Economy Vol. 4 No. 1, 1-6, 2017 ISSN(E) 2313-8181/ISSN(P) 2518-0118 DOI: 10.20448/journal.502.2017.41.1.6 1 Responsiveness of the Indian Tax System: A Time Series Analysis from 1990 to 2010 Debasis Patnaik1  Annie Pillai2 ( Corresponding Author) 1Asst Prof, Department of Economics, BITS Pilani K K Birla Goa Campus, India 2MSc Economics, Department of Economics. BITS Pilani K K Birla Goa Campus, India Abstract The post reform period in Indian fiscal system needed to assess the impact of reforms as regards tax buoyancy and elasticity of Indian tax system in pre GST exercise. This paper studies the variation in buoyancy of the following taxes: Corporation Tax, Income Tax, Customs tax, Union Excise Duty. It also attempts to study the elasticities of the above mentioned taxes by eliminating the impact of discretionary changes. Keywords: Tax elasticity, Indian tax system, Time series, GDP, Tax revenue, Tax buoyancy. Citation | Debasis Patnaik; Ms Annie Pillai (2017). Responsiveness of the Indian Tax System: A Time Series Analysis from 1990 to 2010. Economy, 4(1): 1-6. History: Received: 13 July 2016 Revised: 8 May 2017 Accepted: 24 May 2017 Published: 22 June 2017 Licensed: This work is licensed under a Creative Commons Attribution 3.0 License Publisher: Asian Online Journal Publishing Group Contribution/Acknowledgement: Both authors contributed to the conception and design of the study. Funding: This study received no specific financial support. Competing Interests: The authors declare that they have no conflict of interests. Transparency: The authors confirm that the manuscript is an honest, accurate, and transparent account of the study was reported; that no vital features of the study have been omitted; and that any discrepancies from the study as planned have been explained. Ethical: This study follows all ethical practices during writing. Contents 1. Introduction ......................................................................................................................................................................................... 2 2. Literature Reviews .............................................................................................................................................................................. 2 2.6. Objective............................................................................................................................................................................................ 2 3. Methodology ........................................................................................................................................................................................ 3 4. Data and Results ................................................................................................................................................................................. 3 5. Conclusion ............................................................................................................................................................................................ 4 Appendix ................................................................................................................................................................................................... 4 References ................................................................................................................................................................................................. 6 Bibliography ............................................................................................................................................................................................. 6 http://creativecommons.org/licenses/by/3.0/ http://creativecommons.org/licenses/by/3.0/ https://orcid.org/orcid-search/quick-search?searchQuery=Debasis Patnaik https://orcid.org/orcid-search/quick-search?searchQuery=Annie Pillai https://orcid.org/orcid-search/quick-search?searchQuery=Debasis Patnaik https://orcid.org/orcid-search/quick-search?searchQuery=Annie Pillai https://orcid.org/orcid-search/quick-search?searchQuery=Debasis Patnaik https://orcid.org/orcid-search/quick-search?searchQuery=Annie Pillai Economy, 2017, 4(1): 1-6 2 1. Introduction India has a well-developed tax structure with clearly demarcated authority between Central and State Governments and local bodies. Central Government