Tax to GDP Ratio

Tax to GDP ratio or tax revenue as a percentage of GDP is an indicator about ‘tax money’ which individuals & companies pays and government receives in particular year, compared to other years. This provides an idea, like, what was the tax revenue years back when GDP was half of what is present. The proportion or ratio can be same as of present or it can be higher as well as lower.

Tax revenue when compared to GDP numbers of a country provides answers to questions like:

  • Whether govt follows strict or relaxed tax regime ?
  • Is tax revenue main reason for fiscal deficit (if govt is spending more and receiving less) ?
  • In developed economies, tax revenue increase significantly during economy boom, & sink during recession, hence a clear perception/relation available in these economies.
  • Any structural defect like majority production activities by units those granted tax benefits by government, Less per capita income which remain main reason for less tax revenue (Do not mix this with concept of unequal distribution of income), Fiscal policies keeping many sectors out of tax ambit.

Mathematically it is expressed as: Tax-to-GDP ratio =  Tax revenue / GDP of a country.

From above formula, it is clear that when tax revenue increase and GDP do not,  Tax-to-GDP ratio will increase, and When Tax revenue decrease and GDP increase, Tax-to-GDP ratio also decrease. You can visualize this as two cars, going at same speed, if one car changes it speed, the ratio changes.

It is noteworthy that different taxes like customs duty, service tax, income tax have different contribution in total tax revenue. Government continue to change the % of each tax in every budget (Fiscal policy) but try to increase overall percentage of total tax revenue to total GDP.

State whether True or False:
A) Tax revenue increase with increase in GDP of a nation.
B) Tax-to-GDP ratio increase with increase in GDP of a nation.
C) Tax revenue decrease with less per capita income in economy.
D) Tax revenue decrease with less equitable distribution of National income.
E) Tax to GDP ratio decrease with less equitable distribution of National income.

Answers: A) T B) F  C) T D) F E) F

  1. D) Tax revenue decrease with less equitable distribution of National income.
    E) Tax to GDP ratio decrease with less equitable distribution of National income.
    D) F E) F

    Can you please explain, Sir, as i have not understood the follow.

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