Urgency of tax policy rationalisation

KEY RECOMMENDATIONS ARE AS FOLLOWS:  The weighted average prices of bidi and cigarettes are quite low in Bangladesh and increasing this weighted average price is the only way to reduce smoking and generate 20% growth in year on year revenue from tobacco products. Since 63% of the cigarette industry is low segment, moving the floor price up by increasing the tax would be the way to move forward. The same principle applies to bidi where the tax increases There is virtually no scope for increasing the tax rates on premium, high and medium segment cigarettes.  Any increase in tax rates for the top three segments beyond the current 77% of final price may lead to a fall in revenue. Volumes of sales in these three segments are already falling. For the premium segment the main completion is from smuggled international brands which can flood the market if the domestic price is too high. For the medium segment, the main cause for lower sales is the down trading to cheaper low segment cigarettes. Both social cost and revenue loss are huge and the policy must change.
There should be no Dead Zones in the pricing structure and the pricing issue should be left with the manufacturers so that they can adjust prices to compensate for tax increases.   Differentiation among the 4 different segments of cigarettes (premium, high, middle and low) should be based in terms of identified price floors and there should be no cap on prices for three lower segments and hence no dead zones. This will allow for increase in prices to have a positive impact on tobacco control, yield more revenue, and prevent operators to place illegally smuggled cigarettes into the dead zones.
The health development surcharge should have the dual objective of discouraging consumption and dedicating the revenue collected from the surcharge for targeted smoking control programmes/projects. To discourage consumption the prices of cigarettes should have been increased by at least the amounts of the surcharge and burden of the new surcharge should be on the consumers in order to directly impact their buying behaviour. Furthermore, administrative arrangements should be put in place to direct the funds generated through this surcharge for strengthened tobacco control, prevention and remedial measures.
In line with the global best practice, Bangladesh should also move to a uniform tax structure for all smoked tobacco products. Taxes on top three segments at more than 75% is high and there is virtually no scope for increasing the tax rates on premium, high and medium segment cigarettes. This policy would entail increasing the tax rates on low segment cigarettes and bidi--which are taxed at substantially lower rates--to the current maximum rate of 77% of final retail price. It is morbid to justify lower taxes on low segment cigarettes and bidi to keep prices affordable for the low-income consumers because the harmful effects on their health is not factored in.
Finally, given the very high rates of taxation on cigarettes in Bangladesh for the top three segments, the tax system needs to be supported by good tax administration and collection systems. Adopting more aggressive ways to curbing smuggling and counterfeiting, coupled with the elimination of dead zones (as proposed earlier), would go a long way in containing smuggling and tax evasion and enhancing the buoyancy of the tobacco tax system.
WITHHOLDING OF PAYROLL TAX: Payroll withholding is the most important source of income tax collection in all developed and emerging economies. Generally speaking 70%-80% of the value addition in an economy is attributable to the workers and self-employed. Thus tapping this most important source of income at source, that is, at the stage payrolls are distributed is the most secured way to maximise on income tax collection. Tax administration in Bangladesh is very weak in this respect. For example, Bangladesh collects only 2%-3% of the total income from payroll, compared with more than 87% in the UK and 63% in Australia.

A review of what is collected at source in Bangladesh also reveals the basic weakness of the tax administration and its growing dependence on collecting taxes from a few well-identified sources such as: withholding by government agencies for contractors and suppliers; withholding at the import stage from importers; and withholding through financial institutions. Income tax deducted from salary-earners or payroll amounted to Tk. 5.6 billion in FY12, accounting for only 3.7% of the total tax deducted at source. No good tax administration would go for taxing at contractor/supplier and import level because such methods are dictionary and often corresponds to indirect taxes to be passed on to the consumers. Such practices, which could only be justified as interim measures, have become a permanent phenomenon of Bangladesh direct tax system.   
NBR direct tax wing needs to set up a dedicated department to monitor withholding agents, get the withholdings linked to the payroll of staff provided by withholding agents (the business enterprises), and follow up on persons who has paid withholding tax but not submitted the income tax returns.  

BROADENING OF INCOME TAXPAYERS' BASE: The number of TIN (Tax Payer's Identification Number) holders in Bangladesh is extremely low at 1.8 million in FY15, which has declined from the previous level (FY13) of more than 2.0 million registered taxpayers. This decline with the introduction of e-TIN system is a matter of concern. Furthermore, out of the 1.8 million e-TIN holders only little over 1.0 million submitted tax returns as of November 2014, the final closing date for return filing. The overall situation is disappointing given that, despite the doubling of the size of the economy over the last five years, the number of TIN holders has fallen and the number of return filers has not changed much. Part of the problem is associated with the upward adjustment in the income tax threshold almost every year. The other part is associated with the tax department's inability to expand taxpayers' base through tax surveys and monitoring of payrolls at the enterprise level.
The Direct Tax Wing of NBR should be given a target for increasing the number of TIN holders every quarter and modalities must be worked out how the targets can be achieved. Some other complementary measures may also be considered to help the process, such as:
* No property registration can take place when the parties do not have income tax registration and the process can start with urban properties across Bangladesh.
