Relationship Between GDP and Tax Revenue

There is a strong relationship between GDP and tax revenue.

But before we must know what is GDP (Gross Domestic Product). GDP is an indicator of a countries economic health.

GDP figure also show how big is the economy. But why we use GDP.

In layman terms GDP compares earning and spending power of different countries.

How we know that USA has a stronger economy compared to Pakistan?

This comparison is done by looking at GDP figures of the two countries.

Compared to USA’s GDP of $16,800 Billion, Pakistan’s GDP is only $236.62 billion (1.4%).

What does this comparison tells us? Comparing GDP of two nations we know which country is economically healthier.

In this case GDP of USA is very high compared to Pakistan.

So we can conclude that USA has much healthier economy than Pakistan. The higher is the GDP the better.

Ideally countries must also increase their GDP year after year.

This is know as GDP growth rate.

A country which has faster GDP growth rate will become more prosperous in next years.

GDP of countries in FY 2013-14

Countries GDP in 13-2014Billion USD
India$1,876.80
Neighbouring Countries
Afghanistan$20.72
Bangladesh$129.86
Bhutan$1.88
Pakistan$236.62
Srilanka$67.18
BRIC Nations
Brazil$2,245.67
Russia$2,096.78
China$9,240.27
Developed Nations
USA$16,800.00
UK$2,522.26
Germany$3,624.82
France$2,734.95
Italy$2,071.31
Spain$1,358.26
Saudi Arabia$745.27
South Africa$350.63
Japan$5,960
Australia$1,560.60

Indian states that Contribute most to Indian GDP are..

State/union territory2012–13 nominal GDP
(in Crores of Rupees)
India9,388,876
Maharashtra1,372,644
Uttar Pradesh768,930
Andhra Pradesh754,409
Tamil Nadu744,474
Gujarat670,016
West Bengal620,160
Karnataka524,502
Rajasthan459,215
Madhya Pradesh372,171
Kerala349,338
Delhi U.T.348,221
Haryana345,238
Bihar313,995
Punjab286,809
Odisha255,459
Jharkhand164,876
Chhattisgarh153,621
Assam141,621
Uttarakhand113,958
Jammu & Kashmir75,574
Himachal Pradesh73,710
Goa34,965
Chandigarh U.T.26,162
Tripura23,855
Meghalaya18,135
Puducherry U.T.17,192
Nagaland14,832
Arunachal Pradesh12,091
Manipur11,983
Sikkim9,957
Mizoram8,053
Andaman and Nicobar Islands U.T.5,067

Relationship between GDP and Tax Revenue can be established by knowing how GDP is calculated

GDP is generally calculated by Expenditure Approach.

Measuring GDP is complicated. But by using expenditure apprach the complexity gets slightly reduced.

GDP is calculated by adding total consumption, investment, government spending and net exports.

When we see the GDP formula, a big portion of countries GDP comes from Government Spending’s.

Generally government spendings are done to make economy more productive.

Some activities where Indian government spends its revenues are:

  • PLANNED EXPENDITURE (as per 5 Years Plan) – 35%
  • CAPITAL EXPENDITURE (for creation of new asset)
  • Education Institutions Construction
  • Build Roads
  • Bridge Construction
  • Airport Construction
  • Assets for Urban Infrastructure
  • NON-PLANNED EXPENDITURE – 65%
  • Maintenance of Assets (existing)
  • Expense for Administration Services
  • Interest Payment
  • Expense due to Subsidies
  • Part of Expense on Defense Services

In order to meet the target of government’s spending, government must first collect sufficient Revenues

Government target for ‘spending’ in represented in ANNUAL BUDGET.

A typical Annual Budget of India is shown here.

Annual budget can be dividend into three main component.

First talks about how government collects its revenues. It is called ‘Total Receipts’.

Second talks about how government plans to spend its revenues.

It is called as “Total Expenditure”. Ideally Total Receipts = Total Expenditure without resorting to borrowing money.

But Indian economy is not so blessed.

Indian economy has fiscal deficit.

It has to resort to borrowing to meet the target of ‘Spending’.

From the above Annual Budget figures, one can see that out of the total GDP, 14.79% is constituted by Government Spending’s.

In order to spend the 14.79% of GDP government must first collect sufficient revenues from public.

It is clear that 14.79% of GDP means Rs 16.65 Lakh Crore.

Out of these Rs 16.65 Lakh Crore, almost Rs 8.85 Lakh crore (53%) comes from Tax Revenues.

Conclusion

There is a strong relationship between GDP and tax revenue.

To calculate GDP, government spending is a very important component.

In order to meet the target of government spending it must first collect enough revenues.

Major portion of government’s revenue collection is Tax Revenue.

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