Under the constitutional provisions, the Finance Commissions are required to determine the shares of divisible central taxes for each state in India.
However, in order to determine the grants under article 275, the Finance Commissions follow a methodology that requires forecasts of states’ non tax revenues as well as the shares of central taxes that will accrue to the states be forecasted.
This is because the revenue gap grants are determined as the difference between the assessed needs and assessed own tax and non-tax revenues as well as the respective shares in central taxes during the recommendation period.
The quality of the forecasts of central taxes is quite important for the determination of the amount of grants that are fixed in nominal terms. If the share of states in the central taxes is overestimated, grants would be less than what is actually required.
If, on the other hand, states’ shares in central taxes are underestimated, larger grants would be recommended as compared to what is actually required.
This study considers four states; Andhra Pradesh, Gujarat, Orissa, and Assam to examine the relationship between assessed own tax revenues and actual own tax revenues for these states.
The paper discusses the methodology of forecast evaluation and analyzes the forecast errors of cenral tax revenues by Finance Commissions. It makes a comparison of state’s own tax revenue assessment with actuals for four states.
Results of the study show the following;
most of the finance commission have underestimated the central revenues but some have overestimated these
for income tax, for the period 1989-90 to 2007-08, revenues were underestimated for 15 out of nineteen years
in the case of corporation tax, there was under-estimation except for 4 years under the Eleventh Finance Commission
in the case of customs duties, there was over estimation in 12 out of 19 years
for total central taxes revenues, for 10 years there is underestimation and for 9 years there is over-estimation