levies taxes on income (except tax on agricultural income, which the State Governments can levy), customs duties, central excise and service tax. Indian taxation system has undergone tremendous reforms during the last 2 decades. The Tax Reform Committee was set up in 1990 to rationalize the tax system in India. Various reforms were brought into the system from the recommendations of this committee. Thus it is important to study how effective these reforms have been and hence the period of study chosen is from 1991 to 2010. The tax rates have been rationalized and tax laws have been simplified resulting in better compliance, ease of tax payment and better enforcement. The process of rationalization of tax administration is ongoing in India. It is important to analyze the responsiveness of tax revenue to aid the policy makers in this process. To measure the tax sensitivity, tax elasticity and tax buoyancy are used widely. Tax elasticity is change in the tax revenue due to a change in GDP (or relevant GDP component). Tax buoyancy is change in tax revenue due to a change in tax rates, bases, rules, administrative efficiency, etc. (discretionary changes). Thus, we see that tax buoyancy measures total change in tax revenues i.e. including effect of discretionary measures and GDP changes. It is vital to study both effects as each of these corresponds to increase in the tax revenue due to different factors. Tax buoyancy is effect of increase in the tax base along with the impact of tax reforms whereas tax elasticity excludes the effect of discretionary tax measures focusing only on the impact of increase in the national income. 2. Literature Reviews 2.1. Elasticity and Buoyancy of Major Taxes in Pakistan Fauzia (2001) estimates the elasticity and buoyancy for four major tax revenue sources of Pakistan – direct tax, sales tax, customs duties and excise duties – for the period 1981-2001 using the Chain Indexing Technique. Elasticity is calculated by first removing the effects of discretionary changes on the tax revenues and then a two- step regression analysis which gives the responsiveness of the tax base to the GDP and tax revenue to tax base. The paper finds that the elasticity of direct and sales taxes have a relatively higher elasticity as compared to customs and excise duties, which appear to be very rigid. Also, it was found that the discretionary measures were found to have a positive effect on the tax structure, improving the elasticities of all the taxes. 2.2. The Trends and Responsiveness of Personal Income Tax in India Ankita (2009) presented in the Fourth Annual International Conference on Public Policy and Management, analyses the responsiveness of personal income tax revenue to changes in income and tax reforms . Tax elasticity and buoyancy have been used to measure this response. To study the data the hypothesis used: H0: Buoyancy of Personal income tax in pre and post liberalization period has remained same. The hypothesis is tested using time series data and OLS method. The paper concludes by rejecting the null hypothesis and implying that there has been a significant change in the buoyancy between the pre and post liberalization period which can be attributed to the tax reforms in the later period. 2.3. The Effect of Tax Elasticity on Government Spending Eleanor and James (1980) explore the effects of tax elasticity structures on the amount of spending by state governments. The authors define tax elasticity as tax revenue generating capability of a tax structure in response to increases in tax payer’s income without a change in statutory tax rates. The authors measure this for the case of US during the years 1970-1975. The authors used OLS estimation to test the hypothesis and conclude that there is significant relation between tax elasticity and government spending levels i.e, states with significantly higher tax elasticities tend to spend more than the states with correspondingly lower tax elasticities. 2.4. Tax Elasticity in Sierra Leone: A Time Series Approach The authors (Brima and Festus, 2012)study the impact of the tax reforms on the tax revenues. The impact is studied by calculating the tax buoyancy and the tax elasticity for different types of taxes. To adjust the tax data for discretionary changes, Singer’s dummy variable method was used. This analysis was empirically applied to data for Sierra Leone for the period from 1977 to 2009. The paper concludes by accepting the importance of discretionary measures of the government in maintaining the tax revenues during the period. 