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Bangladesh's current economic crisis and tax policy

Shafiun N Shimul | November 23, 2022 00:00:00

Taxpayers submit their returns at a centre of the National Board of Revenue in Dhaka

Recently, the possibility of a financial crisis in Bangladesh has been looming. Even though Bangladesh has achieved sustained growth in recent years, this pace of consistent growth appears to come to be coming to a standstill.

The Covid-19-induced economic downturn; and reduced global demand for our export items ensuing from the financial slowdown in many countries, maybe partly to blame.However, some deep-rooted inefficiencies are also the culprits, such as poor macroeconomic management, poorly regulated financial sectors, and poor taxation strategies combinedly also playing a significant role.

Even though Bangladesh's economy is fundamentally different from Sri Lanka's, some similarities remain. For instance, large investments in many mega projects without carefully considering their economic viability, low tax-GDP ratio, the emergence of business and political elites, and rampant corruption allude to the grave and grim realities in the coming days.

Even though the financial crisis of Sri Lanka surfaced only recently, the problem resulted from wrong macro policies, many of which were previously warned by experts, but those omens were ignored.

A similar trend is prevalent in Bangladesh. This culture of denial has to be overcome immediately. Currently, Bangladesh is facing two major setbacks: internal economic shock stemming from inflation, and repeated power failures, which are again connected to the second one-declining foreign reserves. While Bangladesh has limited options for boosting reserves very quickly, some remedial measures can be taken to halt the pace of dwindling reserves. For instance, Bangladesh bank should enhance its current capacity and willingness (with strong government support, of course) to reduce money laundering. It is not unknown what the potential routes of that capital flight are. One is definitely under or over-invoicing of export-import. In addition, it is well known that many of those capital flights are routed through some countries where it is easy to transfer money elsewhere. Bangladesh Bank can strengthen monitoring of those sectors and companies or individuals who might be potentially using those routes.

Even though we provided strong incentives for the RMG sectors, some allege that the government rarely provides such support for other export industries. It is high time to do that to increase our export earnings and thus increase foreign reserves. Prompt and immediate actions regarding what to do to promote exports are paramount.

Historically, Bangladesh remained over-reliant on indirect taxes such as VAT. While it is often regarded as less distortionary compared to other direct taxes, interestingly, it is hard to believe that the main reasons for choosing indirect taxes over other taxes are driven by economic rationale. Rather this tax structure is adopted for ease of doing things. In addition, the business and political elites have always preferred this tax structure as, in this case, the burden of taxes rarely falls on them. Due to poor governance, it is difficult to collect taxes from large companies or corporations as they are sometimes also part of the ruling elite. Bangladesh opted for VAT, which is regressive in nature, and the poor bear a larger proportionate burden of taxes.

The economic crisis has put double pressure on the government. On the one hand, tax revenue may decline substantially, and an increased need for government expenses due to the enhanced need for social security and to keep economic activity running. Therefore, designing a good tax structure is of paramount importance.

As mentioned before, Bangladesh has a very low tax GDP ratio, partly due to low tax collection from non-VAT or direct taxes. Even though it is often believed that high income and corporate taxes may affect the economy negatively, that may not be the case for Bangladesh as it is already low if we consider the effective collection. Bringing the business rouges under the tax umbrella can significantly increase the tax revenue even if we do not increase taxes. In addition, it will have a positive effect on economic management and can increase taxes. The government would need to explore more sources for collecting taxes from the sector that will be less responsive to the tax increase. Imposing taxes on tobacco or related products can be a good option to enhance revenue.

Tobacco and related products are relatively inelastic or less responsive to prices. Therefore, the price increase with higher tax rates can be a win-win situation. On the one hand, consumption will decline, especially in the relatively young and low-income category, as the elasticity in this group is relatively larger. While the tax and price increase may slightly reduce consumption, overall tax collection, in fact, can increase substantially. On the other hand, decreased consumption has some other health benefits. Even though the health benefit may not be immediate, a tax increase will eventually yield a significant health benefit. Therefore, this type of tax is a viable option for countries like Bangladesh.

Finally, the government can form a high-level advisory group consisting of some neutral experts, including Bangladeshi-origin experts from all over the world, to take necessary actions in the current crisis. If the government is over-reliant on bureaucracy and politically motivated experts, the outcome will be the same. Hence, the selection of those experts is also equally important.

No doubt, Bangladesh has been under intense pressure unseen in the recent past. Our honeymoon period of growth is dimming. However, we must do something before it gets too gloomy. We have to start somewhere, and taxation and financial regulation could be our starting points. The economic crisis is not a problem of the government but of the country, and so we have to behave accordingly, and a wholehearted effort is needed-more than ever before.

Shafiun N. Shimul, PhD, Associate Professor, University of Dhaka, Post-Doctoral Fellow, Georgia State University, United States.

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