Fiscal space in Bangladesh is constrained by low tax revenues relative to the estimated size of the economy. At around 9% of GDP, tax collection has trailed behind peers. The pandemic unraveled fiscal vulnerability. Interest to tax revenue ratio rose from 21.9% in FY19 to 26.3% in FY20 as lockdowns hit revenues.
Pay and allowances increased from 23.6% to 25.6%, respectively. These two non-discretionary budget lines alone used more than one out of every two taka of FY20 tax revenues.
A lay of the tax land
The math underlying low tax collections suggest that the most serious ailment lies not as much in the average statutory rates or the taxable capacity as in the rate structures, discretionary tax treatments, and the way taxes are collected. This is a key takeaway from the NBR's recent pre-budget discussions with stakeholders.
For instance, the 15% Value Added Tax is not too different from the comparable international standard rate. According to the National Board of Revenue, around Tk 2.5 lakh crore was supposed to be mobilised at 15% on Vatable transactions of Tk 16.6 lakh crore in 11 sectors in FY21. The actual VAT collection was just over 40% of the estimated capacity.
Of the eight million small and large economic units (BBS data), only 0.3 million obtained Business Identification Number after the new VAT law took effect. One-third of them do not submit monthly returns.
The government introduced electronic fiscal devices in 26 types of businesses, including shops. Over the last three years, about 3,500 business organizations have installed such devices.
Only 1 in 5 registered businesses pay corporate income tax (NBR data). Of the 7.4 million with Tax Identification Number, 2.3 million submitted returns in FY22.
The tax net has shallow catchment with many holes in the net providing safe exit to the evaders. The net is torn apart by the big fishes.
There is a deeply entrenched perception that the existing tax system is onerous with a serious lack of horizontal and vertical equity. To meet their targets, tax collectors routinely put pressure on those who pay taxes while many in their same tax categories evade with impunity. Once in the net, stuck in a web. The rich are generally perceived to escape their fair share of taxes even though Bangladesh has a progressive personal income tax system.
Where is the problem?
Complaints about "high" rates dominate discussion on corporate income tax and VAT. The business community views the corporate income tax rate structure on the higher side of international practices. The statutory rates range from 25% to 45%, compared with 6% to 15% in the rest of South Asia. The global average is about 23%.
You may think this is the problem, but wait. The low-rate sectors are as vociferous for rate reduction as the high-rate sectors. Almost all business associations want a reduction of the CIT rate gradually by 2-3% annually for the next three years. This includes apparel makers whose current rate is 10 and 12%; primary textiles 15%; backward linkage industries 30%; and the mobile phone operators 40% and 45%. Demand for rate cuts in VAT was also loud and clear, including from jewelers and supermarket owners with 5% current rate, restaurant owners 7.5 and 10%; dressmakers 10% and e-commerce providers 15%.
The averages are uninformative because of the multiplicity of rates embedded in a web of advance payments, concessions under various labels (exemptions, rebates, waivers, holidays), and unequal treatment of equals.
Details worth reckoning
Pay first, assess later. Tax at source, advance income tax on imports and minimum tax are deducted in 111 sectors. Rates of tax deducted at source range between 5-7%, except exporters who pay 0.5%. A 5% advance income tax is collected on commercial imports. There is a minimum 0.5-2% tax on industrial and service turnovers. About 75% of the total income tax comes from these withholding and advance taxes deducted at the beginning or end of the business before calculating income and expenditure.
There is no provision for subsequent tax adjustment or refund in 41 or more sectors even if firms incur losses. Where they exist, the rate of refund of tax deducted at source is less than 1% and the amount refunded is only 0.20% of source tax.
The effective tax rate is much higher because of such presumptive taxation with a dysfunctional refund system. Businesses claim they have not benefited from the reduction in statutory corporate tax rates in the last couple of years because it made no difference to the effective tax rate, allegedly as high as 40-45%. This coexists with generous holidays extended to corporates on various, apparently time-invariant, "strategic" considerations.