2.5. Short- and Long-Run Tax Elasticities: The Case of the Netherlands ‘Short- and long-run tax elasticities: The case of the Netherlands’. This paper provides estimates for the base elasticities of Dutch taxes, paying particular attention to differences between short-and long-term elasticities, and allowing for asymmetric adjustment. Estimates are presented for five tax categories for the period 1970-2005, after making appropriate corrections for effects of discretionary tax measures. The empirical results indicate that short- term elasticities often are lower than long-term ones, notably when taxes are subdued. Consequently, shocks to tax revenues tend to be aggravated by the dynamics of short-term elasticities. Ignoring differences between short- and long-term elasticities contributes to revenue ‘surprises’ and an incorrect assessment of the fiscal stance. 2.6. Objective To find out the relationship between the tax schedule and the tax revenue for the period 1990 to 2010, the following objectives have been formulated 1.To study the variation in buoyancy of the following taxes  Corporation Tax Economy, 2017, 4(1): 1-6 3  Income Tax  Customs tax  Union Excise Duty 2. To study the elasticities of the above mentioned taxes by eliminating the impact of discretionary changes. 3. To analyze the effect of tax reforms in India on the tax revenue. 3. Methodology The responsiveness of tax revenue for each type is measured by its buoyancy with respect to changes in GDP. For time series analysis, tax buoyancy is estimated by using Ordinary Least Square method. The functional form measuring the tax buoyancy is T=a Y b We perform a logarithmic transformation to get the equation Log T= log a+ b log Y + e T = tax revenue Y = national income a = constant b = buoyancy coefficient When this equation is fitted into the data, the regression coefficient b gives the percentage change in tax revenue (T) corresponding with a percent change in income. If the coefficient b turns out to be more than one, the responsiveness of tax system will be considered relatively high and if it is less than one, the same will be considered as relatively low. The above mentioned method assumes the existence of significant correlation between T (tax revenue) and Y (national income). An indication of this is provided by the statistic R2 that measures the goodness of fit of the functional relationship being measured. In order to obtain the buoyancy coefficient the series of gross tax receipts is regressed (inclusive of revenue yield from discretionary measures) on the income series. Conceptually, the most appropriate measure of the responsiveness of tax revenues to changes in the base for most analytical applications is the ‘elasticity’, which seeks to relate the percentage change in tax revenue to a percentage change in the tax base with a given tax structure. However, since legislative changes in the tax structure alter this relationship from time to time, direct measurement of the tax elasticity from a historical revenue series often becomes problematic. In estimating the elasticity of a tax, therefore, either the time series data on tax revenues need to be adjusted to eliminate the effects of discretionary tax measures[1], or a suitable estimation methodology has to be adopted, or a combination of the two. The most appropriate method would clearly depend upon the availability, nature and reliability of information on tax revenues, discretionary changes in the tax structure and tax bases. Over the years, at least four approaches have been used : (1) proportional adjustment (2) constant rate structure (3) Divisia index (4) econometric methods (use of dummy variables) [1]A discretionary tax measure is a change in the tax rate or base coverage with the aim of increasing the tax revenue The proportional adjustment method [2] has been used here to eliminate effects of discretionary tax measures. In the Indian case, estimates of tax yields arising out of discretionary changes in tax rates and coverages are routinely available in the budget documents. Therefore, the application of the proportional adjustment method is perfectly feasible for estimating tax elasticities in India. The method for calculating the adjusted tax revenue