Plug the holes when new tax is not there

According to a TBS report (14 April 2021), businesses are seeking wholesale tax relief in the FY21 budget. They have demanded exemptions and concessions from taxation on goods, services, and profits. They want the corporate tax rate lowered by 5 percentage points, withdrawal of the minimum 2% turnover tax, VAT refunds on all goods and services, revoking duty on raw material imports, tax holiday facility for new industries and so on. This list is long, but you get the point.

To a cynic, these proposals could sound like seeking a tax-free budget. Last year the Pakistan government considered such a budget, calling it a "corona-budget". The International Monetary Fund stood in the way. Although taxation played a relatively minor role in the ancient world, it has been there from time immemorial. There is a good reason why tax is held at par with death on the scale of certainty. Money is needed for running the government machinery. Printing notes risk hyperinflation if taken to excessive scale. Borrowing is not without consequences either. Taxation is not only a financing tool but also an instrument of economic policy.

The case for reduced taxation

Seeking a tax-free budget is in fact not a fair characterisation, considering the impact the pandemic continues to have on economic activities. Indeed, the second wave is causing additional jobs and income losses for millions of households and enterprises. Industrial entrepreneurs have been hit hard by disruption in production. Traders claim a dominant fraction of the currently registered companies are in red. Even more headwinds are in the horizon.

The second wave of the virus and the lockdown have effectively left many enterprises with no or substantial source of revenue. The financial support provided so far has reached far less the "small guys" than the "big guys". Younger and poorer people suffered most, being at much greater risk of losing their jobs and incomes. One of the financial-moral dilemmas is taxing Cottage, Micro and Small Enterprises (CMSEs) in such a distressful time.

The pandemic has caused both a reduction in demand and supply. What is needed is to boost business operations and empower consumers to spend more. Tax reductions, when incomes and employment are down, are often recommended as countercyclical fiscal policy. The government should give up part of the expected tax through expanded tax reduction mechanisms, tax cuts or exemptions subject to maintaining employment. It can either reduce waste or borrow to meet the budgetary needs.

The case against

How will the government manage its budget without putting the taxpayers, who undeniably are in great difficulty, in an even more dire position? This seemingly impossible-to-solve equation highlights the inadequacy of the tax system as it exists today.

Total revenues declined to 9.6% of GDP in FY20, compared with 9.9% the previous year. Tax revenue collected by the National Board of Revenue (NBR) declined 2.5% in nominal terms for the first time in over two decades in FY20. The tax-GDP ratio dipped even lower from 8.9% in FY19 to 8.1% in FY20. Despite recovery in economic activity, nominal tax revenue growth was only 5.3% in the first eight months of FY21, compared with a 43.7% revenue growth target in the budget.

Domestic resource mobilisation in Bangladesh is too low compared to other countries at a similar level of income. Containment of public expenditure, often by default, helped keep the budget deficit from blowing up. The government's net borrowing from the banking system has decreased in the first nine months relative to the same period in FY20. However, the costs of debt service relative to revenue rose with the increased use of high-cost National Saving Certificates. Increased non-concessional external borrowing has increased and may push up the debt path in the future.

The government is in a bind. The concern is most about CMSEs, seasonal entrepreneurs, small business owners in the informal economy, petty traders, artisans, and such other small fellows. Yet the NBR will have to earn more. There is little room for big tax cuts when faced with the imperative to boost revenue collection. The tax dilemma for the government is to design mechanisms to raise revenues without reducing the entitlement to livelihoods of the taxpayers. The government cannot do both and hence seems doomed to fail. No matter what it does, it will have to do something it ought not to do.

The taxpayer's dilemma

When in distress the morals tend to decay or find rationale for taking a backseat. Should honest tax entities pay when the system seems to have delegitimised tax payment by over taxing those who pay? Allowing, for instance, a permanent and highly concessional window to tax evaders together with delinquency in the provision of public goods and social services do not incentivise tax payment. It is essential that a good tax system is equitable to all taxpayers.

Yet people pay. Some pay out of duty, some grudgingly out of fear of the coercive apparatus of the state, some do not pay, and others do not know whether to pay or not to pay. For all of them, there is no simple moral condemnation of their actions or omissions when the tax system is recognised to be flawed. There is a direct relationship between weak governance and a taxation problem.

