First Report (covering only the year 1989-90), belies this expectation. Since a fully satisfactory estimation process of taxable capacity is wellnigh impossible, the exercise would always imply certain risk in judging whether poor (commendable) tax performance of a particular state is due to its smaller (larger) taxable capacity or its inadequate (adequate) tax effort. One way of minimising that risk would be to look for more and more economic factors which would increasingly explain the varying tax performance of the states and then arrive at a judgment (by whatever method) about which part of the unexplained tax performance should be ascribed to the tax efforts of the states. But, unfortunately, the regression analysis done by the commission seems to be rather oblivious of this risk and it seems to be carried away with the (statistical) fact that the all-important regressions meant for measuring the taxable capacity and effort'of^the states have all R-bar square values excluding 0.99. In two separate articles [Prasad, 1989; Coondoo and Mukherjee, 1989] a number of relevant observations have already been made pointing to the limitations of the exercise. In the present note, we would like to mention two points, the first of which relating to a flaw in the statistical estimation procedure is the more serious one but has not been commented upon by any of the earlier critics. The second observation has been mentioned earlier (Prasad, 1989] but only briefly and it relates to the interpretation of the coefficients of state-dummies in the regression equations.

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