The tax effort is an indicator used to evaluate the incidence of government revenue in the production of society. It measures the relationship between the percentage of public revenue with respect to gross domestic product (GDP) and per capita income. In other words, it measures the relationship between the tax rate and a country’s per capita income. Thus, it is defined as the ratio of public revenue to GDP and the per capita income of the territory.
When, as is happening now, inflation is running rampant and prices are skyrocketing, taxes gain even more notoriety. This happens largely because of the impact they have on business and on people’s lives.
We can say, therefore, that the tax effort is an indicator that serves to measure the tax collection impact of a given State on its economy. In other words, it helps us to know whether the citizens of a country pay a lot of taxes or not. And, therefore, and in certain circumstances, it is more representative than the tax rate, since it allows us to know the sacrifice involved in a given tax collection incidence. This statement is not without controversy, but we will see it later.
What is the tax effort?
As mentioned above, the tax effort is a calculation that evaluates the relationship between the percentage of a country’s public revenue in relation to gross domestic product (GDP) and per capita income.
In this sense, it allows calculating the percentage of taxes on the GDP per capita of workers in the country. This, in turn, allows a more objective comparison than that offered by the tax rate.
How is it calculated?
To calculate the tax effort, we must first know the tax rate. And then, knowing this data, the calculation responds to the following formula:
Tax effort = (Tax rate / GDP per capita) x 100
Which is the difference with the tax rate?
First of all, we have just seen that, in order to calculate one, it is necessary to know the other. Although in practice they are concepts that serve to evaluate the incidence of tax systems, the different magnitudes that are contrasted are not the same. Nor do they have the same calculation methodology.
To calculate the tax rate we use the GDP of a country or territory. Meanwhile, to obtain the tax effort we take into account the GDP per capita of the taxpayers of that country or territory.
Although both concepts are closely linked, their main difference is that one is used to find out whether taxpayers pay a lot in a territory and the other is used as a comparative indicator between countries at the tax level.
If taxes in a country increase, but at the same time GDP grows, the relationship between GDP and tax collection (tax rate) would be the same, or even lower, in its calculation.
Moreover, the calculation of the tax rate does not reliably measure whether taxes have been raised or reduced in the territory. A country could raise taxes (personal income tax, VAT, etc.), which, if there is a decrease in the collection of another tax (corporate income tax, etc.), could be compensated, reflecting the same collection and, therefore, a value similar to the one before the increase.
For these reasons, the tax rate would not reflect the objective measurement that would allow us to know whether the tax burden in a territory has increased or decreased.
Objections to the use of the concept of the tax effort
As we said at the beginning, the concept of tax effort also has its detractors. Fundamentally, because its calculation can lead to confusion in certain cases. In particular, if comparisons of tax effort are not made between countries with similar income levels.
But also for two reasons:
First, because two different magnitudes are being divided. One is a percentage and the other an absolute value.
Secondly, because there could be certain very extreme cases in which the tax effort would provide erroneous data. In countries with a relatively low GDP per capita, as could be the case of Spain, even if the tax rate is lower than in other countries, the tax effort may be higher. This happens because in Spain people pay taxes with significantly lower incomes.
For example, imagine a country like Spain, with a tax rate of 35% and a GDP per capita of 30,000. And any other country with a tax rate of 100% and a per capita income of 130,000. The tax effort of the first one would be 0.116. That of the other country would be 0.079. However, the country is collecting as much as it produces.
The tax effort in Spain
Since we have already mentioned Spain, it is now time to see how we are doing. We can see that both indicators follow different trends. Always taking the EU as a reference:
Meanwhile, Spain has a tax rate lower than the EU average. We are talking about 37.5% compared to the 41.3% average, according to Eurostat. On the other hand, the tax effort in Spain is 52% higher than the EU average.
According to data from the Institute of Economic Studies (IEE) in its latest document on tax competitiveness. To which we must add that no major world economy presents such a high effort.
This means that in Spain less taxes are collected than the EU average, but taxpayers are subject to a higher tax burden. In other words, Spanish workers spend more of their income on taxes than those in other countries.