Governments play a huge role in a nation’s economy. One way economists measure the size and economic impact of the government is with the ratio of total revenue to gross domestic product. This ratio is useful for assessing the current and future implications of revenue and economic growth as they affect fiscal policy.
Total Revenue/GDP Ratio
Total revenue refers to the sum of individual income taxes, business income taxes and other tax revenues a government collects over a given period of time, usually one year. Gross domestic product is the total value of goods and services a nation’s economy produces. In the United States, GDP is measured by adding together spending for final use goods and services, exports and business investments and then subtracting the value of imported goods. The total revenue/GDP ratio is equal to total revenue divided by GDP. For example, if U.S. GDP equals $19 trillion and total revenue comes to $3.3 trillion, the total revenue/GDP ratio equals 17.4 percent.
Significance of the Ratio
Total revenue tends to grow as GDP grows. Conversely, when there is an economic downturn, revenues usually decrease. This becomes important when total revenues are compared to government spending. If spending increases at about the same rate as economic growth and the total revenue/GDP ratio remains constant, the overall size of government stays about the same as a proportion of economic activity. However, if spending growth outpaces increases in total revenues, the government will eventually be forced to borrow money, raise taxes or cut spending.