Home ›› 04 Jun 2023 ›› Editorial

Tax to GDP ratio in historical context

Mir Obaidur Rahman
04 Jun 2023 00:00:00 | Update: 03 Jun 2023 22:37:21
Tax to GDP ratio in historical context

The Tax-GDP ratio is an essential criterion in measuring the size of the public economy and thus determines the government expenditure pattern through the budget document. The annual budget is the operational document of the fiscal policy -- that outlines the complex process of revenue and expenditure and thus needs the vetting of the national parliament. The historical development of the public sector over the past century manifests the state’s role in the inclusive growth and well-being of ordinary people.

Government expenditure was only a tiny proportion of the GDP, less than 10 per cent of GDP at the beginning of the twentieth century. Expenditure then rose steadily over the next century, and now in 2023 reached the ceiling for many developed and developing countries. For many industrialized countries such as the USA, the UK, Japan, France, and Germany, the public expenditure was 12 per cent in 1910. Till 1930 the ratio ranges between 20 and 30. The Great Depression of 1930 is the genesis of the urgency of the state’s role with the Keynesian philosophy of effective demand in economic crisis. However, the United States had the lowest spending level of the five countries in 1966 at 32.4 per cent, one-third of the GDP. France had the highest level of public expenditure at 55 per cent, with the Tax-GDP ratio increasing from 43.4 per cent in 2000 to 45.1 per cent in 2021. The OECD average Tax-GDP ratio was 32.9 per cent in 2000. Currently, the ratio is 34.1 per cent. Overall, the trend suggests convergence in the level of expenditure among the countries.

Historically, the low Tax-GDP ratio is a significant weakness in the macro aggregate of Bangladesh’s economy compared to many neighboring and developing countries. The Tax-GDP ratio reached an all-time high of 9.62 per cent in 2015 and a record low of 7.0 per cent in 2020. The Tax-GDP ratio was 8 per cent in December 2022, close to 7.9 per cent in December 2021. The Tax- GDP ratio was above an average of 9 per cent from 2011-15; the lowest was 9.29 in 2011; the highest was 9.62 per cent in 2015, with an average of 8 per cent during 2021-22. The budget for 2023-24 projects a Tax-GDP ratio at the threshold of 9 per cent-- a requirement of the IMF Quantitative Performance Criteria [QPC]. The country needs to earn an additional tax revenue of 0.5 per cent of GDP with a binding that the budget deficit will be limited to 3.3 per cent.

The current budget size of Tk 7,61,785 crore is about 15 per cent of GDP and the revenue of Tk. 5,00,000 crore is about 9 per cent of GDP. However, the deficit of Tk. 2, 61 785 is 5.2 per cent of GDP. Thus, the budget deficit as a per centage of GDP is higher than the prescribed limit of 3.3 per cent. The budget deficit was 5.5 per cent in the last year’s budget. Indeed, the budget deficit as a per centage of GDP can be a practical guide in the inflation expectation of a country. The projected inflation of 6 per cent may not be tenable with this indicative budget deficit and the insipid inflation of about 9 per cent. The pattern of financing the deficit is fundamental in studying the repercussion in the macro scenario. Thus, when the government borrows heavily from the banking sector, this crowds out investment by the private sector—the liquidity crisis in the banking sector pushes interest rates upwards, fueling inflation. Surprisingly, the budget deficit is close to the Annual Development Programme, the development arm of the budget, and thus may be vital in implementation. The only hope is the low implementation of the ADP.

The Herculean task in the budget formulation exercise is to eliminate the system glitches of the low-level trap of the Tax-GDP ratio.

With a Tax-GDP ratio of 18 to 20 per cent, the government could afford to meet many contingencies and lead the economy toward a sound growth path. However, the footprint of the past could not be a guide in this arduous journey.

The rigidity in the structure, especially in direct and indirect taxation, is a barrier to significant revenue augmentation. The 50 per cent contribution of direct taxes could be a viable alternative, but the current contribution of Tk. 1,53,260 crore is 31 per cent of the target of Tk. 5,00,000 crore, with the highest tax slab of 25 per cent. The budget is aligned with more indirect tax, with a share of vat above 32 per cent.

The Tax-GDP ratio was meager in the UK before 1832. It is interesting to read how the Tax-GDP ratio was raised through endogenous political change. The amendment of the 1832 Reform Act increased the electorate from 492,700 to 806,000, representing 14.5 per cent of the adult male population. Subsequently, a series of amendments, such as the Second Reform Act in 1867, the Ballot Act of 1872, and the Corrupt and Illegal Practices of 1883, and the parliamentary reform agenda enunciated through the National Reform Union in 1864 paved the way for changes in the electoral process. The electorate was doubled again by the Third Reform Act of 1884, which extended the same voting regulations already existing in the urban constituencies to the rural constituencies. The Redistribution Act of 1885 removed many remaining inequalities in the distribution of seats.

This is the brief manifestation of political changes that could bring dynamism to the economic institution. Liberal and Conservative governments introduced many labor market regulations, fundamentally changing the nature of industrial relations in favor of workers. During 1906-14, the Liberal Party, under the leadership of Henry Asquith and David Lloyd George, introduced modern redistributive Britain, including health and unemployment insurance, government-financed pensions, minimum wages, and a commitment to redistributive taxation. “ As a result of the fiscal changes, taxes as a proportion of GNP more than doubled in the thirty years following 1870, and then doubled again, and taxes became more progressive .”

This could be a lesson for many countries struggling to raise the tax-GDP ratio.

The writer teaches at BRAC University and BIDS as an adjunct Faculty in the Master’s Programme in Economics. He can be contacted at mirobaidurr7@gmail.com

×