Q. A decrease in tax to GDP ratio of a country indicates which of the following?
- Slowing economic growth rate
- Less equitable distribution of national income
Select the correct answer using the code given below. (UPSC Prelims 2015)
Answer:
1 only
Notes: The correct answer is
[A] 1 only. The Tax-to-GDP ratio is a key indicator of a government's ability to finance its expenditures and reflects the efficiency of the tax administration relative to the size of the economy.
- Slowing economic growth rate (Statement 1 – Correct): Tax revenue is generally "elastic," meaning it rises and falls with economic activity. When the economy slows down, corporate profits drop and consumer spending decreases, leading to lower direct (Income / Corporate) and indirect (GST / Customs) tax collections. If the GDP grows slower or tax collection falls faster than the GDP, the ratio decreases.
- Less equitable distribution of income (Statement 2 – Incorrect): The Tax-to-GDP ratio is a measure of the quantity of tax collected relative to the total economy. It does not inherently describe the quality of wealth distribution. While a highly progressive tax system (taxing the rich more) can help reduce inequality, a simple decrease in the overall ratio does not automatically mean income has become less equitably distributed; it could simply mean tax compliance has dropped or tax rates were slashed across the board.
Key Implications of a Low Tax-to-GDP Ratio:- Fiscal Constraint: A declining ratio limits the government’s ability to spend on social infrastructure like health and education.
- Tax Base: It often indicates a narrow tax base or a large informal economy that remains outside the tax net.
- Compliance issues: It may suggest rising tax evasion or inefficient tax collection mechanisms.
In the Indian context, the Tax-to-GDP ratio has historically hovered around
10% to 11%, which is considered low compared to OECD nations, prompting continuous reforms like GST and digitalization to broaden the base.