The government levied Income tax on an individual's or entity's earnings based on applicable tax slabs and regulations.

What factors affect a country’s tax-to-GDP ratio?

Economic Policies: Tax rates, exemptions, deductions, and incentives all affect the total tax collected. Economic Growth: When the economy grows, incomes and profits usually rise, increasing tax revenue. Tax Administration: Efficient tax collection and efforts to combat tax evasion directly impact the tax-to-GDP ratio. Sectoral Composition: Economies with high-tax sectors typically have higher tax-to-GDP ratios than those reliant on low-tax sectors. Informal Economy: A larger informal sector often results in lower tax collection, as many transactions are unrecorded and untaxed.

What is India's direct tax-to-GDP ratio?

India's direct tax-to-GDP ratio stood at 6.6% in 2023-24 and is expected to increase to 6.7% in 2024-25.

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What Is the Tax-to-GDP Ratio? What Is a Good One?

Archana Chettiar
February 17, 2025

Let’s return to school and look at a familiar example—test scores. Suppose you scored 85 out of 100 while your friend from another class got 65 out of 70. At first glance, 85 seems higher than 65, but can we say you performed better? Not necessarily, because factors like total marks, difficulty level, and subjects differ. To make a fair comparison, we convert both scores into percentages.

Now, let’s pan out and look at a bigger scale- comparing a nation’s tax revenue and tax systems. Since countries vary in size, economy, and population, tax revenue alone isn’t enough for comparison.

That’s where the tax-to-GDP ratio comes in—offering a standardized way to assess a country’s taxation efficiency. Let’s dive deeper into what this ratio means and how it connects with different income tax concepts.

What is the Tax-to-GDP ratio?

The tax-to-GDP ratio measures the proportion of a country’s tax revenue relative to its total economic output (GDP). It reflects how effectively a government collects taxes and whether it has sufficient funds to meet public expenditures. A higher ratio suggests a well-funded government capable of investing in infrastructure, public services, and economic development, while a lower ratio may indicate revenue constraints and reliance on borrowing.

This ratio also serves as a benchmark for comparing tax policies across countries. Developed nations usually have higher tax-to-GDP ratios, supporting extensive public services, whereas developing economies may struggle with lower tax collections. In India, the Direct Tax-to-GDP ratio reached 6.6% in 2023-24, the highest in 15 years.

How Is Tax-to-GDP Ratio Calculated?

The tax-to-GDP ratio is calculated using the following formula-

Tax-to-GDP Ratio = (Total Tax Revenue Gross Domestic Product)* 100. Here,

Tax revenue is the total amount a government collects in taxes within a specific period.
Gross Domestic Product (GDP) represents the total value of goods and services produced in the country during the same period.

For instance, say there are two countries- M and N

	Country M	Country N
Tax Revenue	Rs.7 lakh crore	Rs.5.5 lakh crore
GDP	Rs.21 lakh crore	Rs.25 lakh crore

The tax-to-GDP ratio by country would be

Country M = (7 lakh crore / 21 lakh crore) x 100 = 16.67%
Country N = (5.5 lakh crore / 25 lakh crore) x 100 = 22%

Even though Country N collects more tax revenue, its higher tax-to-GDP ratio suggests a more efficient tax collection system than Country M. This is why economists, investors, and stock advisory firms use the metric to assess a country’s financial strength and economic structure.

What Is The Optimal Tax-to-GDP Ratio?

The World Bank identifies 15% as the ideal tax-to-GDP ratio for sustainable economic growth and development. This threshold is crucial for countries transitioning from low-income to middle-income status, allowing governments to invest in essential public services, reduce economic volatility, and foster inclusive growth.

Why is 15% considered optimal? Research suggests that:

A tax-to-GDP ratio of at least 12.5% is linked to a noticeable acceleration in economic growth over the next decade.
13% is associated with stronger inclusive growth, reducing income inequality, and enabling better access to public services.
At 15%, countries usually transition from low to middle-income status. Data shows that in the decade leading up to this transition, nations experienced a 3-4% increase in their tax collection relative to GDP.

