Fiscal Policy and Tax-to-GDP Ratio in India

Discussions on fiscal policy in India often focus on the necessity to increase the tax-to-GDP ratio. This analysis is based on two main perspectives.

1. Need for Higher Tax-to-GDP Ratio

• Developing nations like India require a larger government role, necessitating a higher tax-to-GDP ratio.
• Policy recommendations include: 
  • Identifying new revenue sources.
  • Reducing or eliminating exemptions and concessions.

2. Measuring the "Tax Gap"

• The "tax gap" is the difference between potential revenues and actual collections.
• Policy options focus on improving tax administration to combat evasion and avoidance.
• Estimates often use a stochastic frontier approach with cross-country data.

World Bank Study on Tax Performance

The World Bank's report, "The South Asia Development Update, April 2025", examines tax performance in Emerging Market and Developing Economies (EMDEs), comparing India with other EMDEs in four tax categories.

Findings of the Study

• India's aggregate tax gap is smaller than the EMDE average.
• Specific findings include: 
  • Personal income tax and consumption tax gaps are < 0.25% of GDP, below the EMDE average.
  • Corporate income tax gap exceeds 1% of GDP, above the EMDE average.
  • Trade tax gap is similar to the EMDE average at 0.20% of GDP.

Challenges and Considerations

These findings are both interesting and challenging:

• For corporate income tax, India's higher average price-to-earnings ratio may overestimate the tax gap due to differing market capitalizations and tax regimes.
• Personal income tax might be underestimated due to the composition of non-corporate incomes and high exemption thresholds.
• Trade taxes are influenced by exemptions and concessions within the Customs duty structures, which differ due to free trade agreements.

Conclusion

When comparing revenue performance across countries, caution is advised. Differences in tax structures and economic contexts can lead to misleading results.