Reading between the tax lines

World Bank report suggests India's tax gap is smaller than its peers' — but inter-country comparisons can be misleading

- R KAVITHA RAO

Fiscal policy discussions in India have consistently emphasised the need to raise the country's tax-to-gross domestic product (GDP) ratio. The analysis in this context follows two distinct lines of reasoning.

Given the articulated need for an expanded role of the government in a developing country like India, a higher tax-to-GDP ratio is argued to be desirable. Policy prescriptions here focus on identifying new sources of revenue and reducing or eliminating exemptions and concessions. The other line of argument focuses on measuring the "tax gap" — the difference between potential revenues and actual collections. Policy options in this approach include improving tax administration, as the gap could be attributed to evasion and avoidance. In recent studies, potential revenues are estimated using a stochastic frontier approach with cross-country data.

Many of the studies in the latter approach combine data from all types of countries to obtain an estimate of potential revenue. Clearly, this potential revenue is based on a comparison of the performance of different countries. The World Bank recently released a report titled "The South Asia Development Update, April 2025", which adopts a somewhat different approach and arrives at different conclusions. To understand what we can take away from this report, the results are summarised below.