The challenge of achieving tax revenue target

Bangladesh's solid track record of continued macroeconomic stability is largely attributable to prudent fiscal management. Successive governments have demonstrated solid fiscal management, despite limited public sector resource availability, primarily through strict expenditure control and prudent debt management. Over several decades the government has contained the overall fiscal deficit at or below 5% of GDP (gross domestic product) which, together with its policy of relying on concessional external financing, helped reduce the burden of public debt over time. This is certainly a remarkable achievement for a developing country like us.
This achievement notwithstanding, it is also true that the fiscal policy in Bangladesh is on a "low level equilibrium" with a very small size of government-measured in terms of level of fiscal spending-which is incapable of addressing the growing social spending and infrastructure needs of the society. At less than 16% of GDP the size of the government is too small, forcing the government to limit its expenditure on all major categories of spending: expenditure on health at 0.8% of GDP; on education at 2% of GDP; social protection at 1.6% of GDP; and infrastructure spending at --% of GDP. All of these major categories of spending are at or below 50% of what their desired level should be when compared with many other developing and emerging economies.
This low-level fiscal operation must change if Bangladesh is to achieve the socio-economic objectives envisaged under the 7th Plan. The Plan aims to increase the size of the Government by about 5 percentage points to 21% of GDP by FY20. More than 20% of the increase will be on account of the larger ADP. However, much of the expanded spending will be directed to expanded coverage and better quality of public service delivery. With the type of structural transformations outlined in the 7th Plan, expenditure side of the government budget would look more like Figure 1 below.

 This positive  turnaround both in terms of non-ADP spending and financing of a larger proportion of ADP by own savings  will only be possible if the strategy for revenue mobilization is realized as Planned. The remainder of the paper outlines the Revenue Mobilization Strategy Under the 7th Plan and what needs to be done in the next budget, which will also be the first budget under the 7th Plan and should lay the foundation for the sustained increase in tax/GDP ratio over the Plan period.
REVENUE MOBILISATION UNDER THE SEVENTH PLAN: The Seventh Plan is being formulated against the background that the revenue targets set under the Sixth Five Year Plan were not achieved despite strong performance in the first two years of the Sixth Plan (Table 1).

The total revenue target was not achieved in any of the years, although performance was reasonably better in the first two years of the Plan period. The major shortfall in terms of GDP ratio was to a large extent attributable to a significant upward revision of the GDP series with the rebasing of GDP to FY05 from FY95 base. The upward revision of the GDP series in general contributed to a reduction of the revenue to GDP ratio by about 1.2 percentage points. Thus while the average annual revenue shortfall appears to be 3.3% of GDP, the actual shortfall was about 2.1% of GDP after taking into account the upward revision of the GDP series due to rebasing to FY05 the whole national accounts series. The shortfall was mainly from NBR taxes, since non-tax revenue was mostly in line with its targets, except for the GDP revision induced effect.
Figure: 2 Growth in Tax Components under the Sixth Plan  

Source: SFYP Documents and NBR
Growth of domestic VAT and direct (income) tax has been on a persistent decline after recording respectable growth in the first two years of the Sixth Plan, partly due to non-implementation of necessary reforms. In the past, high growth years (in terms of revenue collection) such as FY08 and FY11-FY12, have coincided with years in which some tax reforms and tax measures were implemented. However, since the reform process was not sustained, the positive impacts have started to diminish in the years that followed. In FY11, some VAT and income tax reforms (particularly widening of withholding at source) were implemented which led to the increase in tax collections surpassing the set targets. While the positive effects of these reforms continued until FY12 and some up to FY13, because the new package of reforms was delayed the tax buoyancy started to diminish eventually leading to the slump in revenue collection experienced in FY14. The tax revenue growth rates from FY06-FY15 are show in Table 2 below.

In light of these considerations, achieving the tax revenue target under the 7th Plan will be a major challenge. The required growth rate would need to be almost 24% per annum over whole Plan period, compared with 17.8% average growth recorded over the Sixth Plan period. The higher growth rates observed in the first three years of the Sixth Plan could not be maintained, mainly because NBR reform efforts were not sustained over the whole Sixth Plan period.
Figure 3: Growth in Taxes under different scenarios

 Source: PRI Staff Calculations
In line with the growth scenario under the Plan, the tax-GDP scenario is presented in Figure 4 below. These scenarios build a strong case for the need for tax reforms, particularly in the collection of domestic taxes which would constitute bulk of the revenue collection effort. If there are no major reforms during the 7th Plan period, it would be quite possible that tax revenue performance will fall back to the pre-SFYP (FY06-FY10) levels and thereby would result in a tax/ GDP ratio of 11.4% by FY20.
Figure 4: Tax-GDP Ratios under Various Scenarios

 Source: PRI Staff Projections
Based on the analysis presented above, the revenue targets under the 7th Plan are presented in Tables 3 and 4 below. In the last five years, NBR revenue constituted 96.5% of the total tax revenue which is expected to continue into the 7th Plan period since, Non-NBR taxes has been stable accounting for about 3.5% of total tax revenue. Therefore, the NBR revenue target should be set at 14.3% of GDP against a total tax revenue target of 14.7% of GDP at the end of the seventh five year plan period. The resultant total revenue target will be 16.1% of GDP, which is five percentage points higher than the 11% of GDP estimated for FY15.

The 7th Plan revenue projection presents an opportunity for Bangladesh to break out of the 10%-11% of GDP level that it has been stuck in recent years. The 4 percentage point increase in revenue in relation to GDP over a 5 year period, while ambitious in the Bangladesh context, is quite possible if we review the revenue performance of other developing countries. Many developing and most middle income countries have already done it and certainly Bangladesh can do it, despite its unimpressive track record on this front. For example, despite all gains, currently Bangladesh VAT system is one of the most inefficient in the world with the lowest VAT productivity (Figure 5). This must change if we are to achieve the revenue objective in the long run. The same inefficiency applies to the Bangladesh direct tax system.
Figure 5: VAT Rates and Productivity in Selected Countries

 Source: Selected Issues, Fiscal Affairs, IMF, 2013.