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What is the 'Tax-To-GDP Ratio'

The tax-to-GDP ratio is the ratio of tax collected compared to national gross domestic product (GDP). Some countries aim to increase the tax-to-GDP ratio by a certain percentage to address deficiencies in their budgets. In states where tax revenue has gone up significantly in comparison to GDP, policymakers may decide to increase the percentage of tax revenue they apply towards foreign debt or other programs.

BREAKING DOWN 'Tax-To-GDP Ratio'

Some countries have a high tax-to-GDP ratio; Sweden, for example, had a tax-to-GDP ratio of 35% as of 2014. Estonia, on the other hand, had a very low 1% tax-to-GDP ratio in 2014. As of 2014, the U.S. tax-to-GDP ratio was 11.7%.

When tax revenues grow at a slower rate than the GDP of a country, the tax-to-GDP ratio drops; when tax revenue grows faster than GDP, the ratio increases. For example, if a country has a $10 trillion GDP and tax revenue of $2 trillion, its tax-to-GDP ratio is 20%. If its GDP increases to $15 trillion and its tax revenue jumps to $3 trillion, it retains its 20% ratio. In contrast, if GDP increases to $18 trillion and taxes only increase to $3 trillion, the ratio falls to 16.7%, and conversely, if tax revenue climbs to $4 trillion and the GDP rises to $12 trillion, the tax-to-GDP ratio grows to 33.3%.

What Does the Tax-to-GDP Ratio Mean?

The tax-to-GDP ratio gives policymakers and analysts a metric that they can use to compare tax receipts from year to year. In most cases, because taxes are related to economic activity, the ratio should stay relatively consistent. Essentially, as the GDP grows, tax revenue should grow as well.

However, in cases of major shifts in tax law or during serious economic downturns, the ratio can shift, sometimes dramatically. For example, during the 2000s, Australia's tax-to-GDP ratio rose to a record high of 24.2%, but during the global financial crisis, the ratio fell to 3.7%. Australia implemented a lot of tax cuts during that period, further depressing the ratio.

During economic downturns, tax revenues typically fall because consumers earn less and spend less, paying less property tax and consumption taxes. In addition, property taxes fall as property values decrease. However, tax receipts tend to fall at a faster rate than GDP, pushing the ratio down.

What Is Tax Revenue?

Tax revenue consists of all compulsory payments to the central government. When calculating the tax-to-GDP ratio, analysts exclude Social Security payments, fines and penalties. Property, sales, payroll and income taxes are included, while speeding ticket fines and other civil penalties are excluded. Customs and duties paid by users of goods and services are also included in the ratio.

What Is GDP?

The gross domestic product is the total value of the goods and services produced by a nation's economy, minus the value of goods and services used in production. GDP includes consumer spending, government spending, investments and net exports (exports minus imports).

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