has been outlined in the Appendix I. The adjusted tax revenue thus found was then regressed with its respective proxy base and the proxy base subsequently with GDP. The coefficients were multiplied to get the elasticity. [2] Pronab (2009) A Note on Estimating tax Elasticities, Planning Commission Report 4. Data and Results Tax revenues and their budgeted estimates were taken from the receipts budget section in the Union Budget Report of each of the years from 19990 to 2010. The proxy bases used for corporate and income tax is non agricultural GDP which was taken from the DCH databook of Centre for Statistical Organisation. The proxy tax base used for union excise duty is private consumption (also known as household consumption). Data for this has been used from the World Bank database. The customs tax is regressed with trade volume as the base and the data for this has been used from the annual reports of the Directorate General of Foreign trade. All sources of data were secondary. The regression results were as follows: All taxes showed high R2 value when regressed with GDP implying the significance of GDP on tax revenue. Table-5.1. Influence of Individual Taxes on GDP Tax R- square Corporate Tax 88.84% Taxes on Income 99.12% Union Excise Tax 92.7% Customs Tax 95.4% Source: Based on World Bank Data The elasticity and buoyancy coefficients along with percentage change in tax revenues due to tax reform Economy, 2017, 4(1): 1-6 4 Table-5.2. Buoyancy, Elasticity and Changes in Tax Revenues due to tax Reforms Tax Buoyancy Elasticity % attributed to tax reforms Corporate tax 2.18 3.24 -48.43 Taxes on Income 1.40 0.65 53.22 Customs tax 0.753 0.30 60.00 Union Excise tax 0.75 0.24 68.29 Source: Based on World Bank Data Thus the results imply that the indirect taxes customs and union excise duties are better affected due to the tax reforms. The tax reforms have positively affected the revenues. Moreover the taxes on income attribute most of their growth in tax revenue to the growth in the tax base and hence are more elastic than the indirect taxes. The tax reforms in the corporate sector seem to have negatively affected the tax revenues and the buoyancy coefficient shows that its automatic growth is really high as compared to the others. This can be due to the instability in the tax reforms in the corporate sector. In 1997-98 company tax rate was brought down to 35 % and the 10% dividend tax rate was shifted from the individual to the company. In 2001 dividend tax rate was increased to 20% and in the subsequent year it was again reduced to 10% and the individuals were taxable for the dividends instead of the company. In 2003-04 there was a reversal of policy again. Due to these continuous fluctuations and instability the reforms have adversely affected the tax revenues. 5. Conclusion The tax buoyancy and elasticity were calculated and analyzed for four main types of taxes namely the corporation tax, income tax, union excise duties and custom duties for the time period 1990 to 2010. Out of the four, the two direct taxes namely the corporation and the income tax were observed to be highly elastic. This is supposed to work in the favor of a growing economy like India as the revenue from these taxes will rapidly increase along with the increase in the respective tax bases resulting from changes in the GDP without changing the tax rates by much. The difference between the tax buoyancy and elasticity for the two direct taxes and for customs duties were found to be marginal indicating that the increase in tax revenue has been mainly due to increase in GDP. For the remaining two indirect taxes, the elasticity was observed to be lower than the direct taxes. Moreover the tax reforms seem to have had a positive effect on the tax revenues and have affected indirect tax revenue more than the direct tax revenue. Appendix Appendix-1. The data cleaning process may be described in the following manner: Let : ATi = the adjusted or cleaned tax yield in year i Ti = the actual tax yield in year i Di = budget estimate of the yield arising out of discretionary tax changes in year i In the reference year ‘0’, i.e. the year whose tax structure is to be used as the basis for building up the adjusted series, the adjusted tax yield is set at the actual: AT0 = T0 (1) For the following year : AT1 = T1 – D1 Since AT0 is equal to T0 by equation (1), no further adjustment is