Fiscal Capacity

Reviewed by Anjaneyulu | Updated on Jul 26, 2021



Fiscal capacity means simply income-generating power. Since most government revenue worldwide is through taxation (other than different fees and dividends), the tax-to-GDP ratio is often taken as a metric for a government's fiscal efficiency.

Understanding Fiscal Capacity

Fiscal capacity is the ability of the country to collect income to provide public goods and perform certain functions of the country in the sense of an administrative, fiscal accounting structure.

In economics and political science, fiscal capacity can be referred to as tax capacity, extractive capacity or tax power since taxes are the main sources of public revenue. However, while tax revenues are important to fiscal flexibility, taxes may not be the only source of revenue for the government. The other sources of revenue include foreign aid and natural resources.

In addition to the amount of public revenue derived from state extracts, fiscal flexibility is the country's expenditure in the country structures, including supervision, administration, and enforcement through the training of tax inspectors and the efficient operation of the revenue service.

Finally, provided that tax-funded public goods include the construction of infrastructure, health, education, military and social insurance, a country's fiscal capacity is essential to its economic growth and development.

How to Improve?

We can have a look at the history of countries that have succeeded in building strong fiscal capacity by broadening their income tax base to draw lessons for India.

Between 1913 to 2017, the income tax collections were increased rapidly in the four nations of the UK, US, France, and Japan. Their governments were jumping on the need to raise fiscal efficiency by taxation due to the two World Wars.

Income tax is fundamental to the Citizen-State modern social contract. Widening the base of income tax does more than increasing fiscal efficiency. This improves democracy by making people accountable to the government. If citizens pay taxes, then what matters to them is tangible and precise effects, and the country stays responsible when it takes care of people.

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