What Is a Tax-To-GDP Ratio?

A tax-to-GDP ratio is a gauge of a nation's tax revenue relative to the size of its economy as measured by gross domestic product (GDP). The ratio provides a useful look at a country's tax revenue because it reveals potential taxation relative to the economy. It also enables a view of the overall direction of a nation's tax policy as well as international comparisons.

Key Takeaways

  • The tax-to-GDP ratio is a measure of a nation's tax revenue relative to the size of its economy.
  • This ratio is used with other metrics to determine how well a nation's government directs its economic resources via taxation.
  • Developed nations typically have higher tax-to-GDP ratios than developing nations.

Understanding the Tax-To-GDP Ratio

Taxes are a critical measure of a nation’s development and governance, and the tax-to-GDP ratio is used to determine how well a nation's government directs its economic resources. Higher tax revenues mean a country is able to spend more to improve infrastructure, health, and education—keys to the long-term prospects for a country’s economy and people.

Tax Policy and Economic Development

According to the International Monetary Fund, developing countries should have a tax-to-GDP ratio of at least 15%, to ensure they have the money necessary to invest in the future and achieve sustainable economic growth. Developed countries generally have a far higher ratio. The average among members of the Organisation for Economic Co-Operation and Development was 34% in 2018.

According to one theory, as economies become more developed and incomes rise, people generally begin to demand more services from the government, whether in health care, public transportation or education. This would explain, for example, why the tax-to-GDP ratio in the European Union, at an average of 40%, is so much higher than in Asia-Pacific, where in 2017 no country had a ratio as high as the OECD average of 34%.

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Tax-To-GDP Ratio

The Direction of Tax Policy

Policymakers use the tax-to-GDP ratio to compare tax receipts from year to year because it offers a better measure of the rise and fall in tax revenue than simple amounts. Tax revenues are closely related to economic activity, rising during periods of faster economic growth and declining during recessions. As a percentage, tax revenues generally rise and fall faster than GDP, but the ratio should stay relatively consistent barring extreme swings in growth.

However, in cases of significant shifts in tax law or during severe economic downturns, the ratio can shift dramatically. For example, according to the OECD, the U.S.'s tax-to-GDP ratio fell in 2018 by the most among all OECD members. This was mostly a result of the $1.5 trillion tax cut signed by President Donald Trump a year earlier.

At 24%, the U.S. ratio ranked 32nd among the OECD's 36 members. France had the highest ratio at 46%, followed by Denmark and Belgium, each at 45%. Mexico was the lowest at 16%.