Volatility in Tax Revenue and Economic Growth A Case Study of Indian States

Abstract

In India, tax revenue refers to the compulsory transfers to the government for public purposes. The government collects tax revenue by imposing both direct and indirect taxes. A tax system with relatively higher rates of taxes would deter savings and development, while relatively lower tax rates would lead to less revenue to the state. Taxation is the major tool of fiscal policy and a source of revenue collection for government in India. The effective tax system is crucial and indispensable for economic growth in developing countries. newlineThere are a lot of studies done by researchers on tax revenue, volatility and GDP relations in the world, and in India as well. Two of the early studies by Hinrisch (1966) and Musgrave (1969) examined the relationship between the ratios of tax revenue to GDP (TAX/GDP) and found it was relatively low in the developing countries. The results from the empirical analyses of Kneller et al. (1999), Gemell et al. (2006), Widmalm (2001), Schwellnus and Arnold (2008), Vartia (2008), Lee and Gordon (2005) are considered as sufficiently reliable evidence for the nature of the studied relationship. There is also some evidence that shows a positive impact of taxes on economic growth which conclude that taxes can lead to economic growth. Insufficient tax revenue can distort resource allocation and reduce the economic welfare and growth. Hence, an ideal buoyant tax system is essential to achieve a balance between resource allocation and economic growth with stability newline