OP-ED: Government revenue crunch could constrain development progress
Sadiq AhmedEconomy
Bangladesh not only has one of the lowest tax to GDP ratio in the world, it has been declining in recent years.
The country collects 8-9 per cent of GDP as taxes, while the average tax rate is 20 per cent of GDP in Upper Middle-Income Countries (UMIC) and 14 per cent in low-income countries (LIC).
The structure of taxes is primitive.
While UMICs collect 6 per cent of GDP as income taxes and 11 per cent of GDP from VAT, Bangladesh collects only 2.6 per cent of GDP from income taxes and 3.3 per cent of GDP from VAT.
Unlike other UMICs, Bangladesh is heavily reliant on trade taxes that hurt export industries and favour inefficient import substitution through heavy trade protection.
Although COVID-19 has hurt the fiscal 2019-20 tax performance, the problems are deep-rooted, as indicated by the long-term decline in tax performance and the weak tax structure.
Without a major boost to its tax performance, Bangladesh will find it difficult to finance the development needs required to achieve UMIC status by fiscal 2030-31.
Bangladesh has not reformed its tax system over a long period.
Consequently, tax revenue is barely enough to finance the fixed costs of running the government and service its debt obligations.
Development spending is financed through borrowings.
Revenue shortages are constraining programs in health, education, social protection, water resources, agriculture and infrastructure.
There is no tax planning or tax policy analysis capacity.
Tax targets are politically set at the last minute of the new budget cycle with no relationship with reforms and tax administration constraints.
The NBR scrambles to find easy tax handles and inevitably ends up relying on import duties, tobacco taxes, bank accounts, mobile phone users, foreign telecom enterprises, and harassing those who comply with tax laws to pay more.
These have caused serious distortion of tax policy for investment, discouraged FDI, created a disincentive to the spread of ICT, as it faces amongst the highest tax structure globally, and punish the voluntary taxpayers.
The income tax structure is complex, discretionary with multiple exemptions, and ridden with corruption.
The concept of universal income as a tax base does not exist because many sources of income are exempt (tax holidays) or treated very lightly (e.g. capital gains tax).
The tax rates are high but tax compliance is low.
Negotiated informal settlements are rampant, causing serious revenue erosion.
The tax administration has low capacity and functions as a bureaucracy with frequent changes in the NBR chairman.
The NBR is run manually with a frequent interface between taxpayer and tax collector and administered in the spirit of a “police” department rather than as a revenue service agency.
The income tax forms are complex and filing requirements taxpayers who risk facing NBR harassment.
Given the above situation, the core tax reforms will need to comprise of the following:
Separation of tax policy from tax collection
An essential institutional reform is to separate tax policy from tax collection.
The NBR’s single-minded focus on tax collection has come into serious conflict with formulating a broad-based tax policy that is consistent with revenue goals as well as the efficiency of tax collection.
A better arrangement would be to assign NBR the responsibility to collect taxes and give tax policy to a special unit in the Internal Resource Division.
Strengthening tax policy and tax collection agencies
Both tax policy and tax collection efforts have to be substantially strengthened through the induction of tax professional staff.
Professional tenure-track selection of NBR chairman
The chairman should be selected on a professional basis with a minimum tenure of 4-5 years.
This will de-politicise this position and provide stability and incentive to take tough actions against corrupt practices.
Similarly, the head of the Tax Policy Unit should be the competent professional staff.
Fully digitising tax administration
Full digitisation of the tax administration is of the highest priority, especially for personal income taxation, as it will reduce corruption, improve compliance and increase revenues.
Reform of the VAT
The VAT Law of 2012 aimed to convert the VAT into a modern system with potentially high revenue yield. It should be implemented urgently in its original form.
Income taxation
A major overhaul is needed, based on positive global experiences:
• The best approach to increasing tax compliance is to provide incentives for voluntary compliance through low marginal and average tax rates.
• The tax system must adopt the principles of universal income with limited exemptions, self-assessment and productive and selective audits. It must be fully digitised with no interface between the taxpayer and the tax collector.
• The tax system must be simple with low compliance cost. In particular, the requirement to balance income with expenditure in the tax form is intrusive, a source of major harassment, and causes anxieties for voluntary compliance. It leads to revenue loses through collusive behaviour and non-filing and must be removed.
• Separate the wealth tax from the income tax by establishing a modern property tax system.
• The audit system should be highly selective and productive. The objective of the audit system should be to discourage tax avoidance and not used it for bribery and harassment.
• The attitude of NBR should change from tax “policing and harassment” to voluntary tax compliance based on a user-friendly and tax service approach.
Property taxation
A modern property tax that is based on the true market value of properties and evaluated and updated systematically using a computerised property ownership database is an essential element of a modern tax system.
There are many country-specific models of a well-designed property tax system that can be researched and implemented in the specific political economy context of Bangladesh.
Implementation can proceed in a phased manner with the capital city of Dhaka and then extended to other divisional cities and finally to all urban areas.
Sadiq Ahmed is vice-chairman of the Policy Research Institute of Bangladesh