India's large informal economy is the primary cause of its low tax-to-GDP ratio. This informal sector remains largely outside the formal tax net, which limits the tax base and constrains revenue collection efficiency, despite ongoing reforms.

CURRENT STATE

The size of India's informal sector restricts tax base expansion, keeping gross tax revenue at an estimated 11.2% of GDP for 2026-27. While compliance is improving and income tax returns have risen from 6.9 crore in FY22 to 9.2 crore in FY25, the Income Tax Act 2025, which aims to formalize more economic activity, has not yet taken effect.

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