Tax-GDP ratio

What is tax-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.

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 are 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 have 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

• 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.

Measures to be taken

• The individual taxpayer base should be widened to increase revenue collection.
• 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.

It is essential that in order to increase the tax to GDP ratio India’s informal sector is brought into the formal fold and there should be progressive income taxes, complemented by indirect taxation, property taxes, and capital taxes, etc. Thus focus should be on widening the tax base rather than simply deepening it.

Source: Indian Express