Q. Consider the following statements:

  1. Tax revenue as a percent of GDP of India has steadily increased in the last decade.
  2. Fiscal deficit as a percent of GDP of India has steadily increased in the last decade.

Which of the statements given above is/are correct?

  • 1 only
  • 2 only
  • Both 1 and 2
  • Neither 1 nor 2

Answer: (d) Neither 1 nor 2

Tax-to-GDP Ratio:
  • Tax revenue is defined as the revenues collected from taxes on income and profits, social security contributions, taxes levied on goods and services, payroll taxes, taxes on the ownership and transfer of property, and other taxes.
  • Total tax revenue as a percentage of GDP indicates the share of a country’s output that is collected by the government through taxes. It can be regarded as one measure of the degree to which the government controls the economy’s resources.
    • The tax burden is measured by taking the total tax revenues received as a percentage of GDP.
  • The tax-to-GDP ratio measures 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.
  • Higher tax revenues mean a country can spend more on improving infrastructure, health, and education—keys to the long-term prospects for a country’s economy and people.
  • According to the World Bank, tax revenues above 15% of a country’s gross domestic product (GDP) are a key ingredient for economic growth and poverty reduction.
Tax revenue as a percent of GDP
Tax revenue as a percent of GDP
Fiscal Deficit
  • Fiscal deficit is the difference between the government’s total expenditure and its total revenue (excluding borrowings).
  • It is an indicator of the extent to which the government must borrow in order to finance its operations and is expressed as a percentage of the country’s GDP.
  • High and Low FD:
    • A high fiscal deficit can lead to inflation, devaluation of the currency and an increase in the debt burden.
    • While a lower fiscal deficit is seen as a positive sign of fiscal discipline and a healthy economy.
  • Positive Aspects of Fiscal Deficit:
    • Increased Government Spending: Fiscal deficit enables the government to increase spending on public services, infrastructure, and other important areas that can stimulate economic growth.
    • Finances Public Investments: The government can finance long-term investments, such as infrastructure projects, through fiscal deficit.
    • Job Creation: Increased government spending can lead to job creation, which can help reduce unemployment and increase the standard of living.
  • Negative Aspects of Fiscal Deficit:
    • Increased Debt Burden: A persistent high fiscal deficit leads to an increase in government debt, which puts pressure on future generations to repay the debt.
    • Inflationary Pressure: Large fiscal deficits can lead to an increase in money supply and higher inflation, which reduces the purchasing power of the general public.
    • Crowding out of Private Investment: The government may have to borrow heavily to finance the fiscal deficit, which can lead to a rise in interest rates, and make it difficult for the private sector to access credit, thus crowding out private investment.
    • Balance of Payments Problems: If a country is running large fiscal deficits, it may have to borrow from foreign sources, which can lead to a decrease in foreign exchange reserves and put pressure on the balance of payments.
Fiscal deficit as a percent of GDP
Indias Fiscal Deficit as of GDP