A decrease in tax to GDP ratio of a country indicates which of the following?
1. Slowing economic growth rate
2. Less equitable distribution of national income
Select the correct answer using the code given below.
(a) I only
(b) 2 only
(c) Both 1 and 2
(d) Neither I nor 2
The answer is slightly complicated. Let us analyze the two situations.
Slowing economic growth will mean lower GDP growth and also lower tax collection. However, whether the reduction in tax collection is proportional to the fall in GDP cannot be determined without additional data. So reason 1 is not the culprit here.
Less equitable distribution of national income could be a potential reason for a decrease in Tax to GDP ratio of a country. The taxes paid by individuals and the corporate sector constitute the majority of the tax collection. Inequitable distribution of national income, especially in developing countries like India, means that only a fraction of the population has to pay taxes. So while the GDP grows, the tax collection still lags behind. This could be a potential relatively long term reason for a decrease in tax to GDP ratio. Some other reasons for perennial low tax to GDP ratio may include tax evasion, lower tax rates, high poverty levels, etc.
So choice (b) is the answer.
A decrease in tax to GDP ratio of a country indicates: (B) less equitable distribution of national income.
Let's consider why this is the correct answer:
When income is distributed inequitably across a nation, only part of that population's nation will be acting as active taxpayers. Thus, if the nation's GDP increases under these circumstances, the tax collection will still fall short. Over a period of time, this can cause a decrease in tax to GDP ratio. This does not indicate slowing economic growth rate; it simply means that tax revenues are not keeping up with GDP growth. Theoretically, tax revenue should increase as GDP increases.
As the previous educator who answered this mentioned, this decrease in the ratio can also be attributed to other circumstances, like individuals and businesses who owe taxes failing to pay them, tax rates being set too low, and the expanse of poverty (such as in developing countries).