Tax to GDP Ratio - Indian Economy Notes
The tax to GDP ratio is the ratio of tax collected compared to national gross domestic product (GDP). It gives policymakers and analysts a parameter that can be used to compare tax receipts from year to year. As of 2021 Gross tax to GDP in India is around 10.2% in 2021. A greater tax to GDP ratio indicates that the government can cast a wider fiscal net. It helps a government become less reliant on borrowing. In this article, we will discuss the tax to GDP ratio which is important for the UPSC examination.
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What is Tax to GDP ratio?
- It is used as a measure to determine how well the government controls a country's economic resources.
- The tax to GDP ratio measures the size of a country's tax revenue compared to its GDP.
- The higher the tax to GDP ratio, the better the country's financial position. The ratio denotes the government's ability to fund its expenditures.
- A greater tax to GDP ratio indicates that the government can cast a wider fiscal net. It helps a government become less reliant on borrowing.
| Other Relevant Links | |
|---|---|
| Tobin tax | Pigovian tax |
| Wealth tax | Tax Expenditure |
| Negative Income Tax | Laffer Curve |
Tax to GDP of India
- India consists of one direct taxpayer for every 16 voters present. Income tax is paid by only 1% of India’s population.
- India’s Gross tax to GDP which was 11% in FY19, fell to 9.9% in FY20 and marginally improved to 10.2% in FY21 (partly due to decline in GDP) and is envisaged to be 10.8% in FY22, this is much lower than the emerging market economy average of 21 percent and OECD average of 34 percent.
Reasons for Low Tax to GDP Ratio in India
- There is the presence of a large informal/unorganized sector in India which makes it vulnerable, causing greater tax evasion.
- There is greater dominance of the agriculture sector, for instance out of 25 crore households in India, 15 crores belong to the agricultural sector which is exempted from paying taxes.
- There is a high number of disputes between tax authorities and taxpayers, with one of the lowest proportions of recovery of tax arrears.
- The direct to indirect tax ratio in India is around 35:65, which is lower than most of the OECD economies where the ratio is 67:33 in favor of direct taxes.
- There has been a number of generous government policies which benefited the richer private sector by providing various tax exemptions.
- Another factor that contributes to the low tax to GDP ratio is low per capita income and high poverty.
Implications of low tax to GDP Ratio
- Due to a decrease in tax revenues, the Indian State becomes incapable of spending on national security, welfare system, public goods, etc.
- There is heavy borrowing due to the low tax revenue of the government, this causes a persistent deficit bias in fiscal policy.
- Such a system creates political incentives for the government to borrow money to buy votes rather than work on building an effective tax system that will lead to economic growth and development.
- Widespread tax evasion goes unchecked which hampers growth and most of the tax burden falls on the high-productivity sectors that need growth.
- Lower tax collections decrease the capacity of the government to incur expenditure for welfare schemes.
- There is increased dependence on indirect taxes which are regressive in nature.
- There is an increase in social inequality due to the asymmetric distribution of economic resources in society.
Various Measures To Increase The tax to GDP Ratio
- The individualtaxpayer base should be widened to increase revenue collection.
- Merging of CBDT and CBEC based on the recommendations of the Tax Administration Reform Commission (TARC).
- Exemptions provided under various provisions such as transfer pricing, base erosion and profit shifting (BEPS), etc should be re-assessed.
- Providing effective dispute settlement mechanisms.
- Citizens' attitudes must be changed by instilling a feeling of national responsibility.
Conclusion
It is essential that in order to increase the tax to GDP ratio there should be progressive income taxes, complemented by indirect taxation, property taxes, and capital taxes, etc. It is essential that India’s informal sector is brought into the formal fold. Therefore focus should be on widening the tax base rather than simply deepening it.
| Other Relevant Links | |
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| Indian Economy Notes | Tax Evasion |
| Taxation | Types of Taxes |
| Indirect Tax | Direct Tax |
FAQs
Question: What does the Tax-to-GDP ratio indicate?
Answer: The Tax-to-GDP ratio indicates the percentage of a country’s GDP that is collected through taxes. It reflects the government’s ability to generate revenue and the overall efficiency of the tax system.
Question: Why is the Tax-to-GDP ratio important for economic growth?
Answer: A higher Tax-to-GDP ratio enables the government to have more resources for public investments in infrastructure, education, healthcare, and social welfare, which contribute to long-term economic growth.
Question: What are the challenges in improving India’s Tax-to-GDP ratio?
Answer: Challenges include a large informal economy, tax evasion, inefficient tax collection, agricultural income exemptions, and limited tax compliance, which collectively hinder India’s ability to increase its Tax-to-GDP ratio.
Question: How does the Tax-to-GDP ratio compare between developed and developing countries?
Answer: Developed countries typically have a higher Tax-to-GDP ratio (above 30%) due to better compliance and efficient tax systems, while developing countries like India have lower ratios (around 17-18%), reflecting structural challenges in tax collection.
Question: How can India improve its Tax-to-GDP ratio?
Answer: India can improve its Tax-to-GDP ratio by broadening the tax base, reducing exemptions, improving tax administration, and promoting better compliance through measures like GST and digital tax initiatives.
