As the budget preparation goes forward there are many suggestions as to appropriate changes in taxation.
One area of regular interest is the taxation of the profits of companies.
By companies here, I mean those economic organisations that are formed as limited companies, protecting the owners from efforts to get at their individual assets in the event of bankruptcy.
When a limited company earns a profit, it is usually taxed at a flat rate on these profits.
After paying this company tax what happens to the remaining profits?
The company may distribute profits to its owners or may retain the profits for future use.
Dividends distributed to owners will again be taxed by the authorities through the individual income tax.
This double taxation raises the rate of taxation of earnings of capital, discouraging investment and saving.
If company taxes are reduced, returns to investment are higher, raising saving, investment and growth.
Lower company taxes may also lead to higher wages: If the company has a target return on capital, then if company taxes are lowered but profit levels are maintained unchanged, wages may increase.
But the double taxation persists for political reasons.
Many believe that this is a higher tax on the rich than the poor.
But the owners may “pay” the tax by lower wages or slower growth of the economy (less investment).
Of course, lower taxes mean less government expenditures.
When the limited company retains profits for future use the value of the company increases.
The owners are now wealthier. For a company that is not listed this wealth is not very liquid.
An owner could use the increased value of the company to borrow money, or he could sell his interest in the company to someone else.
Neither is really very useful for the owner to find liquid funds from his increased wealth.
The shareholder of a listed company should see the share price increase due to the retained earnings; he can then sell his shares and get hold of his part of the profits.
This calls for taxation on the capital gains from selling the shares.
The best way to tax companies is not to tax them at all but to require dividends and realized capital gains to be taxed as individual income.
Of course, capital losses must be allowed as a deduction from taxable income if one sells shares at a loss.
But it is unrealistic to expect that such a tax system will be put in place and one must examine adjustments to the system that now exists.
Four questions will be discussed:
1. Should there be a difference in the company tax rates between listed and non-listed companies?
There is no good reason for such a difference, so the short answer is NO.
It discriminates against small companies that Government policy is trying to promote.
It is argued that this will encourage more companies to want to be listed, but there is no evidence that this is true.
The one thing that is surely true is that a lower tax rate for listed companies makes the income distribution less equal, the rich obtain the greater benefits.
This follows from the simple observation that the high-income individuals own most of the share.
The frequent recommendation to increase the spread between listed and non-listed companies is exactly the wrong direction.
The gap should be reduced to zero. Proponents of a greater spread are probably attempting to lower the rate on listed companies.
2. Should different types of companies have different tax rates?
Good tax systems are neutral; the tax rate should not be used to favour one sector over another.
Governments have shown no ability to predict successful industries either in Bangladesh or anywhere else.
The reason for these different rates is the belief that some companies make too much money and so should be taxed more heavily.
This is a completely bogus argument. Sectors that earn high returns, if there is competition, should be encouraged to expand.
There may be special reasons for wanting to tax a company at a higher rate, but this should be done through an excise tax not a profits tax.
Profitability in the presence of competition is a clear sign that more investment is justified in a sector.
Consider the banking system: The high tax rates result in insufficient investment in the bank’s own facilities: Banks have weak, vulnerable IT systems and much additional investment is needed.
Better IT systems will improve loan collection.
Further profitability of the banks is often fake, resting on BB not enforcing its own rules; high taxation rates harm the weaker banks more than the strong banks.
Agricultural credit operations are insufficient for the opportunities available but this type of credit is expensive to operate. The private banks need to invest more in this area.
Overall, more investment in financial institutions is required; the high tax rate discourages investment.
On the other hand, excise taxes on tobacco sales have a clear social benefit to reduce tobacco use.
The telecoms sector is particularly interesting. It is hard to build competition as three firms have a head start that is very difficult to overcome.
Furthermore, with three firms and BTRC policy trying to move market shares towards equality, competition is being restricted not supported.
The government wants more investment in telecoms and the behaviour of the public indicates that people want more services.
Taxation and fees are far too high. Apparently, the Bangladesh Telecommunication Regulatory Commission believes its mission is to collect as much revenue as possible, not to improve and develop a better telephone system.
This is poor public policy.
For example, the speed of the internet is far too slow.
Surely the telecoms companies can be encouraged to invest in activities to speed up the internet.
Fibre optics networks need to be increased.
Instead of imposing taxes and fees, to say nothing of audit conflicts one wants profits to be spent in the sector due to the high returns that can be earned.
The overall point is the company tax should be neutral.
I do not expect that the government will reduce or remove the different rates but one should understand the result is underinvestment in the IT and financial sectors.
Tax the winners and subsidise the losers has been the motto of bureaucratic organizations everywhere.
All it does is reduce economic growth and harm ordinary people. Remarkable how power and stupidity go hand in hand.
The problem of the garment sector is discussed in the next point.
3. Does Bangladesh need a lower company tax rate on export sectors to be competitive with other countries?
The garment sector claims its profits are too thin to be taxed at regular rates.
The structure of the sector is that there are a lot of companies, many quite small, whose profits are low.
Application of the standard company tax for non-listed companies would force many of these companies out of business.
But the larger more profitable companies would be able to accept this. The reality is the government is not very efficient in its interactions with the RMG sector.
First, the export subsidies are paid very slowly after a lot of paperwork; that is odd since the shipping documents should be sufficient to verify the actual exports and the value of the shipment.
If the BB is waiting for the receipts to be transferred by the buyer that is ridiculous as it is easy to make adjustments for any short payment.
There are continuing difficulties with customs that seem completely unnecessary.
In the age of powerful computer networks, everything to do with Customs for the key sector should go smoothly.
The inability of customs to manage the garment sector with greater efficiency is a very disturbing phenomenon.
These are issues that need to be taken up by the Bangladesh Garment Manufacturers and Exporters Association.
Ultimately, however, the export sector most pay the same company tax as everyone else.
One reasonable approach is to examine the company tax policy towards exports of Bangladesh’s competitors e.g. if Vietnam does not collect company tax on exports that is a good reason for Bangladesh to do the same.
4. Is the company tax rate too high?
Yes! At the present level, it discourages foreign investors.
In many interviews we have done over the past 20 years with both domestic and foreign investors they always plead for a tax holiday as long as possible as no one wants to deal with the NBR.
But tax holidays are dangerous incentives.
A new investment project will not earn any profits for the first two or three years depending on the complexity of the technology so how long should a tax holiday be?
If you want to reduce the early tax burden, allow depreciation on whatever schedule the investing company wants to make.
That permits high early depreciation reducing the tax burden in the early years.
Suggestions
a. Reduce the company tax rate to 15 per cent for all companies listed or unlisted and no difference among sectors. [15 per cent is below most advanced country rates so should encourage foreign direct investment. Company tax rates have been declining among advanced economies and are now about 23 per cent.]
b. Allow the company to set the depreciation rates.
c. Bring all company tax rates to the standard 15 per cent within three years.
d. Establish excise taxes where appropriate to siphon off excess profits in sectors where the government wants to discourage investment.
e. For calculation of individual income tax, cash dividends may be inflated by 20 per cent and taxed according to be individual income tax bracket.
When a system is in place to determine capital gains one simply adds actual dividends and capital gains to other income to determine the base for individual taxation.
Then dividends and net capital gains are taxed as personal income.
f. Design a capital gains tax on shares to start up in three years. Expand that system to include land transactions.
g. Study the treatment of company taxation for exports of competitor countries and determine how to treat company taxation of exporters based on competitors.
The author is an economist