* Getting payrolls from all public and private enterprises and issuing them TIN numbers when they do not have their own.
* Issuing all home and land owners in all large and medium cities [TIN numbers], unless they already have one.
* No Bangladeshi 25 plus years old passport holders can purchase tickets if they do not have TIN numbers.  
INCREASING THE TAX RATE ON RMG AND KNIT EXPORTERS: Garment and textiles sector is the most dynamic sector of Bangladesh and it is the most under-taxed sector as well. Over the last several years the tax rate on the RMG exporters was slowly increased from 0.25% of export volume to 0.8% of export volume in FY13 budget. However, in order to mitigate the higher costs incurred by the sector in FY14 due to political disturbances the rate was temporarily cut down to only 0.3%, on a time-bound basis. This rate should now go back to at least the original level of 0.8% in FY16 and should further go up in the coming years.
There is no justification for taxing the fastest growing sector at such an artificially low rate while taxing the rest of the economy at much higher rates. It is generally believed that on the assumption of 10% average profit on turnover the rate which would make the turnover tax equivalent to the top rate of 30% would be 3%. Thus even at 0.8% rate the sector is being taxed very lightly in a discriminatory manner and this should change in the coming years. The revenue impact from this modest move of getting back to the old rate would be about Tk. 6.0 billion.
INTRODUCTION OF A PROPER PROPERTY TAX SYSTEM: The simplistic manner of imposing Wealth Tax in the form of an Income Tax surcharge of 10%-15% must be abandoned and the NBR should move to develop a proper "Wealth Tax" or "Property Tax". The current practice essentially increases the top personal income tax rate by additional 3-4.5 percentage points to 33%-34.5% which is very high. Such high tax rates diminish the incentive to work and in most cases tend to increase tax avoidance. This practice must be discontinued. NBR has to build up its capacity for proper administration of property/wealth tax with proper study and to determine the right way to collect the tax, not simply by taxing the tax-paid taxable income once again in the form of a surcharge. Implementation of a proper property tax system with necessary administrative preparations will take at least two years and the process should start in FY16.
TAXATION OF CAPITAL GAINS FROM ALL SOURCES: All capital gains should be subject to taxation. The capital gains should be collected at the point of sale when the transaction is recorded. For example, capital gains from every sale of land or apartment should be collected at the point of sales registration as a withholding tax and to be reported at the time of income tax return. All land/apartment registrations should be linked with the income tax wing of NBR and sales information should be accessed from central data bank or based on reports sent by registration offices to the nearest income tax department. The tax rates should be uniform (as much as possible) and the base should be as broad as possible.
RATIONALISATION OF SUPPLEMENTARY DUTY STRUCTURE IN LINE WITH THE NEW VAT LAW: Government of Bangladesh intends to implement the new VAT law in FY17. Along with systemic improvements and elimination of some of the distortions, the law also aims to remove Supplementary Duties (SD) imposed on most imports. More specifically, law suggests imposition of SD on around 250 items, compared with about 1400 items subject to SD at the import stage at the moment.
A recent study by PRI titled "Revenue, Price and Protection Impacts of the New VAT Law" indicates that currently there are more than 16,500 tariff lines (i.e. products) subject to SD at different rates ranging from 0%-500%. Out of these the number of products with positive SD rates is 3,439 (or 20.8%). Almost 14% of tariff lines fall between SD rates of 10% to 60%. Only 0.57% of tariff lines fall under rest of the five high SD rates (i.e. 100% to 500% SD rates). Tariff lines associated with special imports (Special imports include imports for President and duty-free cars for the Members of Parliament. These also include relief goods, defence equipment, equipment for disabled persons, imports under baggage rules. Duty-exempt imports by foreign diplomatic missions and development partners are also included under special imports.) are 1,065 or 6.43% of all tariff lines. Thus, SD rates on 3,439 products need to be rationalised in conformity with the proposed VAT law. A phased strategy may be adopted where SD rates on half of 3,439 products may be rationalised in FY16 and rest in FY17.
The report concludes that implementation of full package of the new VAT law is revenue augmenting. Elimination of SD on imports, although may appear revenue diminishing under a comparative static analysis, in reality it may turn out to be revenue augmenting when elasticity factors (please note most of the products under import stage SD are price elastic and hence rationalisation of SD rates would lead to higher import and revenue) are incorporated into the analysis.
TAX POLICY RATIONALISATION OVER TIME: Bangladesh tax policy has a number of distortions and there is need for tax policy rationalisation to enhance growth prospects for certain dynamic sectors of the economy and for making economic growth environmentally sustainable. Based on detailed background studies prepared by PRI, we would like to mention some of them:
Telecom/ICT Sector: Telecom/ICT sector in Bangladesh is subjected to extremely high level of taxation. A study by Miller and Atkinson under the auspices of the International Technology Information Foundation (ITIF) shows that Bangladesh has the highest rate of taxation of ICT among the 125 countries reviewed in the study (Figure 10). The primary basket of ICT goods and services used in the study consists of taxes and customs duties on the following: basic mobile phones, smart phones, computers and other digital products like digital cameras and digital audio devices.  Taxes are computed as a per cent of cost of service provided.  China imposes the lowest taxation (3%) while Bangladesh the highest (an astounding 58%). The second highest taxation is in Turkey, at 26%.  Taxes in 40 of the countries in the study are in the low range of 3-5% and taxes in the remaining others are mostly in the 5-20% range.  In the global context, Bangladesh is clearly an outlier in the matter of high ICT taxation.
