Tax-to-GDP Ratio

Reviewed by Anjaneyulu | Updated on Aug 27, 2020

Introduction

Tax-to-GDP ratio represents the size of the tax revenue from the government, expressed as a percentage of GDP. The higher the tax ratio to GDP, the better the country's financial position will be. The figure illustrates the government's ability to finance its expenditures. A higher tax-to-GDP ratio means the government can spread its fiscal net across the board, and it reduces the reliance of a government on borrowing.

Importance

A higher tax-to-GDP ratio means that the tax buoyancy of an economy is solid, as the share of tax revenue increases in tandem with the rise in GDP of the country. Tax-to-GDP ratio shows the richness of the government's exchequer. The government's ability to spend on socio-economic development programs, military, salary, pension heads, etc., depends on the tax-to-GDP ratio.

India has failed to expand the tax base, despite seeing higher growth rates. The lower tax-to-GDP ratio restricts government spending on infrastructure and pressures the government to meet its fiscal deficit targets. Even though India has improved its tax-to-GDP ratio in the last six years, it is still far lower than the average OECD (Organisation for Economic Co-operation and Development) ratio of 34%. India's tax-to-GDP ratio is lower than some of the other developing countries. Usually, developed countries tend to have a higher tax-to-GDP ratio.

How to Improve

The gross tax-to-GDP ratio declined to 10.90% in 2018-19 fiscal year, whereas the expected ratio was 16%. The most important measure to increase the ratio is to ensure that the people pay their taxes. In this way, the implementation of the Direct Tax Code (DTC) will help to achieve greater compliance. Rationalisation of GST and switching to a two-rate system can also help to improve enforcement and end tax evasion. While the measures taken to widen the tax base and improve tax compliance will yield higher tax revenue, we can not ignore the importance of higher economic growth.