What is Tax to GDP Ratio?

Explanation

The 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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How to Calculate Tax to GDP Ratio?

It is calculated by dividing the period’s tax revenue by the gross domestic product. The formula for the calculation is expressed mathematically as below:

Where,

  • 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. 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:

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 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.

Solution:

Now,

  • Tax revenue of the nation during the period of Country A = $ 2.50 trillionTax revenue of the nation during the period of Country B = $ 4 trillionGross domestic product of the nation of Country A = $ 15 trillionGross domestic product of the nation of Country B = $ 20 trillion

So,

For Country A

  • = $ 2.50 trillion / $ 15 trillion= 16.67%

And,

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.

Importance

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 following are the uses:

  • 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 the 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.

Conclusion

Thus 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, 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 the 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 –

  • Top 10 Best Microeconomics BooksGDP Per Capita Example Types of Equity in EconomyGDP vs GNPMeaning of Nominal GDP