MCQs
1. What does a high Tax-to-GDP ratio imply about a country’s economy?
A. Low government revenue
B. High efficiency in tax collection
C. Decline in GDP
D. High levels of tax evasion
Answer: (B) See the Explanation
A high Tax-to-GDP ratio implies that the government is collecting a significant portion of the economy’s output in taxes, reflecting high efficiency in tax collection.
2. Which of the following factors negatively affects India’s Tax-to-GDP ratio?
A. High economic growth
B. Large informal economy
C. Increasing foreign investment
D. Growth in the service sector
Answer: (B) See the Explanation
A large informal economy reduces the taxable base, thereby negatively affecting India’s Tax-to-GDP ratio as much of the income goes untaxed.
3. What was one of the major initiatives to improve tax compliance in India?
A. Direct Tax Code
B. Goods and Services Tax (GST)
C. Make in India
D. Digital India
Answer: (B) See the Explanation
The introduction of Goods and Services Tax (GST) was a major reform aimed at improving tax compliance by simplifying the indirect tax system and broadening the tax base.
4. How does the Tax-to-GDP ratio benefit a country’s fiscal policy?
A. It leads to increased debt levels
B. It reduces the need for external borrowing
C. It limits government spending
D. It decreases tax compliance
Answer: (B) See the Explanation
A higher Tax-to-GDP ratio allows the government to collect more revenue internally, reducing the need for external borrowing to finance public spending.
5. Which country is likely to have a higher Tax-to-GDP ratio?
A. France
B. India
C. Nigeria
D. Afghanistan
Answer: (A) See the Explanation
Developed countries like France typically have higher Tax-to-GDP ratios due to efficient tax systems and better compliance, compared to developing countries like India or Nigeria.
GS Mains Questions and Model Answers
1. Discuss the significance of the Tax-to-GDP ratio as an indicator of fiscal health. How does India’s Tax-to-GDP ratio compare with that of other emerging economies?
Answer: The Tax-to-GDP ratio is a key indicator of a country’s fiscal health, reflecting its ability to mobilize domestic resources for public spending and economic development. A higher ratio enables the government to fund essential services like education, healthcare, and infrastructure, reducing dependency on external borrowing. India’s Tax-to-GDP ratio, at around 17-18%, is lower than many other emerging economies such as Brazil and South Africa. This suggests inefficiencies in tax collection, a large informal economy, and the need for broader reforms to enhance tax compliance. Recent initiatives like the GST have aimed to improve tax collection, but structural issues like tax evasion and exemptions still pose challenges.
2. Analyze the impact of the Goods and Services Tax (GST) on India’s Tax-to-GDP ratio.
Answer: The introduction of the Goods and Services Tax (GST) in 2017 was a landmark reform aimed at streamlining India’s complex indirect tax system by integrating multiple state and central taxes into a single tax. GST has had a significant impact on India’s Tax-to-GDP ratio by broadening the tax base, reducing tax evasion, and simplifying tax compliance. However, the initial years saw challenges such as technical glitches, confusion over tax rates, and delayed refunds, which slowed revenue collection. As these issues are addressed, GST is expected to improve tax compliance further and positively impact India’s Tax-to-GDP ratio in the long run.
3. Examine the challenges faced by India in increasing its Tax-to-GDP ratio and suggest measures to address these challenges.
Answer: India faces several challenges in increasing its Tax-to-GDP ratio, including a large informal economy, tax evasion, limited compliance, and exemptions for certain sectors like agriculture. These factors reduce the government’s ability to mobilize sufficient revenue to meet its fiscal needs. To address these challenges, India needs to: Broaden the tax base by bringing more informal businesses under the tax net. Reduce tax exemptions, particularly for sectors like agriculture. Strengthen tax administration and use technology for better tracking of transactions. Encourage voluntary compliance through taxpayer-friendly measures and reduce the complexity of tax laws. Implementing these measures would help improve India’s Tax-to-GDP ratio and strengthen its fiscal capacity.
Previous Year Questions on Tax-to-GDP Ratio
1. UPSC CSE Prelims 2019
Question: Which of the following reforms was introduced to simplify India’s indirect tax structure and improve the Tax-to-GDP ratio?
A. Income Tax Act
B. Goods and Services Tax (GST)
C. Fiscal Responsibility and Budget Management Act
D. Minimum Alternate Tax
Answer: B
Explanation: The Goods and Services Tax (GST) was introduced to simplify India’s indirect tax structure by integrating multiple taxes into one, thereby improving compliance and broadening the tax base.
2. UPSC CSE Mains 2017 (GS Paper 3)
Question: Discuss the challenges in improving India’s Tax-to-GDP ratio and evaluate the role of recent tax reforms such as GST in addressing these challenges.
Answer: Improving India’s Tax-to-GDP ratio is challenging due to factors like a large informal economy, tax evasion, and numerous exemptions. Tax reforms such as GST have aimed to simplify tax structures, broaden the tax base, and improve compliance. While GST has streamlined the indirect tax system and reduced cascading taxes, issues like compliance difficulties and technical challenges need to be resolved for its full potential to be realized. Going forward, reforms in direct taxation, improved tax administration, and measures to integrate the informal economy into the tax system are crucial for boosting India’s Tax-to-GDP ratio.
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