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This paper examines the impact of restricted and unrestricted fiscal grants on tax effort of Panchayats (Elected Village Councils) using nationally-representative panel data on finances. The authors propose three pathways through which these impacts accrue: wages, profits, and incentives.
In order to deal with the simultaneities of grants received and taxation, a system of equations is estimated simultaneously, where the first stage equations predict the grants. The results show that a wage impact on taxation exists, but is very small and the productivity impact of grants on taxes is negligible. This means that incentives effects associated with the specifics of the intergovernmental fiscal system in the states are the main determinant of village taxation. Several policy conclusions are advanced.
Raghbendra Jha is Professor of Economics and Executive Director of Australia South Asia Research Centre, Arndt-Corden Department of Economics, The ANU Crawford School of Public Policy.