Understanding India's Tax to GDP Ratio: A Look at Revenue Collection

The tax-to-GDP ratio is an essential measure of a country's capacity to generate tax revenues in relation to the size of its economy. In this article, we will explore the tax-to-GDP ratio, examine how to calculate it and provide insights into its implications. It is interesting to note that Budget 2026-27 figures show gross tax-to-GDP falling to 11.2% (from 11.4% FY26). It is due to factors like direct tax collection at ~7.1% and GST resilience.

Key takeaways

• The tax-to-GDP ratio measures the extent of a country's tax revenue against its GDP.
• Tax to GDP Ratio = Tax revenue of  the nation during the period/Gross domestic product of the nation.
• The tax to GDP ratio improves when the government of the country ensures people pay taxes properly and on time.
•  A balanced ratio supports sustainable government spending, stability, and equitable income distribution. 

What is the tax-to-GDP ratio?

The tax-to-GDP ratio measures the extent of a country's tax revenue against its gross domestic product (GDP). It gives a more detailed picture of the country's tax revenue and taxation as a share of its output. The ratio also indicates the approach to taxation a nation uses, making it helpful in comparing its tax revenues with those of other countries.

Direct tax to GDP ratio of India in 2024-25

Official information on India's direct tax-to-GDP ratio for 2024-25 shows that it increased to 6.8%-7.1%, up from 6.6% in 2023-24. This can be attributed to upward trend from compliance and formalisation.

Indirect tax to GDP ratio of India in 2024-25

For 2024-25, India's indirect tax-to-GDP ratio stood at 4.9% down from 6.86% in 2023-24. Based on the latest GST collections data, this figure ties to base effects, rate rationalisations, and focus on direct tax collection.

How to calculate the tax to GDP ratio

The formula for calculating the tax-to-GDP ratio is given below: 

Tax to GDP Ratio = Tax revenue of  the nation during the period/Gross domestic product of the nation

Where,

• Tax Revenue = Total revenue collected by a country's government in taxes over a period.
• Gross domestic product (GDP) = Value of all finished products and services produced in the country throughout the given period. When computing the gross domestic product, any value associated with intermediary products and services and the value of commodities and services that cannot be bought or sold on the open market is subtracted.

How to improve tax to GDP ratio

The most significant thing is to ensure people pay their taxes. Implementing the Direct Tax Code (DTC) would help improve compliance. Rationalising GST and moving towards a two-rate system can also help improve enforcement and curb tax evasion. However, higher economic growth can not be underestimated even with all these efforts to expand the tax base and enhance compliance.

Decrease in tax to GDP ratio of a country indicates

A decrease in the tax-to-GDP ratio of a country can signify two possible economic situations. It indicates a fall in government revenues from taxes, driven by changes in policy that have reduced the number of tax payments, fewer people qualified to pay taxes and a slowdown in business that affects taxable income. On the other hand, it could also signal an impressive turnaround in its economy, where GDP grows by leaps and bounds. Yet, there has been no corresponding increase in taxes collected, even though they remain optimistic. This latter scenario challenges governments as they rely on tax revenue to fund essential public services and infrastructure.

Implications of tax to GDP ratio

The tax-to-GDP ratio has several implications for the economy of a country:

• A high level of taxation enables more significant investment in public utilities like infrastructures, institutions and health facilities, which foster long-term economic development and citizenry welfare.
• A sound ratio points to the ability of the government to sustain its obligations without much borrowing, thereby boosting economic stability and investor trust.
• More progressive tax systems with higher ratios are likely to result in fairer income disbursement since they impose heavier taxes on high-income earners and use such funds to finance social programs for low-income individuals.
• High rates of taxation that accompany high ratios may lead to reduced levels of post-tax earnings; this could also serve as a deterrent for investments, inhibiting possible economic growth.
• Developed nations tend to have larger tax bases; hence, their ratios are usually higher due to more efficient collection systems.
• It should be noted that different countries have different ideal ratios depending on their specific circumstances, and these should be considered alongside other economic indicators when making comprehensive economic assessments.

In conclusion, the tax-to-GDP ratio is critical to understanding a country's fiscal health and economic strategies. A balanced ratio supports sustainable government spending, stability, and equitable income distribution. Improving this ratio through compliance and economic growth is vital for India's development.

Read more - GST and Its Impact on GDP