The lack of confidence in the tax administration and perception of unfairness breeds aversion to taxation. High rate of tax evasion exists among individuals and corporates. Government failure to provide fundamental amenities may be part of the problem. However, it is undeniable that tax policies and implementation modalities are also responsible for the conditions that make individuals and businesses opt for tax avoidance and tax evasion. It has become a favorite crime of many, making many other crimes seem like misdemeanors.

The perception that few rent-extracting politicians, public officials and connected businesses can escape taxation with impunity divests the act of tax evasion from any moral consequence. One party's failure to fulfil its obligations can lead to the moral justification of the other party's refusal to fulfil its own obligations.

No easy way out

The Secretary-General of the United Nations Antonio Guterres has governments "to consider a solidarity or wealth tax on those who have profited during the pandemic, to reduce extreme inequalities." Earlier, the World Food Program Executive Director David Beasley appealed to the more than 2,000 billionaires in the world, with a combined net worth of $8 trillion, to open their bank accounts. Most recently, the IMF has proposed a temporary solidarity tax on high-earners and companies that have prospered in the coronavirus crisis. This policy would help boost citizens' perception "that everybody contributes to the effort necessary for recovery from Covid-19", the Fund said.

The intentions and motivations behind a temporary solidarity tax are hard to fault. The devil comes with the details. Who would pay the tax and on what quantity? What would prevent companies from passing on such taxes to their customers? A solidarity tax applied may be to entire industries or all businesses that experienced profit increases over a certain amount could be expensive to implement and enforce.

There exists a cash economy of significant proportions over which the tax authority has no control in Bangladesh. This includes bribery, fraud, commissions, the expropriation of public property, extortion, extracted funds from development projects, over- and under-voicing, and so forth. Those who own most of this wealth are obliged by never ending whitening of "black money" facility without any question asked. We rarely see any sustained effort to stop its source. A solidarity tax on the wealthy in such an environment is a pipe dream.

The best hope against hope

There is no practical room for fresh taxation. The government will have to find ways to boost economic recovery and ensure the buoyancy of revenues to such a recovery. This requires reforms in the tax structure and reducing tax evasion. Changes in the tax system itself can be brought about only slowly and in stages. Standing still or backtracking, however, never helps building a tax system that is efficient, inexpensive to administer, flexible to respond to changes in economic conditions, easily ascertainable and fair in its treatment of different individuals. The expectation that the gravity of the pandemic would prompt reforms to improve the aptitude of the tax administration and address the ubiquity of corruption has so far proven elusive.

Reforms to automate VAT and income tax have vacillated. The VAT Online Project was initiated in 2013 to implement the VAT and Supplementary Duty Act 2012 and do away with the manual system in VAT collection. According to the World Bank's latest Bangladesh Development Update (April 2021), only five out of 16 modules are ready, yet not fully functional. The use of Electronic Fiscal Devices for VAT collection started on a pilot basis from August 2020 onward. Yet, the NBR still "plans to install 1,00,000 EFDs by June 2021".

The story is not vastly different on automation of income tax returns. "Coordination challenges between authorities and suppliers resulted in only partial implementation of the Bangladesh Integrated Tax Administration System (BITAX) project. The NBR subsequently initiated the development of an online tax return filing system using its own internal resources", according to the WB. One cannot help wondering why accommodating the suppliers necessitated a switch in funding!

Reforms in tax policy and administration have been victims of ambitious plans not backed by a political will to implement. The principal factors contributing to poor tax performance include noncompliance, narrow coverage of the existing tax instruments, and the arbitrariness and discretion of the tax officials. These are manifest in widespread tax evasion and leakage.

Some might think that raising tax revenue by ending tax avoidance might harm what seems like a fragile economy. Taxes on profits do not affect companies that are not profiting except when there is a minimum payment required irrespective of the financial bottom line. Raising revenue by shutting down special breaks and loopholes in the tax regime would not affect businesses that are laid low by the pandemic.

This is where the best hope against hope for revenue gain in the immediate future is.

Zahid Hossain is the former Lead Economist at  World Bank's Dhaka office