needed. In every subsequent year, however, the non-discretionary component of tax receipts have to be adjusted in the following manner: 1j 1j jjj T AT )DT(AT     j = 2, ......., n (3) Through sequential substitution it can be shown that equation (3) can be rewritten as :      j 2i 1i ii 1j T )DT( .ATAT  j = 2, ......., n (4) which is in essence the Mansfield equation for proportional adjustment data cleaning. Appendix 2 Data tables used for regression analysis Economy, 2017, 4(1): 1-6 5 Table-6.1. Union Excise Taxes Year GDP Pvt consumption union excise duty Adjusted tax (AT) 1990-91 515,032 339226.4362 23588.4656 23588 1991-92 594,168 386335.6105 27094.0608 21081 1992-93 681,517 457530.9015 29782.2929 18288.25273 1993-94 792,150 523893.4333 30973.065 15009.04756 1994-95 925,239 592420.8519 35899.2732 14061.91939 1995-96 1,083,289 739072.9268 38890.0751 12102.17185 1996-97 1,260,710 820886.8664 44376.992 11375.2055 1997-98 1,401,934 919719.1474 47245.1758 9433.076532 1998-99 1,616,082 1015310.643 53200 8492.632391 1999-00 1,786,526 1156852.866 68526.13 11023.22293 2000-01 1,925,016 1220725.272 91433 16270.50742 2001-02 2,097,726 1354622.042 82309.52 13023.45988 2002-03 2,261,415 1445846.659 90774.31 13410.81157 2003-04 2,538,170 1481432.788 99125.43 13156.34032 2004-05 2,971,464 1711301.961 111225.56 13394.27361 2005-06 3,390,276 1931135.79 117612.76 13996.39089 2006-07 3,953,276 2201706.966 123611.03 13923.71514 2007-08 4,582,086 2685660.144 108612.78 8938.268029 2008-09 5,303,567 3036922.621 103621 8292.436469 2009-10 6,091,485 3439185.361 138299 11571.68652 Source: Union Budget Reports and World Bank Database Table-6.2.Taxes on Income year base- non agriculturalgdp taxes on income AT (adjusted tax) 1990-91 364232 5150.32 5150.32 1991-92 418002 6476.431 4197.86 1992-93 483948 7632.99 2997.798 1993-94 562978 8951.295 2233.757 1994-95 661344 11102.87 2172.479 1995-96 796343 15057.72 2401.326 1996-97 915690 18028.15 2289.469 1997-98 1035809 28459.26 4570.329 1998-99 1195596 29367.35 5110.79 1999-00 1340011 31764 5746.105 2000-01 1475451 34438 5115.129 2001-02 1611109 36866 4635.361 2002-03 1789355 41387 4866.344 2003-04 2005828 49268 5597.795 2004-05 2406038 60757 6280.269 2005-06 2752504 80409 8621.746 2006-07 3230292 111821 13388.73 2007-08 3745568 106075 8840.653 2008-09 4360363 132314 12649.71 2009-10 5012120 146586 15784.75 Source: Union Budget Reports of each year and Economic Surveys Table-6.3. Customs Tax revenue year Trade Volume (Tax Base) customs tax revenue AT(adjusted tax) 1990-91 77,751 19828.732 19828.73 1991-92 91,893 21449.4648 19309.93 1992-93 117,063 22967.1229 18019.67093 1993-94 142,852 21704.91 14559.41135 1994-95 172,645 25721.6442 14719.31292 1995-96 229,031 34665.248 14246.54634 1996-97 257,737 42359.856 13220.94371 1997-98 284,277 40656.086 10350.87681 1998-99 318,085 44342.78 9755.242856 1999-00 374,797 47542.2 8818.415461 2000-01 434,444 45193 6596.626312 2001-02 454,218 44851.62 6496.966795 2002-03 552,343 48629.22 6939.761459 2003-04 652,475 57610.9 8701.141983 2004-05 852,411 65067.14 11622.32692 2005-06 1,116,827 86327.24 17074.0648 2006-07 1,412,285 104118.94 21650.89115 2007-08 1,668,176 99878.86 16807.62566 2008-09 2,215,191 83323 11551.75651 2009-10 2,209,270 135812 21714.08028 Source: Union Budget Reports and Annual Report of Directorate General Of Foreign Trade Economy, 2017, 4(1): 1-6 6 Table-6.4. Corporate Tax Revenue year corporate tax revenue AT (Adjusted tax) 1990-91 5150.32 5150.32 1991-92 7545.934 8070.8672 1992-93 1771.944 1798.889129 1993-94 1901.16 1733.282226 1994-95 3978.528 -6876.881382 1995-96 5091.458 16277.41979 1996-97 5673.195 -33612.06817 1997-98 7149.863 72579.38743 1998-99 29915 294180.5361 1999-00 35696 357486.5353 2000-01 39059 339677.7396 2001-02 46172 380287.9227 2002-03 63562 622868.3827 2003-04 82680 753799.1511 2004-05 101277 838603.9922 2005-06 144318 1288632.937 2006-07 192911 1941371.559 2007-08 213395 2017040.042 2008-09 244725 2199745.43 2009-10 298687 2661024.563 Source: Union Budget Reports (Receipt Budgets) References Ankita, G., 2009. The trends and responsiveness of personal income tax in India. Fourth Annual International Conference on Public Policy and Management, IGIDR Proceedings-Project Reports Series. pp: 062-29. Brima, I.B.K. and E.O. Festus, 2012. Tax elasticity in sierra leone: A time series approach. 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