Bangladesh has made noteworthy progress in revenue mobilization in recent years. The tax revenue-to-GDP ratio was fairly stable during fiscal year (FY) 05-09, at an average of 8.6 per cent. Since FY10, the tax revenue ratio has been on a rising path, reaching 10.5 per cent of gross domestic product (GDP) in FY14. Non-tax revenue as a ratio to GDP averaged 2.0 per cent annually during FY05-14.
The increasing tax revenue ratio reflects expansion of the tax base as a result of improvements in tax administration and enforcement. The key reforms included separation of tax policy from tax administration, placement of the two Large Taxpayer Units (LTUs) under one roof, efforts to increase registration of tax payers, reducing tax exemptions and exclusions, and promoting voluntary compliance through social awareness.
TAX STRUCTURE CHANGING IN THE RIGHT DIRECTION: The increase in the tax revenue-to-GDP ratio involved a shift in the tax structure toward domestic-based taxes. The share of import-based taxes in total (National Board of Revenue or NBR) tax revenue has fallen from 39.7 per cent in FY 09 to 29 per cent in FY14. In contrast, the share of domestic-based taxes in total revenue has increased from 60.3 to 71 per cent during the same period. Within domestic-based taxes, the share of income tax has increased more than the share of domestic value added tax (VAT), so much so that income tax now constitutes the single largest (32.8 per cent) source of NBR tax revenues. Increasing share of domestic production and rendering of services in domestic consumption led to the shift in the composition of VAT revenue from import-based VAT to domestic VAT. The expansion of domestic-based VAT to wholesale, retail and service sectors has played an important role. Some sectors subject to VAT- such as cell phone-based communications, the formal construction sector, travel, transport, and hotels and restaurants-have grown faster than GDP.
Despite the gains, tax collection in Bangladesh is among lowest in Asia, such as Vietnam (24 per cent), China (18 per cent), India (15 per cent), Nepal (13 per cent), and Sri Lanka (13 per cent). The collection of both direct and indirect taxes relative to GDP is significantly lower than the Asian comparators, while the collection of international trade taxes relative to GDP exceeds that of most comparators. With comparatively high nominal tax rates and low revenue yields, Bangladesh's revenue productivity for personal income tax and the VAT remains very low compared to the region. Continued excessive use of a variety of tax incentives, structural flaws in the main taxes and corruption contribute to the low tax productivity.
MOVING THE REFORM AGENDA FORWARD: Bangladesh entered the new fiscal year on the heels of a disappointing revenue performance in FY14. In the FY14 budget, the government had set an ambitious NBR revenue target of Tk 1,360 billion, which was 25.2 per cent higher than the FY13 actual. This would have been challenging even under normal circumstances. Economic slowdown exacerbated by shutdowns and strikes made its achievement harder. The revenue growth slowed across the board, although the deceleration was dominated by trade-based taxes, which increased only 3.9 per cent in the first eleven months of FY14 relative to the same period the previous year. Both VAT (domestic) and income tax revenue growth have been well below the rates of growth required to achieve their respective budget targets. The government has reduced the Advance Income Tax (AIT) on exports for FY15. In this context, achieving 20 per cent growth in tax revenue in FY15 will be a major challenge.
As envisaged in the FY14 budget, getting 4.0 per cent of GDP additional tax revenues over a five-year period is possible, but will require significant improvement in the mobilization effort. This year's budget aims to modernize the tax structure by increasing reliance on a progressive income tax system. Income inequality is high, while the share of taxes paid by the rich is comparatively low. This reflects a serious governance problem, where the rich and powerful easily get away with tax avoidance and cheating. The budget attempts to address this problem through a range of measures, including taxation of capital gains. But the budget does not go far enough.
Reforms are still needed in a number of areas. The income tax measures should be broadened substantially and replaced by a well-conceived property taxation policy. All personal income derived from engaging in economic activities in Bangladesh should be taxable, irrespective of the source. If tax incentives are needed to motivate additional domestic and foreign investment, those concessions should be provided in a way that does not undermine tax compliance. The tax base needs to be broadened through stronger enforcement of tax laws, along with efforts to further simplify tax filing and the tax payments system.
