Two cheers for the taxman

Jyoti Rahman

Published in the Daily Star on 13 July 2010.

This piece explores the revenue outlook in this year’s budget.

TYPICAL debates surrounding our budgets focus on the expenditure side, particularly the size and implementation of the annual development program, forgetting the other side of the ledger. As it happens, it’s the revenue side where there may be some reasons to celebrate in the near term, and a closer observation is warranted into the medium term.

Let’s start with the first possible reason to celebrate. Much like the development program, our budgets used to be characterised by ambitious revenue targets that were revised down subsequently, with the final outcomes missing even the revised targets. In more recent years, targets were revised up, but the outcome continued to underperform.

As is shown in Chart 1, revisions to 2009/10 (FY10) revenue targets have been minimal. And according to analysts, buoyant household consumption is generating enough revenue such that there is a very good chance that these targets will be met.

That’s cheer number one. But there are reasons to fret too.

The first concern is that revenue in Bangladesh has been far lower than other comparable economies in the region (Chart 2). This is not news. But it is always worth repeating the fact that our government does not collect enough revenue to pay for our teachers, nurses, and police officers, not to mention the public investment needed to achieve 7%-8% economic growth and cut poverty.

It is also worth stressing that it is possible to have significantly more revenue relative to the economy without draconian measures underpinned by radical political changes — India raised revenue by 4% of GDP in the past decade, for example.

A relatively lesser-known cause of concern is about where our revenues come from.

Other than non-tax revenue such as asset sales, there are three broad classes of tax that fill the public coffer; income taxes, consumption taxes and import taxes.

Income taxes, whether levied on wages and salaries, profits, or capital gains, are equitable, particularly if they are on a progressive scale, because the relatively affluent pays more. However, these taxes can discourage wealth creation, and thus stifle prosperity, if levied at too high rates.

Consumption taxes such as the Value Added Tax that are levied on goods and services are the least distortionary in terms of economic impacts. But they can be inequitable as they can impact more heavily on the less affluent.

Taxes on imports — tariffs and customs duty, or VAT on imports — are inequitable, and distort economic activities by sheltering domestic producers from competition. The result is often inefficient production and resource allocation, the cost of which is ultimately borne by the (often poor) consumer.

As is shown in Chart 3, we rely far more on taxes on imports than our neighbours do, while income taxes make a smaller contribution to revenue in Bangladesh than in other similar economies.

The government is well aware of the first concern, acknowledging it in budget documents. The government’s medium term target is to raise the revenue-to-GDP to about the same level as that achieved by India and Pakistan currently. This is going to be achieved through tax administration reforms that seek to improve collection, help the taxpayer, and eliminate opportunities for tax evasion.

Specific initiatives such as separating tax collection from officials by allowing payment through banks or online can go a long way in meeting the target. And articulating such an agenda is certainly worth a cheer — the second one.

But as shown in Chart 4, this projected revenue boost comes mainly from VAT and supplementary duties. The projection leaves the contribution of income taxes to total revenue unchanged. And if recent trends in VAT and supplementary duties from imports continue, we will still be heavily reliant on import taxes.

The government claims that it is looking into the possibility of reducing the reliance on customs duties and ad hoc supplementary duties. We are told that there is a National Board of Revenue Taskforce on tariff rationalisation. And the government is considering the proposal for separating tax-policy-analysis functions from the tax administration functions of the NBR (this separation is the norm in most countries).

However, as things stand, these are rather vague notions. This budget has been described as an honest pro-growth one that is necessarily ambitious. For these views to be tenable, genuine tax reforms are needed. And for that, we can’t raise a cheer quite yet.

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