Tax to GDP Ratio

Updated on February 1, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is Tax to GDP Ratio?

Tax to GDP ratio refers to the ratio of the country’s tax revenue concerning 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. It is calculated by dividing the period’s tax revenue by the gross domestic product.

Tax-to-GDP-Ratio

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This ratio, along with the other metrics, is used to measure the control of the government of the nation on its economic resources. Generally, with the increase in the country’s Gross domestic product, the tax revenue also increases. So, the direct Tax to GDP ratio remains constant except in unexceptional circumstances. Typically, countries with lower are less developed when compared with higher countries.

Key Takeaways

  • Tax to GDP ratio is the country’s tax revenue ratio related to the country’s Gross domestic product (GDP) that determines the country’s government’s control of the economic resources. 
  • Tax revenue means the total revenue collected by the country’s government from the people.
  • Gross domestic product (GDP) is the total final goods and services produced in the nation in a particular period. 
  • The tax-to-GDP ratio is generally stable, except in exceptional circumstances. It is considered a useful measure of a country’s fiscal health and its ability to provide public goods and services to its citizens.

Tax To GDP Ratio Explained

The tax to GDP ratio is the comparison between the tax collected within a year in comparison to the Gross Domestic Product (GDP). It gives the government, market experts, and citizens a benchmark with which the tax receipts can be compared year after year.

The direct 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 the 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. The Gross domestic product does not include the value of goods and services that are not purchased and sold by the persons in the market and the value of goods and services in the process, i.e., the value of Intermediary goods and services.

Using these parameters, this ratio will be calculated by dividing tax revenue by Gross domestic product. This ratio is used in a country to know 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.

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Video Explanation of GDP vs GNP

Formula

A low tax to GDP ratio indicates a lesser developed economy or a serious gap in the tax collection within an economy. Let us understand its formula to calculate the percentage as explained below.

Tax to GDP ratio = Tax Revenue of the Nation During the Period / Gross Domestic Product of the Nation

Where,

  • Tax Revenue = Total amount of revenue collected by the government of a country in the form of 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. 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 formulaGross Domestic Product FormulaGDP or gross domestic product refers to the sum of the total monetary value of all finished goods and services produced within the border limits of any country. GDP determines the economic health of a nation. GDP = C + I + G + NXread more is as below:

Examples

The direct tax to GDP ratio of a country as a parameter is closely looked at by policymakers and experts. To understand this complicated concept in depth, let us take the help of a couple of examples.

Example #1

For a year, the comparison is to be made between the two countries, A and B. The tax revenue of country A for the period is $ 2.50 trillion, and that of country B was $ 4 trillion. The gross domestic product (GDP) of 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.

ParticularsAmount (in trillion)
Tax Revenue of the nation during the period of Country A$2.50
Tax Revenue of the nation during the period of Country B$4
GDP of the nation of Country A$15
GDP of the nation of Country B$20

Solution:

Now,

  • 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

So,

For Country A

Tax to GDP ratio Example 1-1
  • = $ 2.50 trillion / $ 15 trillion
  • = 16.67%

And,

For Country B

Tax to GDP ratio Example 1-2
  • = $ 4 trillion / $ 20 trillion
  • = 20%

In this case, the ratio of Country A is 16.67% and Country B is 20%. The values calculated show 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.

Example #2

The Organization for Economic Co-operation and Development (OECD) began compiling data on the tax to GDP ratio by country in 1965.

In 2016 the average of countries was 32.3%, which is higher than the averages of all years ever since this record began. Denmark ranks the highest with 45.9 percent. However, the tax percentage in the U.S. of 25.3 percent is comparatively lower than most other developed countries.

Importance

Let us understand the importance of ensuring a country does not have a low tax to GDP ratio through the explanation below.

The tax to GDP ratio reflects whether any country’s government has sufficient reserves to finance all its expenditures. If the ratio is less, it shows that the government does not have the reserve to meet its expenditure. So, this ratio should be sufficient enough to meet the government’s expenditures of the country. Also, it helps in knowing the country’s status, i.e., whether it is underdeveloped, developing, or developed. Typically the lower ratio shows that the nation is a developing nation and the higher ratio shows that the nation is a developed nation.

Uses

The low tax to GDP ratio can be an indicator and motivator for policymakers to ensure this ratio improves. Other than this there are other uses which we can learn through the discussion below.

  • The ability of spending by the government of the country of any nation on different activities in the nation depends on the country’s tax to GDP ratio. These activities include spending on social development programs, economic development programs, spending on the country’s infrastructure, paying the salary and pension of its employees, etc.
  • Different analysts use it to compare the tax received by the country from one period to another.

Frequently Asked Questions

1. How to improve tax to GDP ratio?

To improve the tax-to-GDP ratio, a government can implement measures such as broadening the tax base by including more taxpayers, increasing tax rates, reducing tax exemptions and loopholes, improving tax administration and compliance, and promoting economic growth and job creation.

2. What does low and high tax-to-GDP ratio indicate?

A low tax-to-GDP ratio may indicate a weak fiscal position, limited public goods and services resources, and a high reliance on borrowing. Conversely, a high tax-to-GDP ratio may indicate a strong fiscal position, significant public investment and welfare spending, and potential concerns about tax burden and economic competitiveness.

3. Which countries have the highest and lowest tax-to-GDP ratio?

According to 2021 data from the Organization for Economic Cooperation and Development (OECD), Denmark, France, and Belgium had the highest tax-to-GDP ratios among member countries. Furthermore, the lowest tax-to-GDP ratios among OECD member countries were in Mexico, Chile, and the United States.

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