In this regard, continuation of the facility to whiten black money has been disappointing. This scheme has consistently failed to meet its investment and revenue objectives. Only Tk 21 billion was whitened during FY09-13, out of which Tk 2.3 billion (10.9 percent of money whitened) was collected in taxes. A regular tax payer in the top income tax bracket will now be paying 30 per cent whereas a tax evader pays 10.9 per cent by whitening the money. This system encourages evasion and penalizes tax honesty and compliance. It makes tax payment an economic decision subject to cost-benefit calculus. Taxpayers weigh the benefits from not paying taxes in terms of lower rates and buying time against the cost of detection. A permanent black money whitening facility reduces the latter nearly to zero, thus making not paying taxes the dominant choice for those who associate no moral costs with tax evasion. A culture of tax evasion with impunity inevitably results.
The budget continues to rely rather heavily on supplementary trade duties. These taxes distort incentives against export diversification. By creating an arbitrary wedge between domestic and international prices, these taxes make production for the domestic market artificially profitable. A significant anti-export bias remains due to the structure of tariffs that raise relative profitability of domestic sales vis-à-vis exports. This applies particularly for firms engaged in production for both domestic and external markets. The supplementary duties have been partially rationalized in the FY15 budget, but much more is needed. Para-tariffs still proliferate and nominal protection rates on domestically-produced consumer goods are prohibitively high.
There is significant potential for increasing VAT collection, including by accelerating implementation of the new VAT law and digitizing VAT collection. The VAT rate which is now charged on the basis of fixed value addition or truncated value for different goods and services has effectively been raised in some cases. The increase will help businesses get ready for paying 15 per cent under the new VAT law, effective from July 2015. Businesses such as government contractors, suppliers and certain types of restaurants have been paying VAT at 4.0 to 9.0 per cent on the basis of a truncated value.
EXPLOITING WIN-WIN: Exploiting win-win opportunities in tax policy is critical. One candidate is the corporate tax rate, which is on average in Bangladesh too high by international standards. Evidence shows that lowering the over 40 per cent rates to below 40 may actually increase corporate income tax revenue. The FY15 budget has taken a tiny step towards harmonizing the corporate income tax rate by reducing the 37.5 per cent rate on non-listed corporates to 35 per cent. The rate cut may encourage those firms to be more compliant, who show losses or low profits to evade taxes. A recent International Finance Corporation (IFC) survey of formal and informal enterprises indicated unhappiness amongst the businesses about the differences in tax rates. NBR should harmonize the rates with a view to encouraging businesses, especially private limited liability companies, to report actual profits in the annual return, which in turn would help increase revenue from business income tax. Tax harmonization is likely to encourage businesses, especially the proprietorship firms, to register themselves with Registrar of Joint Stock Companies and Firms.
The NBR Modernization Plan needs to be implemented in a much quicker pace. The plan has all the key ingredients of making the organization modern, efficient and capable of delivering the challenging revenue targets. There has been some progress on VAT in the context of the International Monetary Fund (IMF)-supported Extended Credit Facility (ECF) program. The new VAT Act of 2012 modernizes the VAT, but this has to go hand in hand with a reformed VAT administration along functional lines. It has to be backed by modern information technology (IT)-based integrated business processes. Currently, the Bangladesh VAT system is one of the most inefficient in the world, with the lowest VAT productivity.
It is critical to improve communications with taxpayers. Businesses want a clearer picture of their legal obligations and the expected procedures. They want straight answers to their tax-accounting questions. NBR has been holding tax fairs, which also allow businesses to obtain Tax Identification Number (TIN) on the same day. More rigorous dissemination of information is needed about all tax procedures and about taxpayers rights and obligations. Electronic and print media campaign as well as regular seminars can be used. The mass scale campaigns can also be done in partnership with mobile service providers. The other important step is capacity development. Some NBR officials may need further training in tax accounting as it applies to business. In addition, small businesses currently in the fixed regime would surely benefit from guidance in basic bookkeeping.
Innovative approaches to improving compliance can help. One such approach is to leverage firms' interest in social recognition to increase compliance. If the government can cheaply provide recognition and firms find that attractive, then recognition and status programs may be cost-effective in raising revenues. Experiments done recently in Dhaka suggest that in the neighborhoods where some firms were already complying, the promise of exposing information about all firms' tax payment behaviour led to an increase in tax compliance, especially among firms who had not paid the previous year. The upshot is that social incentives and peer effects can be an effective way to improve tax compliance.
Without these broader reforms, the 4.0 per cent of GDP additional taxes over next five years will not likely materialize.
(The writers are respectively Lead Economist and Country Director (Bangladesh, Bhutan and Nepal), the World Bank. Email: mmahbub@worldbank.org)
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