Tax-to-GDP Ratio: Everything You Should Know

Tax-to-GDP Ratio: What Is It?

A country’s tax revenue can be compared to the size of its economy as determined by its gross domestic product using the tax-to-GDP ratio (GDP). Due to the ratio’s ability to indicate future taxes in relation to the GDP, it offers a good look at a nation’s tax revenue. Also, it makes it possible to compare the tax revenues of various nations internationally as well as see the general trajectory of a country’s tax policy.

Key Aspects

• One indicator of a country’s tax revenue in relation to the size of its economy is the tax-to-GDP ratio.
• This ratio is combined with other measures to assess how well a country’s government uses taxation to direct its economic resources.
• The tax- to-GDP ratios is often larger in developed countries than in developing countries.
• A nation’s ability to invest more in infrastructure, health, and education thanks to higher tax revenues is crucial to the long-term prospects of its economy and population.
• The World Bank claims that tax receipts exceeding 15% of a nation’s GDP are a crucial component of economic growth and, eventually, poverty reduction.

The Tax-to-GDP Ratio: An Overview

An important indicator of a country’s progress and governance is its taxation system. Using the tax-to-GDP ratio, one may assess how effectively a country’s government manages its financial resources. A nation’s ability to invest more in infrastructure, health, and education thanks to higher tax revenues is crucial to the long-term prospects of its economy and population.

Economic Development and Tax Policy

The World Bank claims that tax receipts exceeding 15% of a nation’s GDP are a crucial component of economic growth and, eventually, poverty reduction. This amount of taxation guarantees that nations have the resources needed to make future investments and achieve long-term economic growth. In general, developed nations have a much greater ratio. In 2019, the average among Organization for Economic Co-operation and Development members was 33.8%.

One argument holds that people generally start to demand more services from the government, whether in the areas of healthcare, public transit, or education, as economies improve and incomes rise. This could help to explain, for instance, why the tax-to-GDP ratio in the European Union in 2019 was, on average, 41.4%, while in the Asia-Pacific region, it ranged from 11.9% in Indonesia to 35.4% in Nauru (and the majority of nations did not have a ratio as high as the OECD average of 33.8%).

Tax Policy Direction

The tax-to-GDP ratio is used by policymakers to compare tax collections from year to year because it provides a more accurate indicator of the growth and decline in tax revenue than basic quantities. Tax collections fluctuate inversely with economic activity, increasing during periods of greater expansion and falling during recessions. Tax revenues fluctuate more than GDP as a percentage, but absent extreme growth fluctuations, the ratio should remain fairly stable.

The ratio can, however, change significantly when there are significant changes to tax law or when there is a severe economic crisis. For instance, the OECD reports that the United States’ tax-to-GDP ratio decreased more than that of any other OECD member in 2018. The $1.5 trillion tax cut that former President Donald Trump signed into law in 2017 was largely to blame for this.

In the US, the tax-to-GDP ratio dropped from 28.3% in 2000 to 24.5% in 2019. The OECD average in 2019 was somewhat higher than that in 2000 during the same time period (33.8% vs. 33.3%).

In terms of the tax-to-GDP ratio, the United States placed 32nd out of 37 OECD nations in 2019.

There has never been agreement among economists and policymakers over the ideal tax system for economic expansion. On one side, there are those who think raising tax rates will bring in much-needed funds and end the nation’s spiraling debt issue. On the other hand, some people think that tax increases are counterproductive and that lower tax rates boost revenue by boosting the economy.

FAQs

Tax-to-GDP Ratio: What Is It?

The tax-to-GDP ratio measures how much a nation collects in taxes in relation to its gross domestic product (GDP). This ratio is used to gauge how effectively a nation’s leadership manages its financial resources. To determine the tax-to-GDP ratio, divide the GDP by the tax revenue for the relevant time period.

Is Tax Revenue Included In GDP?

In addition to social security contributions, taxes on goods and services, payroll taxes, and taxes on the ownership and transfer of property are also included in the category of taxes that generate income. The sum of a nation’s taxes is regarded as a component of its GDP. Total tax revenue as a percentage of GDP is the portion of a nation’s output that is taken in via taxes.

What Should Tax-to-GDP Ratio Be?

According to the World Bank, a tax-to-GDP ratio of 15% or above ensures economic growth and, thus, long-term poverty alleviation.

In the US, the tax-to-GDP ratio dropped from 28.3% in 2000 to 24.5% in 2019.

How Can Tax Revenue As A Percentage Of GDP Be Graphed?

