# What is Tax to GDP Ratio

12 June 2024

Taxes are a key revenue source for most countries, often contributing 50% or more of government funds worldwide.

Comparing the tax systems of different countries is not simple due to a host of factors. These include the different types of economies of the countries, the different make-up of the populations, industrial development, and the overall level of development, among others.

Instead of looking at the total tax revenue, using the tax-to-GDP ratio offers a better comparison of tax systems across nations.

In this blog, you will learn about the tax-to-GDP ratio, the method of calculation, and more.

## What is Tax to GDP Ratio in India

The tax to GDP ratio measures a nation's tax revenue compared to the size of its economy, as measured by the GDP. This ratio provides a detailed view of the nation's tax revenue and indicates taxation relative to its economy.

It is also an indicator of the country's tax policy and allows for comparisons of tax revenues between different countries.

The tax to GDP ratio indicates whether a country's government has enough funds to cover its expenses. A low ratio suggests the government lacks sufficient reserves to meet its expenditures. This ratio should be high enough to ensure the government can finance its spending.

Additionally, it helps in determining the economic status of a country – developed, developing, or underdeveloped. A higher ratio indicates the country is developed, while a lower ratio means the country is developing.

 Tax to GDP ratio = Tax Revenue of the country During the Period / Gross Domestic Product of the country

Here,

• Tax revenue of a country is the total amount of revenue collected by its government in the form of taxes during a specific time period.
• Gross domestic product (GDP) is the total value of final goods and services produced by a country during a specific time period.

## Example of Tax to GDP Ratio

Now that you have understood what the tax to GDP ratio is, let us look at the following example to understand how it’s calculated.

Consider the following data for countries X and Y:

 Particulars Country X Country Y Tax revenue of the country during the period ₹2.50 lakh crore ₹4 lakh crore GDP of the country ₹15 lakh crore ₹20 lakh crore

For Country X,

Tax to GDP ratio = ₹2.50 lakh crore/ ₹15 lakh crore = 16.67%

For Country Y,

Tax to GDP ratio = ₹4 lakh crore/₹20 lakh crore = 20%

These values of tax to GDP ratios of both countries X and Y depict that Country Y is more developed than Country X.

## Factors Affecting the Tax-to-GDP Ratio

Several factors influence the tax to GDP ratio in India. These are as follows:

• ### Economic Policies

Tax rates, exemptions, deductions, and incentives all affect the total tax collected.

• ### Economic Growth

When the economy grows, incomes and profits usually rise, leading to increased tax revenue.

Efficient tax collection and efforts to combat tax evasion directly impact the tax to GDP ratio.

• ### Sectoral Composition

Economies with high-tax sectors typically have higher tax to GDP ratios compared to those reliant on low-tax sectors.

• ### Informal Economy

A larger informal sector often results in lower tax collection, as many transactions are unrecorded and untaxed.

## How Does the Tax to GDP Ratio Affect the Economy?

The tax to GDP ratio impacts various aspects of the economy. These are as follows:

• ### Public Services

Higher ratios allow governments to invest more in public services and infrastructure.

• ### Fiscal Health

A healthy tax to GDP ratio means the government can fund its obligations without needing to borrow excessively.

• ### Income Distribution

Progressive tax systems leading to higher ratios can promote fairer income distribution if the revenue is used to support social welfare programs.

• ### Investment

High ratios with high tax rates might discourage investment, while moderate ratios with stable tax policies can attract investors.

## The Bottomline

Understanding what the tax to GDP ratio is and how it is measured is crucial to assessing the financial position of India.

The ratio also shows how much of the country's GDP is used to fund the government’s activities. A balanced tax-to-GDP ratio is vital for ensuring sustainable public finances and promoting fair economic growth.

 You may also be interested to know 1. What is Non Tax Revenue 2. Difference Between Tax Evasion and Tax Avoidance 3. How to Save Tax for Salary above 10 Lakhs 4. Benefits of ITR Filing 5. Top Reasons Why You Can Get An Income Tax Notice
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