What is Tax to GDP Ratio?
Tax to GDP ratio refers to the ratio of the tax revenue of the country with respect to the country’s Gross domestic product (GDP) which is used as a measure to know the control of the government of a country on its economic resources and it is calculated by dividing the Tax revenue of a period by the gross domestic product.
Tax to GDP ratio uses two parameters i.e., Tax revenue and Gross domestic product (GDP) where the tax revenue refers to the total amount of the revenue collected by the government of a country from its people in form of the taxes like income tax, property tax, sales tax, estate tax, Social Security contribution, payroll tax, etc and Gross domestic product (GDP) refers to the value of total final goods and the services produced in the nation during the period of time. The Gross domestic product does not include the value of goods and services which are not purchased and sold by the persons in the market and value of goods and services which are in the process i.e., the value of Intermediary goods and the services.
Now using these parameters, this ratio will be calculated by dividing tax revenue by Gross domestic product. This ratio is used in a country as a measure for knowing the control of the country’s government on its economic resources. Typically the developing nations of the world have lower ratios when compared with the countries that are in their developed phase.
How to Calculate Tax to GDP Ratio?
It is calculated by dividing the Tax revenue of a period by the gross domestic product. The formula for the calculation is expressed mathematically as below:
- Tax Revenue = Total amount of revenue collected by the government of a country in the form of the taxes during the period of time.
Gross domestic product (GDP) = Value of total final goods and the services produced in the nation during the period of time. Any value of the Intermediary goods and the services and the value of those goods and the services that cannot be purchased and sold in the market are excluded while calculating Gross domestic product.
The mathematically Gross domestic Product formula is as below:
Tax to GDP Ratio Example
For a year, the comparison is to be made between the two countries A and B. The tax revenue of the country A for the period is $ 2.50 trillion and that of country B was $ 4 trillion. The gross domestic product (GDP) of the countries A and B for the same period was $ 15 trillion and $ 20 trillion respectively. Calculate the Tax to GDP ratio of the two countries.
- Tax revenue of the nation during the period of Country A = $ 2.50 trillion
- Tax revenue of the nation during the period of Country B = $ 4 trillion
- Gross domestic product of the nation of Country A = $ 15 trillion
- Gross domestic product of the nation of Country B = $ 20 trillion
For Country A
- = $ 2.50 trillion / $ 15 trillion
- = 16.67%
For Country B
- = $ 4 trillion / $ 20 trillion
- = 20%
In this case, the ratio of Country A is 16.67% and Country B is 20%. From the values calculated it can see that the Tax to GDP ratio of Country B is greater than that of Country A which shows Country B is more developed than country A.
Tax to GDP ratio reflects whether the government of any country has sufficient reserves in order to finance all its expenditures. If the ratio is less, then it shows that the government does not have the reserve to meet its expenditure. So, this ratio should be sufficient enough for meeting the expenditures of the government of the country. Also, it helps in knowing that the status of the country i.e., whether it is underdeveloped, developing or developed. Typically the lower ratio shows that the nation is the developing nation and the higher ratio shows that the nation is the developed nation.
The following are the uses:
- The ability of spending of the government of the country of any nation on different activities in the nation is dependent on the tax to GDP ratio of the country. These activities include spending on the social development programs, spending on the economic development programs, spending on the infrastructure of the country, paying the salary and pension of its employees, etc.
- It is used by different analysts in order to compare the tax received by the country from one period to another.
Thus this ratio along with the other metrics is used in order to measure the control of the government of the nation on its economic resources. Generally, with the increase in the Gross domestic product of the country, the tax revenue also increases. So, mostly the Tax to GDP ratio remains constant except in cases of unexceptional circumstances. Typically countries with lower are less developed when compared with higher countries.
This has been a guide to what is Tax to GDP Ratio and its meaning. Here we discuss how to calculate the tax to GDP ratio with an example and its uses. You may learn more about financing from the following articles –