The tax-to-GDP ratio is the ratio of tax collected compared to national gross domestic product (GDP). In a simpler language, it would be Tax contribution towards GDP.Some countries aim to increase the tax-to-GDP ratio by a certain percentage to address deficiencies in their budgets. In states where tax revenue has gone up significantly in comparison to GDP, policymakers may decide to increase the percentage of tax revenue they apply towards foreign debt or other programs.
Following reasons can be attributed to the low tax (both direct and indirect) to GDP ratio in India.
High tax evasions-Tax compliance in India is extremely low.
Low per capita Income: Low average incomes and a high poverty rate result in a very small portion of the labor force being eligible to pay personnel income tax.
Unorganized sector: India has relatively large informal/unorganized sector, and tax evasion is more rampant in informal sector compare to organized sector.
Small Tax Base and its adverse effect tax buoyancy: In India, only 3% people pay income tax. This is because a large population is still poor and hence don’t earn enough to be in taxable income bracket, but also because even those who fall under the tax bracket, either don’t pay or pay very little taxes. A small tax base unnecessary burdens the honest tax payer. According to Shome Panel, in the last 10 years though the direct tax collection has increased by more than 700%, the number of tax payers has merely grown by 35%.
Lingering of contentious, adversial tax issues: India has one of highest number of disputes between tax administration and taxpayers, with lowest proportion of recovery of tax arrears. For example: the Vodafone tax dispute involving RS 20 K crore lingering since 2008.
Tax exemption and subsidy policies: The exemptions in the taxable income have grown at a much faster rate than the income. As a result, there is less tax buoyancy. Similarly tax expenditure in the form of tax subsidies and exemptions was more than 6 lakh crore in 2015-16.
Loop-holes in double tax avoidance treaties: Provisions for tax exemptions from short term capital gains are often misused by companies to re-route their investments from such countries (called round tripping of funds). Similarly issues related to tax-evasion, double non-taxation and transfer pricing need to be fixed.
Flourishing informal market ecosystem: informal sectors like paying –guest accommodations, Kirana stores, Stationary shops, etc. Evade taxation.