While crossing the 15% threshold can significantly impact a country’s growth and stability, increasing tax revenues is challenging. Most countries raise their tax-to-GDP ratio by only 3 percentage points over a decade, making the jump from 7% (common in weaker economies) to 15% a long-term effort. (Source: World Bank )

What is India’s Tax-to-GDP Ratio?

India’s tax-to-GDP ratio has fluctuated over the years, reflecting economic shifts, policy changes, and structural challenges. The ratio dropped from 11% in FY19 to 9.9% in FY20, largely due to the economic slowdown. It improved slightly to 10.2% in FY21, aided by post-pandemic recovery. In FY 2024-25, India’s tax-to-GDP ratio stands at 11.8%, marking progress but still trailing behind global benchmarks.

India’s figures remain modest compared to developed nations, where tax-to-GDP ratios exceed 30%. Even similar-sized economies like the UK (24.9%), France (24.6%), and Italy (24.6%) have significantly higher tax collections relative to GDP. South Africa, with a smaller economy, maintains a ratio of 24.2%—more than double India’s.

Several factors contribute to India’s lower tax-to-GDP ratio:

Large informal sector – A significant portion of economic activity remains outside the formal tax system.
Tax evasion & narrow base – Despite a population of over 140 crore, only 6.5 crore individuals filed income tax returns in FY 2023-24.
Heavy reliance on indirect taxes – India’s tax structure leans on indirect taxes (5.6%) rather than direct taxes (6.1%), which can be regressive. (Source: PWC)

Know More:  SEBI Registered investment advisory |  Stock investment advisory

How Does the Tax-to-GDP Ratio Affect the Economy?

Public Services & Infrastructure

A higher tax-to-GDP ratio allows governments to invest more in essential public services like healthcare, education, and infrastructure. This improves quality of life and supports long-term economic growth.

Fiscal Stability & Debt Management

A healthy tax-to-GDP ratio reduces reliance on borrowing, ensuring the government can meet its financial obligations without excessive debt accumulation. Low ratios may lead to fiscal deficits and higher public debt.

Income Distribution & Social Welfare

A progressive tax system with a high tax-to-GDP ratio enables better wealth distribution. If used effectively, tax revenues can support social welfare programs, reducing income inequality.

Investment & Economic Growth

The impact on investment depends on tax policies. Excessively high tax rates can discourage private investment, while a moderate tax-to-GDP ratio with stable policies fosters investor confidence and economic expansion.

Bottomline:

The tax-to-GDP ratio is a vital indicator of a country’s fiscal strength, influencing economic stability, public investment, and business confidence. While a higher ratio enables better infrastructure and social spending, excessive taxation can deter investment and economic growth. Conversely, a lower ratio may indicate limited government revenue, affecting essential services and long-term development.

Navigating these dynamics is important for investors as it affects business confidence and long-term financial security. Tools like a retirement planning calculator can help individuals assess tax implications and plan effectively for future financial goals, ensuring stability amid changing tax policies.

Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as a recommendation or investment advice by Equentis – Research & Ranking. We will not be liable for any losses that may occur. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL & certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

FAQs

What is income tax?
The government levied Income tax on an individual’s or entity’s earnings based on applicable tax slabs and regulations.
What factors affect a country’s tax-to-GDP ratio?
Economic Policies: Tax rates, exemptions, deductions, and incentives all affect the total tax collected.
Economic Growth: When the economy grows, incomes and profits usually rise, increasing tax revenue.
Tax Administration: Efficient tax collection and efforts to combat tax evasion directly impact the tax-to-GDP ratio.
Sectoral Composition: Economies with high-tax sectors typically have higher tax-to-GDP ratios than those reliant on low-tax sectors.
Informal Economy: A larger informal sector often results in lower tax collection, as many transactions are unrecorded and untaxed.
What is India’s direct tax-to-GDP ratio?
India’s direct tax-to-GDP ratio stood at 6.6% in 2023-24 and is expected to increase to 6.7% in 2024-25.

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Archana Chettiar

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I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.