VAT on superstores: A reply

An article was published in the Financial Express on February 26, 2014 titled "On the issue of VAT on superstores" which has raised views different from those raised in this writer's article published in the same newspaper on February 23, 2014. This writer appreciates Dr. Md Abdur Rouf for his careful perusal of the article and raising differing views on some issued expressed in that article.
In this article, we would restate some points mentioned in the February 23 article and also address some of the concerns raised by Dr. Abdur Rouf. He said that the write-up missed the spirit and principle of VAT - an issue the writer thinks is of much less importance in this particular case than it is in other cases. The analysis was built up to give the market a room for transition and that can be thought as a special case and not as a universal case to which rules and principles should be applied uniformly.  To clear the confusion, that article didn't lend any support for package VAT demanded by the businessmen. The writer agrees completely what Dr. Rouf outlined in his article about the package VAT and the distortion of VAT principles. The only issue that article raised was how can we justify the removal of present VAT on superstores sales? For this, we reasoned that waiver of such VAT would be beneficial for the economy as a whole.
As for the relationship between the use of formalin and dishonest practices such as unethical behaviour and greed for profit, Dr. Abdur Rouf said, "Other than market malfunctioning, is there no relationship between the spread of the use of formalin and unethical behaviour, greed for profit, etc.?" Different answers can be given to such a question. However, it doesn't matter whether or not one observes a relationship between the use of formalin and the unethical behaviour. One can find such a relationship by using appropriate technique, but the question remains how much precise such relationship is? To give a more vivid scenario in which one can see the illusive relationship obtained from the statistical measurement, we can imagine a situation in which the time interval between consumption and production is so negligible that it is almost instantaneous and no time-bound demand pattern exists in that case. If one doesn't find any significant use of formalin use in this regime, then how can one say that formalin use and the dishonest practice have some valid relationship? Yes, there is a relationship between the dishonest practice and formalin use but that relationship is given rise by the time-bound pattern, not by dishonesty itself. Obviously, one can't claim that people are more honest in the regime of no-time-bound demand pattern than in the time-bound demand pattern. In fact, the people are same; market is same; tastes are same; but the way market performs now is different. Drawing on the previous illustration, we can illustrate this point in the following way:

Now if we draw a graphical view of the above demand function for formalin use, we find the following picture:
In the above figure, the use of formalin is measured on the vertical axis and probability estimate on the horizontal axis. As can be seen, the graph shows a negative relation between the use of formalin and the value of µ. For example, at the value µ2, the use of formalin is zero since the value of probability can't exceed one. But as the value of µ decreases, the use of formalin increases. At µ0 the use of the formalin is F0 which is quite high, and this we have pointed as the current situation of Bangladesh. But if our country wants to decrease the use of formalin to F1, then the value of µ has to be µ1. Whether the value of µ would be µ1 or µ0 depends on how strong the time-bound demand pattern is. Since we said that our economy exhibits a strong time-bound demand pattern, then we rationally expect that the value of µ will not be anyway equal to µ1 instead it is exactly equal to µ0. This raises the pure dilemma here because the use of formalin F1 is not associated with probability value µ0 but with µ1. So, it is not possible to reduce the use of formalin unless some other way is sought. The market is already fraught with so many frictions that removal of those frictions requires some different mechanism, and superstores based selling can be one of the powerful ways to cope up with such dilemma. We would argue that it is the most economically viable and efficient way to get rid of this notorious problem. This simple illustration makes it very clear why the observed relationship between the use of formalin and unethical behavior is a fake relationship. To complete the argument, we draw three comparable regimes of time-bound demand pattern:

In the above, we have drawn three different aspects of time-bound demand pattern. First one, named high formalin use region, depicts a very strong time-bound demand pattern. Demand pattern in our country, especially in cities may fall in this category. But, for example, the general demand pattern for the economy such as the USA and UK perfectly falls in this category of time-bound pattern. How strong the time-bound demand pattern is can be determined by checking the time interval (t1-tn). The second regime which is called the moderate formalin use region shows relatively less time interval than (t1-tn). Finally, the third one shows very insignificant time interval depicting that production and consumption is almost instantaneous and requires no significant time lag.
Now the question is why the formalin use should be very low in the third regime? Are the businessmen more honest in this regime than they are in the first and second regime in which formalin use is very high and moderately high? We argue that this not the case at all. Now, one can visualise more clearly why the observed relationship between unethical behavior and formalin use is mostly a figment that is generated by the naked observation and that ultimately breaks down when we incorporate time-bound demand pattern analysis. To say in the more formal manner, if we take the formalin use as a dependent variable and regress it against the time-bound demand pattern proxy by µ and unethical behaviour or greed as another variable, we will see that unethical behaviour will lose its explanatory power as soon as time-bound demand pattern is incorporated in the regression. That means co-efficient on unethical behaviour will statistically be almost near to zero.  Apparently, it seems that there is a relationship, but a microscopic view will reveal how deceptive such view is. We think that this sufficiently answers the question posed by Dr. Rouf regarding the relationship between formalin use and the unethical behavior.
In the article published on February 23, 2014, we argued how market malfunctions when demand follows the time-bound demand pattern and supported the removal of VAT on superstores on some justifiable grounds such as the transformation of the market structure over the time. Regarding that issue, Dr. Abdur Rouf has said in his article, "For this reason, VAT suspension has been seen as the principal panacea." However, without seeing it as a  principal panacea, we viewed it as a form of incentive (for some policy purpose and duration of which can be moderately long-run) that may broaden the base of customer for superstores coming to down to the even middle class from the now highly concentrated upper class. That's why we advocated the removal of VAT on super stores.
Regarding the market malfunction, Dr. Rouf commented, "In making the market function, Md. Jamal Hossain wants to see the onus lying with VAT." Well, market functioning or malfunctioning in our article had nothing to deal with VAT at all. We rather argued both explicitly and implicitly that such VAT works as an obstacle to create the broad customer base in our country, and since time-bound demand pattern causes widespread use of formalin, on that ground we can justify the removal of VAT on superstores.
This argument can once again be illustrated going back to the negative relationship drawn above between the use of formalin and the value of µ which captures the different degrees of time-bound demand pattern. In the graph, we showed that to reduce the formalin use form F0 to F1, we need to have µ1. But due to strong time-bound demand pattern, it is not possible to raise the value above µ0 which is assumed to be current value for our country. Therefore, we need some mechanism that can render the low use of formalin F1 with µ0. In this instance, superstores sales can render such solution.
In the earlier article we also argued why the comparable welfare benefit from the withdrawal of VAT on superstores would outweigh the welfare benefit achieved now from taxing wealthy consumers who shop in the superstores. The space limitation doesn't permit the illustrative discourse on this issue but a common sense explanation would go like this: If VAT removal acts as an incentive for people in general to shop in superstores creating a broad customer base surpassing the present over-concentrated upper class customer base, then the benefit derived from such removal of VAT will at least be greater than the loss accrued from the lost tax revenue that goes in the form of incentive to the consumer basket. Now, the issue becomes more complicated even and goes like this: Trade-off between the present lost tax revenue and the higher future tax revenue promised by the broader customer base. On this issue, Dr. Abdur Rouf raised a question.  He argued, "How the government will work keeping the big segment of the economy untaxed." He supplemented this argument by arguing further, "If they are kept untaxed, when they will develop they might argue that they are not yet habituated to pay tax. So, they need more time to learn how to pay."
We didn't advance argument saying that government should exclude such big sector from taxation. What we emphasised is that if the formalin problem can be mitigated by making easy transition to superstores based selling of products and if tax waiver (as an incentive for definitely moderate long-run policy purpose) can broaden the customer base, then there should not be any reason to not to claim that such VAT removal is justified. As for the issue how to learn to pay taxes, this is a subjective and more philosophical issue that has little rational content. But we argue that if such widespread development were to occur in our country, then how one could say that one need more time to develop and learn how to pay. We don't see any justification for this claim.
We also discussed recent potato price slump and showed one reasonable way to ensure just price in market without entangling government with the so-called intervention through the development of superstores. The reason we criticised NBR's VAT decision in this respect because 2.0 VAT removal can bring a huge benefit to the economy as whole that such VAT seems to be pointless to us. Dr. Abdur Rouf also mentioned the growth in revenue and sincerity and responsibility of NBR in executing its plan. We don't have any kind of issue with such progress, and we welcome whatever progress has been made. We just claim that current potato selling market is too homogenous to ensure just price for farmers. But the development of superstores would create diverse markets with proper market segmentations that would strengthen the comparative bargaining power of farmers. To reap such benefit, we need to broaden the customer base for the superstores so that they can reach to people in general. Reasonably, VAT removal decision may help, to some significantly measurable extent, to create such broad customer base for superstores in our country.
Md Jamal Hossain writes from the University of Denver, USA.
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