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Why is the tax revenue to gdp ratio very low in many poorer countries?

Level:
A-Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 2 Mar 2023

Often, poorer countries find it difficult to generate the direct and indirect tax revenue needed to find public and merit goods, infrastructure spending and maintain a welfare state safety net. Why are tax revenues measured as a share of a nation's GDP low in such countries?

A selection of countries:

(Tax revenue as a % of GDP, data is for 2020 unless stated, source World Bank development database)

  • Ethiopia 6%
  • Bangladesh 7%
  • Angola 10%

Here are some of the main reasons:

  1. Large informal economy: In many poorer countries, a large portion of economic activity takes place in the informal sector, which is often not taxed or difficult to tax. This can make it difficult for governments to collect taxes and reduce the tax revenue to GDP ratio. For example, in 2020, the informal economy in sub-Saharan Africa was estimated to be 85% of total employment, according to the International Labour Organization.
  2. Low tax compliance: Low tax compliance among individuals and businesses can also contribute to a low tax revenue to GDP ratio. This can be due to a lack of awareness or understanding of tax laws, or a lack of trust in government institutions. For example, the tax compliance rate in Nigeria was estimated to be around 6% in 2020, according to the World Bank.
  3. Low per capita incomes: In many countries average incomes are so low and extreme poverty so high that direct tax systems simply do not collect much in the way of revenue. Low levels of consumer spending also mean that revenue from indirect taxes is limited,
  4. Weak tax administration: Weak tax administration, including limited resources and capacity, can make it difficult for governments to effectively collect taxes. This can lead to low tax revenue to GDP ratios. For example, in 2021, the African Tax Administration Forum estimated that the average tax collection rate in sub-Saharan Africa was only around 16% of GDP.

Real-world data shows the low tax revenue to GDP ratio in many poorer countries. According to the World Bank, the tax revenue to GDP ratio in sub-Saharan Africa was only around 15% in 2019, compared to an average of 34% in high-income countries.

Similarly, in South Asia, the tax revenue to GDP ratio was only around 12% in 2019, compared to an average of 41% in high-income countries.

These low ratios indicate a significant gap in revenue collection that can limit the ability of governments to provide essential public services and thereby promote economic development in areas such as education, health, sanitation and housing.

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