Tax to GDP Ratio India UPSC CSE

Summary of Tax to GDP Ratio

Tax-to-GDP ratio is the comparison of tax collection with a country's GDP. It is a measure to compare a country’s tax collection year-to-year. It is also a measure of a country's strength in redistributing income through taxation and budget. The Central Board of Direct Taxes, under the Ministry of Finance, released the latest data for Direct Taxes for the financial year 2023-24. According to this data, India’s Direct Tax-to-GDP rose to 6.6%, which is the highest in the last 15 years. This data is a clear indicator that the series of reform measures undertaken by the government have started showing results. The rise in direct tax collection is even more significant, as unlike indirect tax, it is a progressive tax and does not hurt the poor. The combined (direct and indirect tax) Tax-to-GDP ratio for FY 2024-25 is expected to reach 11.7%. Although this is a historic milestone for India, this ratio is still lower than the developed countries. For example, the Tax-to-GDP ratio for the OECD is 34.1% (2021) and for the European Union, it is 25.9% (2021).

Background of Tax to GDP Ratio

Taxes are classified into Direct and Indirect Taxes.

Direct Tax are those in which the incidence and impact of a tax fall on the same person. For example: income tax, corporation tax etc. It is a progressive tax. Net direct collection for FY 2022-23 is INR 16.63 lakh crore. It accounts for 54.62% of the total tax collected in that FY.
- Progressive tax: Rate of tax increases when the value on which tax is imposed increases. In other words, there is a higher tax rate for people who earn more and a lower tax rate for people who earn less.
Indirect Tax are those taxes in which incidence and impact fall on different persons. For example: Goods & Service Tax. It is regressive in nature. Because the rate of tax, irrespective of whether one is rich or poor, remains the same. So the poor, who earn less, pay the same rate of tax as the rich.
Tax-to-GDP: It is defined as the measure of tax collected relative to its Gross Domestic Product (GDP). For FY 2023-24, it is 6.6%.
Tax buoyancy: A tax is said to be buoyant when it increases with the increase in GDP (tax rate being unchanged). It describes the responsiveness of tax collected to changes in GDP. Tax buoyancy greater than 1 indicates that there is faster growth in taxes as compared to GDP. For example, tax buoyancy for FY 2022-23 was 1.18.
Tax elasticity: It refers to the change in tax collection in response to change in tax rate.

Reasons for India’s low Tax-to-GDP ratio

Developing Country: Typically, Tax-to-GDP ratio is low in developing countries as compared to developed countries because people in developed countries are capable of paying higher taxes. India has low per capita income.
Untaxed: Agricultural income in India is not taxed. Thus, a large part of the population (15 crore households out of total 25 crore households) is not taxed.
Informal Economy: Despite government efforts to formalise the economy, it is largely informal. This makes it easier for people to evade tax and stay undetected by tax authorities.
Exemptions: To promote savings in the economy, the government gives several tax exemptions, which leads to lower tax collection.
- Due to the generous tax policy of the government, some sectors avoid taxes. For example, corporate tax cuts.
Lower tax compliance.

Importance of high Tax-to-GDP ratio

Growth Leads to Improved Tax Collection: When there is growth in the economy, the level of personal income rises in the economy. So the standard of living also increases, which drives the consumption of goods and services in the economy. This leads to an increase in the profits of corporations. All of these increase the tax collected by the government and a higher Tax-to-GDP ratio.
High Tax Collection Means Sustained Growth: A higher Tax-to-GDP ratio means that the government is able to perform its function of redistribution of income via taxation and budgeting. It can spend more on important sectors such as health, education, and other key infrastructure. Ultimately, it increases the likelihood of a country to sustain growth in the long term.
Consequences Low Tax Collection: On the other hand, low Tax-to-GDP ratio pushes the government to borrow more and increases public debt. Government’s capacity to spend on welfare schemes also decreases which increases inequality in the society. Also there is less capital expenditure that is essential for growth. It also exposes the economy to external shocks.

According to the World Bank, a Tax-to-GDP ratio of 15% is the key to economic growth and reducing poverty.

Reasons for recent surge in Tax-to-GDP ratio

Simplified Direct Tax: It is much easier to file direct tax now. Also, in the new tax regime, there are no exemptions, and a more simplified tax structure is in place. Faceless assessment has also increased compliance.
Record GST collection: Since its introduction in 2017, the GST regime has stabilised and the process has been streamlined. This resulted in record GST collections. For the 9-month period of April-December 2023, GST collection was INR 14.97 lakh crore, a 12% growth year-on-year as against INR 13.40 lakh crore in April-December 2022.
Measures taken to increase the tax base and curb tax evasion, such as taxation on virtual digital assets (VDA), introduced through the Finance Act 2022, PAN-Aadhaar linkage, etc
Amnesty schemes for tax disputes, such as Vivad se Vishawas, have also contributed to increased tax collection.

Measure to increase Tax-to-GDP ratio

MNC Taxation:International cooperation to tax multinational companies that resort to base erosion and profit shifting (BEPS).
Undertake direct and indirect tax reforms.
Speedy resolution of tax disputes and provide an effective dispute resolution mechanism.
Take steps to widen the tax base, such as simplifying tax filings.
Promote digitalisation and formalisation of the economy to expand the tax net.
Optimising the tax structure in GST to increase compliance
Curb tax money laundering and tax evasion through effective implementation of tax evasion laws.
Bring about an attitudinal and behavioural change among the citizens so that they contribute to the nation building through tax payments.

Conclusion for Tax To GDP Ratio

Government efforts to increase tax collection in the last decade are now bearing fruit. An increase in tax collection year after year is a sign of good things to come. But to achieve the World Bank’s recommended target of 15% Tax-to-GDP ratio, a comprehensive approach is required. The focus should be on widening the tax base and formalising and digitising the economy. An increase in Tax-to-GDP is crucial for India to sustain long-term growth and achieve sustainable development.

Prelims PYQS of Tax To GDP Ratio India

Consider the following statements: (2017)
1. Tax revenue as a per cent of GDP of India has steadily increased in the last decade.
2. The fiscal deficit as a per cent of GDP of India has steadily increased in the last decade.
Which of the statements given above is/are correct?

(A) 1 only
(B) 2 only
(C) Both 1 and 2
(D) Neither 1 nor 2

Show Answer

Correct Answer :(D) Neither 1 nor 2

A decrease in the tax to GDP ratio of a country indicates which of the following? (2015)
1. Slowing economic growth rates
2. Less equitable distribution of national income
Select the correct answer using the code given below.

(A) 1 only
(B) 2 only
(C) Both 1 and 2
(D) Neither 1 nor 2

Show Answer

Correct Answer :(A) 1 only

Tax to GDP Ratio