For a few selected nations and economies, the World Bank offers line graphs showing tax income as a share of GDP from 1972 to 2019. Years are shown as values on the horizontal axis (x-axis). The percentage values are shown on the vertical axis (y-axis) (of tax revenue compared to GDP). The data points are shown to show how these values have changed over time.

Do GDP and Tax Revenue Have a Direct Relationship?

Changes in a nation’s or economy’s tax burden have an effect on that nation’s or economy’s level of economic activity (and therefore, its GDP). The relationship between tax policy, employment, and economic growth has been the subject of extensive research by government departments and agencies, think tanks, and academic and private sector academics.

This study’s main goal is to determine if tax rates lead to economic expansion or contraction (more jobs vs. fewer jobs). Real GDP, in particular, is generally regarded as the best indicator of economic growth (which is an inflation-adjusted measure of GDP).

Over time, tax rates for an American family making the average income have stayed largely consistent. For instance, it hovered at 21% in 1947 and remained that way until the middle of the 1960s, when it fell to between 16% and 19%. From roughly the middle of the 1960s until the middle of the 1990s, rates stayed in the range of 16% to 19%. The rate was constant between 2002 and 2015 at 15.5%. The US GDP was $243 billion in 1947. The U.S. GDP increased to over $18,905 billion by 2017, despite the fact that tax rates were largely unchanged during this time.

Moreover, during this time there were roughly 11 recessionary periods. According to this viewpoint, the tax rates paid by the typical American family did not significantly affect GDP during this time.

Although it is true that either raising or lowering taxes (and tax collections) has an effect on economic growth, it is evident that other factors influence the economy’s direction more (including, but not limited to, interest rates set by the Federal Reserve and broader technological advancements in the workforce).

In Terms Of Tax Revenue As A Percentage Of GDP, Where Does The United States Rank?

In terms of the tax-to-GDP ratio, the United States placed 32nd out of 37 OECD nations in 2019. In comparison to the OECD average of 33.8% in 2019, the United States’ tax-to-GDP ratio in 2019 was 24.5%. In terms of the tax-to-GDP ratio, the United States maintained the same position in 2018: 32nd out of the 37 OECD nations.

Which Nations Have Tax Burdens That Are The Highest And Lowest As A Percentage Of GDP?

With 46.2%, France has the largest tax burden relative to GDP. The tax-to-GDP ratios of Denmark (46%), Belgium (44.6%), Sweden (44%), and Finland (43.3%) are similarly relatively high. With 1.4%, Kuwait has the lowest tax loads relative to GDP.

In Terms Of Corporate Tax Revenue As A Percentage Of GDP, Where Does The United States Rank?

The United States collects less money in taxes than other comparable economies. For instance, only 1% of GDP in the United States was generated by business taxes in 2019. The United States’ corporate income tax revenue, at 1%, is the lowest among the Group of Seven (G7) nations, which also includes Japan (4.2%), Canada (3.8%), the United Kingdom (2.5%), France (2.2%), Germany (2.0%), and Italy (1.9%). The G7 countries are a loose alliance of developed democracies, and the annual G7 Summit brings together the leaders of these nations as well as guests from the European Union.

The federal corporate tax rate in the United States peaked in the late 1960s. It has been declining ever since. In actuality, the corporate tax rate now is significantly lower than it was in the 1950s and 1960s.

Can Raising Taxes Stimulate the Economy?

Tax reductions are a successful approach to increase demand in an economy over the short term (the next one to two years). This is due to the fact that consumers have more discretionary income and firms have more money to invest in their operations and hire new employees. Tax reductions boost employees’ take-home pay. Tax reductions also boost businesses’ after-tax cash flow. This additional cash flow can be used by businesses to pay dividends, increase activity, and increase the appeal of recruiting and investing. The converse is true when taxes are raised.

Long-term tax reductions can encourage people to work more, increase the number of low-skilled workers in the workforce, boost saving, urge businesses to invest domestically (as opposed to abroad), and promote the development of novel ideas through research. Long-term tax cuts, however, can potentially impede economic expansion by raising the deficit. However, if tax cuts boost employees’ after-tax pay, they can decide to work less, which could have a negative effect on supply.

Because policy changes never occur in a vacuum—there are numerous factors that contribute to economic growth (or the opposite), making it difficult to separate the effects of raising (or lowering) taxes—it is challenging to examine how rising taxes affects the economy. Higher taxes are, nevertheless, compatible with both economic expansion and employment creation, according to historical statistics. It can be very beneficial for the economy if decision-makers employ tax money to close budget gaps.