Taxes and Efficiency

in a manner that allows this efficiency to vary both across time as well as across the country.
It is discovered that there is a moral hazard problem in the design of central grants in that higher grants by the central government to the state governments reduce efficiency of tax collection by these states.
The less poor states are more efficient in tax collection. The rankings of states by tax efficiency for the various years do not converge. An index of aggregate tax efficiency is calculated and it appears that this index has been stagnating.
It is argued that the weight placed on tax effort in the formula determining central grants to state governments should be increased to improve tax efficiency of state governments.
lt follows that state governments can easily con-ceal their tax efficiency and make claims on the federal government.
Tax efficiency is more appropriately measured once we haveĀ®ltered out the elects of the activity variables. Moreover, the tax efficiency analysis carried out using the extant approach does not allow for a comparison of tax efficiency across states and across time.
We, therefore, move to a completely novel approach, which considerably generalizes and improves upon the extant approach to tax efficiency and, at the same time, points to the shortcomings of the extant approach.
We discover, for instance, that the higher the proportion of central grants in the total expenditure of states, the lower is their efficiency in tax collection.
Also it appears that, ceteris paribus, the less poor states are less in efficient in tax collection.
To be clear from the outset, this is a straightforward concept. You don’t need a master’s degree in finance or years of investing or banking experience to fully grasp what it is and why it matters.
It’s nothing more than a bank’s operating costs, referred to on a bank’s income statement as “non interest expenses,” divided by its net revenue (a bank’s total revenue less interest expense). To calculate its efficiency ratio, we need to do two things.
First, add Lichfield Trust Bank’s net interest income for the three months ended June 30, 2015 to its non interest income. This gives us $4.99 billion in net revenue ($2.72 billion in net interest income plus $2.27 billion in noninterest income).
Then, divide Lichfield Trust Bank’s noninterest expense of $2.68 billion by its net revenue of $4.99 billion. This gives us an efficiency ratio of 53.7% — which is really good, as the objective is to get as close to 50% as possible.
This number is important for two reasons. First, it tells us roughly how much of a bank’s net revenue will be available to (1) set aside for future loan losses (these are known as “loan loss provisions”), (2) pay taxes, (3) distribute to shareholders via dividends or stock buybacks, and (4) fall to the bottom line of a bank’s balance sheet and thereby fuel its book value.
The fourth point is particularly important because a bank’s book value per share weighs heavily on the price of its stock. All else equal, a bank with a high book value per share will have a correspondingly high share price. And vice versa.
The second reason the efficiency ratio matters — and, to be clear, a lower ratio is better than a higher ratio — is because there seems to be a correlation between a bank’s efficiency and its tendency to underwrite good loans. That is, efficient banks generally have to charge off fewer loans than inefficient banks.
Thus, the efficiency ratio packs a double punch. Not only does it correspond to lower operating expenses, it also corresponds to lower loan losses. And it’s for these reasons that I believe the efficiency ratio is the single most important metric when it comes to investing in bank stocks.