What is tax-to-GDP ratio & where does India fare on this indicator?
Reasons for the low tax to GDP
- India’s gross tax-to-GDP ratio fell to 10.9 per cent in 2018-19 on account of lower than estimated GST collection.
- For years, India has struggled to increase its tax-to-GDP ratio, a marker of how well the government controls a country’s economic resources.
- A low tax-to-GDP ratio poses significant challenges for the government to spend money on creating necessary infrastructure in the economy and raise investment.
- Slowing economic growth in the current fiscal has raised questions on meeting the tax collection target. This could further hurt India’s tax-to-GDP ratio.
- “Generous” government policy
- Tax exemption raj that benefited the richer private sector.
- India has a relatively large informal/unorganised sector, and tax evasion is more rampant in the informal sector compared to the organised sector.
- Low per capita income, high poverty, keeps tax collections low.
- Out of 25 crore households in India, 15 crores belong to the agricultural sector which is exempted from taxes.
- A parallel economy of unaccounted incomes and expenditures exists which goes untaxed.
- India has one of the highest numbers of disputes between tax administration and taxpayers, with the lowest proportion of recovery of tax arrears.
- India’s direct to indirect tax ratio is roughly 35:65. This is in contrast to most OECD economies where the ratio is the exact opposite, 67:33 in favour of direct taxes.
What is the tax-to-GDP ratio?
- Tax-to-GDP ratio represents the size of a country’s tax kitty relative to its GDP. It is a representation of the size of the government’s tax revenue expressed as a percentage of the GDP.Higher the tax to GDP ratio the better financial position the country will be in.
- The ratio represents that the government can finance its expenditure. A higher tax to GDP ratio means that the government can cast its fiscal net wide.
- It reduces a government’s dependence on borrowings.
- The tax-to-GDP ratio is the ratio of tax collected compared to national gross domestic product (GDP).
- The tax-to-GDP ratio gives policymakers and analysts a metric that they can use to compare tax receipts from year to year.
- The number of taxpayers is a key indicator of fiscal capacity.
Why is it important?
A higher tax to GDP ratio means that an economy’s tax buoyancy is strong as the share of tax revenue rises in sync with the rise in the country’s GDP. India, despite seeing higher growth rates, has struggled to widen the tax base. Lower tax-to-GDP ratio constrains the government to spend on infrastructure and puts pressure on the government to meet its fiscal deficit targets.
Where does India stand among global peers?
Although India has improved its tax-to-GDP ratio in the last six years, it is still far lower than the average OECD ratio which is 34 per cent. India’s tax-to-GDP ratio is lower than some of its peers in the developing world. Developed countries tend to have a higher tax-to-GDP ratio.
How can it be improved?
- The most important measure for improving tax to GDP ratio is ensuring the citizens pay their taxes. The introduction of the Direct Tax Code can help in greater compliance in this regard. Rationalisation of GST and moving towards a two-rate structure can also help in increasing compliance and putting an end to tax evasion. While measures to improve tax compliance and widen the tax base will yield higher tax revenue, the importance of higher economic growth cannot be ignored. The onus to bring back the Indian economy on a higher-growth trajectory will be on the upcoming Budget.
- The imbalance between the number of people who pay income tax on the one hand and the number of people who can vote on the other hand has profound implications for the Indian social contract.
- It creates political incentives for successive governments to borrow money to buy votes rather than build an effective tax system that will spur economic growth.
- Citizens are also less likely to put pressure on governments to spend wisely on public goods.
- The Indian State is incapable of spending for national security, a modern welfare system or public goods from its tax revenue.
- Because of low tax revenue government has to borrow heavily. The result is a persistent deficit bias in Indian fiscal policy.
- Successful nation states cannot be built on widespread tax evasion.
- Most of the tax burden falls on the precisely the high-productivity sectors that need to grow.
- Lack of adequate tax base create avenues for creation of black money and It hampers governance due to generation of black money and parallel economy
- Lower revenue collection reduces the Government capacity to incur expenditure for welfare schemes. For ex. Recent cut in the budget of ICDS, shutting down of Nutrition Bureau etc.
- It will increase government’s dependence on Indirect tax which is regressive.
- Widen social inequality due to ineffective distribution of economic resources