There is a growing debate that is it worthwhile to track an indicator like Tax-GDP Ratio? The debate is fueled by the fact that in India, this ratio is low when compared with any other historical benchmark or countries. Even then, the country can be said to be more or less macro-economically stable.
Interestingly, the government claims that in last 60 years, India’s tax to GDP ratio has increased from 6% to 17%. But fact is that most of this growth has come pre-liberalization. Since 1991, the ratio has remained closer to 17% and hence, almost nothing has happened in last 25 years on this front. Some argue that low taxes are the reason why India is facing the problem of economic equality. But there is no data to back that argument.
So is it true that tax to GDP ratio rises with increase in per capita income? India seems to be out of sync with the previous statement. Though per capita income has risen substantially in last 25 years, there has been zero increase in tax-GDP ratio. But it’s also possible that there is no link between the two. There is some logic in saying that states can tax more as GDP increases. Hereby allowing taxes (in absolute sense) to rise. But once the government has decided how much it wants to spend (funded through taxes), the tax-GDP will then be dependent on the spending mandate of the government and not growth in GDP.
So, the tax and government spending will rise roughly in proportion to GDP and keep the tax-GDP ratio almost constant – a case similar to India’s. Even though there is no evidence to support either views, it seems clear that unless the government of India decides to spend more than it currently does (for which it will need more revenues from taxes), the tax-GDP ratio will remain constant in the long run.