Consider the following statements:
1. Tax buoyancy refers to the responsiveness of tax revenue growth to changes in GDP.
2. Tax elasticity refers to changes in tax revenue in response to changes in tax rate.
Which of the statements given above is/are correct?
Both 1 and 2
Neither 1 nor 2
When a tax is buoyant, its revenue increases without increasing the tax rate. Tax buoyancy explains the relationship between the changes in government’s tax revenue growth and the changes in GDP. Tax buoyancy is an important indicator of the efficiency and responsiveness of tax revenue mobilisation to GDP growth. It is calculated as a ratio of percentage growth in tax revenues to growth in nominal GDP for a given year. Tax buoyancy is an important metric to know the expected level of government borrowings from the debt market. Higher tax buoyancy would mean the government would borrow less — keeping interest rates lower — while giving room for corporates also to borrow at lower rates.
A similar looking concept is tax elasticity. It refers to changes in tax revenue in response to changes in tax rate. For example, how tax revenue changes if the government reduces corporate income tax from 30 per cent to 25 per cent indicate tax elasticity.