VAT has morphed into a sales tax in most cases and excise duty in some. Unlike the original VAT Act 2012 with a single rate and limited exemptions, the law, implemented in 2019, came with seven rates and widespread tax exemptions. The FY22 budget extended VAT breaks to agriculture, food, home appliance, light engineering, ICT, women-led SMEs, private hospitals, and manufacture of LPG cylinder, refrigerators, freezers, polypropylene staple fibre, air conditioners, compressors, motor cars and vehicles.
A VAT without input credit is an emperor without clothes. Bangladesh is probably the only country in the world where different VAT rates are applied to the same products at different stages of processing. Input credit is not workable in such a multi-rate, multi-stage system.
Horizontal inequities are ubiquitous. An analysis by NBR's Income Tax Wing found 34 statutory regulatory orders issued in FY19 after passage of the budget to offer CIT waivers. Income of companies in Special Economic Zones and power generation are fully exempt beyond 2030s. In VAT, meals include 10% in air-conditioned restaurants or fast-food shops and 7% in non-air-conditioned restaurants. Clothes costing Tk 1,000 offline cost over Tk1,100 if bought from e-shopping sites due to Tk 100 VAT in different layers.
More of the same demanded anyway
Demand for tax breaks is galore amidst rampant oversight of foregone revenues. Tax exemptions and concessions are provided under the industrial, export, import, SME, and fiscal policies.
Land developers demanded a tax holiday for five years in metropolitan cities and 10 years for municipality areas. Xiaomi Bangladesh wants a ten-year tax exemption to mobile phone manufacturers. e-CAB sought withdrawing VAT on office rent. BGMEA wants withdrawal of VAT in the factories making products under sub-contracts and on purchase of raw materials, goods and services required for garment exports. DCCI recommended increasing VAT exemption from Tk 3 crore annual turnover to Tk 4 crore in the next budget.
It's not just the private sector who adore exemptions. Different government organisations and ministries, sometimes even in development partner supported projects, pressure NBR for, say, VAT exemption.
An opportunistic argument for domestic market protection has surfaced. The FBCCI urged refraining from any supplementary duty on goods made in Bangladesh for Bangladesh. The government may not be able to continue protecting the domestic market from foreign competition, like it has been doing all along, after LDC graduation in 2026. Tax and duty exemption to import substituting industry should therefore be expanded till 2026. If it sounds like a down payment from the government to producers in the run up to LDC graduation, you will find International Trade 101 on your side.
Tax policy and administration is trapped in a low productivity equilibrium. The complexity of the tax ecosystem is a legacy of policy ad-hocism and fragmented administration over the past decades. The priorities are to reduce rate heterogeneity, simplify collection, catch non-compliance, stem leakage, mitigate tax fraud, and digitise reengineered business processes. This, déjà vu all over again, is a pre-budget consensus every fiscal year.
The conundrum essentially is the disconnect between this consensus and the behaviour of those on the demand and supply sides of tax money. The outcome from their strategic interactions looks like a disproportionately thin forest amongst many trees. Sadly, we all recognise the forest is too thin (read low tax-GDP ratio), yet we keep cutting the trees (read demanding tax concessions). There is a failure of collective action. The failure may have something to do with the public trust in the ability of the system to deliver the public goods financed by the current and future generations of taxpayers.
There is a 'who will bell the cat' type of problem. Taxation and public trust are connected through public goods. Citizens baulk at paying for the public goods not necessarily because they don't want them or because they believe they can easily get a free ride. It is often because they believe the system used to fund the public goods is rigged in favour of interest-groups. The smartest strategy then is to be part of individual groups that seek narrow returns for their members regardless of the costs to the broader economy. All make defensible excuses from their own standpoints. But the collective outcome is underfinancing and hence under provision of the public goods the society needs which in turn erodes trust.