What Is Tax-To-GDP Ratio?

The tax-to-GDP ratio is a ratio of a nation's tax revenue relative to its gross domestic product (GDP), or the market value of goods and services a country produces. Some countries aim to increase the tax-to-GDP ratio to address deficiencies in their budgets. 

Taxes and GDP are generally related. The higher the GDP, the more tax a nation collects. Conversely, countries with lower taxes produce a lower GDP. Analysts, economists, and government leaders can use this ratio to see the rate at which taxes fuel a nation's economy.

Understanding the Tax-To-GDP Ratio

The tax-to-GDP ratio is used in conjunction with other metrics to measure how much a nation's government controls its economic resources.

Tax revenue is income collected by governments through taxation. It includes revenues from income taxes, Social Security contributions, product sales tax, payroll taxes, and other items. Social Security payments, fines, and penalties are normally excluded from calculations. Tax revenue in underdeveloped and developing countries is typically insufficient to fund state operations. Tax collection agencies may be central governments or licensed third-parties representing central governments.

Tax revenue includes income taxes, Social Security contributions, product sales tax, payroll taxes, and other items.

The gross domestic product is the total value of the final goods and services produced by a nation's economy during a given period. Intermediary goods and services—products, and services used in the production of an end commodity or service—are excluded from GDP. Goods and services not bought and sold in markets such as homemaker activities and babysitting are also not included. 

The calculation of GDP is the sum of consumption expenditures such as durable and nondurable goods, services, and investments—including business fixed, residential, and inventory investments—and government purchases less the net exports for the country. So GDP = Exports - Imports.

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Tax-To-GDP Ratio

How Tax-to-GDP Ratio is Used

Policymakers and analysts use the tax-to-GDP ratio to compare tax receipts from year to year. In most cases, because taxes are related to economic activity, the ratio should stay relatively consistent. Consequently, as the GDP grows, tax revenue should increase as well.

However, in cases of significant shifts in tax law or during severe 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 fell to 3.7% during the global financial crisis. Because of a series of fiscal policy changes, Australia's tax-to-GDP ratio was further depressed.

Economic downturns result in lower rates of growth. During these times, unemployment usually rises, and consumer spending decreases. As a result, fewer property and consumption taxes are collected. During downturns, reduced consumption significantly and quickly affects tax receipts, pushing the tax-to-GDP ratio downward.

Key Takeaways

  • The tax-to-GDP ratio is a ratio of a nation's tax revenue relative to its gross domestic product.
  • Countries with higher GDP generally collect more taxes, while those with lower taxes produce a lower GDP. 
  • This ratio is used with other metrics to measure how much a nation's government controls its economic resources.
  • Developed nations typically have higher tax-to-GDP ratios, while those of developing nations tend to be lower.

Tax-to-GDP Ratio Examples

When a country's tax revenues grow at a slower rate than its GDP, the tax-to-GDP ratio drops. As tax revenue grows quicker than the GDP, the ratio will increase. GDP is the difference between gross domestic product and tax revenue.

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 rises to $18 trillion and taxes only increase to $3 trillion, the ratio will fall to 16.7%. Conversely, if tax revenue climbs to $4 trillion and the GDP rises to $12 trillion, the tax-to-GDP ratio grows to 33.3%.

U.S. Tax-to-GDP Ratio

Developed nations typically have higher tax-to-GDP ratios, while those of developing nations tend to be lower. So countries like Kazakhstan and India have lower ratios.

According to a report from Organisation for Economic Co-operation and Development (OECD), the tax-to-GDP ratio for the United States was fairly low compared to other developed countries in the group. Based on figures from 2017, the report stated taxes for the U.S. were 27.1% of the nation's GDP. Only Korea, Turkey, Ireland, Chile, and Mexico's were lower. France—at 46.2%, Denmark—at 46%, and Belgium—44.6% were the top three in terms of tax-to-GDP ratio.