Figure 10: Taxation of ICT as a per cent of Cost

The development role of knowledge economy through ICT has just started and the returns are already being felt. The future growth and revenue potential of this sector is immense and the Seventh Plan will need to adopt consistent strategies and policies to take this forward. Two special challenges will be to further increase the mobile telecom-density and expand internet and bandwidth connectivity through investments in network infrastructure and incentive for the un-served population to use these services. The supply expansion and demand increase will both require substantial reductions in ICT taxes. This will be a win-win policy because a larger subscription volume will both benefit service expansion and total tax revenues from ICT. DUTY RATIONALISATION FOR ENVIRONMENTALLY-FRIENDLY CAPITAL MACHINERIES: The textile sector in Dhaka comprising 1700 washing, dyeing and finishing (WDF) units currently consumes 1,500 billion liters of groundwater annually to produce 5.0 million tons of fabric (300 liter per kg fabric). The WDF units in Bangladesh are extremely inefficient in water use with the average water use per kilogram being 300 liter compared with the global standard of 50 liter per kg. This inefficient use of groundwater at a massive scale contributes to 1-2 meter per year decline in the water level in certain parts of Dhaka city, whose impact is already being felt through seasonal water shortages in Dhaka and its environs.
The sector is also a major contributor to water pollution and scarcity, impacting health, food production, and other economic sectors.  In case of water pollution, textile sector is the second highest polluter following tanneries. With the projected expansion of RMG (ready-made garment) and Textile sector in Bangladesh over the next 15-20 years and adhering to current inefficient production process suggest substantially faster depletion of ground water. Furthermore, influx of untreated water wastes from the textile and leather factories due to lack of ETP (effluent treatment plant) facilities would continue to contribute to large-scale pollution of water bodies in Bangladesh. Thus, textile and other sectors in Bangladesh need to upgrade equipment, machinery and treatment facilities not only to improve water efficiency but also to lessen water pollution. Upgradation and modernisation process would require access to low-cost financing as well as other incentives in the form of conducive tax policy.
In terms of the current tax structure, the APEC list (the list of goods prepared by the Asia and Pacific Economic Cooperation) of environmental goods contains around 70-72 items out of which many items have a Customs Duty Rate (CDR) of 25%, 12% and 0% while the majority have a CDR of 3%. Although, there is no Supplementary Duty on most of these items contained in the APEC list, only two items are subject to a Supplementary Duty Rate (SDR) of 20%. Regulatory Duty Rate (RDR) of 5% has been imposed on few of the items while the rest are not subject to no RDR.
The proposal is to set CDR on all APEC listed capital goods at 3% with no supplementary duty and regulatory duty. PRI background study indicates that such a move would lower the price of APEC goods significantly leading to higher use of water and energy efficient investment with negligible revenue loss.
DUTY RATIONALISATION TO DISCOURAGE USE OF HAZARDOUS CHEMICALS IN THE TEXTILES WET PROCESSING AND LEATHER SECTORS: Hazardous chemicals are being used in Bangladesh, particularly in the textiles wet processing (washing and dyeing) and leather industry, without regard to health and environmental considerations. Bangladesh is considered to be the number one producer of denims (blue jeans) which is a major source of chemical pollution. While we all would like to have industrial expansion, the growth should be environmentally sustainable and not at the expense of human health for the current and future generations. As part of an international initiative called Zero Discharge of Hazardous Chemicals (ZDHC), Bangladesh Government and industry also need to play their due role in this regard.
The roadmap to Zero Discharge Hazardous Chemicals (ZDHC), if adopted by the Bangladesh Government and industries, will help lead the industry towards zero discharge of these identified hazardous chemicals by 2020. As part of that initiative, Bangladesh can start with either increasing the tax rates on these hazardous chemicals to discourage their use and at the same time encourage the users to switch over to better and non-/less-hazardous chemicals. The Government may also impose an outright ban to discourage their use by industries, including textiles and footwear.
Increasing the tax rates will not lead to revenue losses for NBR even if the tax rates are prohibitively high because in all cases there are better substitutes and firms will replace these hazardous chemicals with better import substitutes. Industries currently have the readily available option to switch to substitutes which are environmentally friendly. According to chemical industry sources, it would generally cost about 10% more for the firms to switch to better substitute chemicals. As a matter of fact, this potential substitution would be revenue augmenting rather than losses as these substitutes are about 10% more expensive to import than the hazardous chemicals.
Dr Ahsan H Mansur is the executive director of Policy Research  Institute (PRI ).
[email protected]