The revenue emperor has little clothes

Economists, policymakers, local think tanks and multilateral agencies have been foaming about low revenue mobilisation for a long time. In its $4.7 billion loan programme document, the IMF has a simple diagnostic attributing it largely to accumulated tax exemptions, complicated tax codes and wide administrative discretion. This causes low productivity across all major taxes. Expectations were raised by the presence of the Fund programme that reforms targeting these causes may get a new life. Sadly, the revenue game plan envisaged in the FY24 budget looks more like "the emperor with no clothes".

Heightened ambition

The FY24 budget has set a total revenue target of Tk5 lakh crore. The target for the NBR is Tk4.3 lakh crore, compared with Tk3.7 lakh crore target for the current fiscal year. The target for non-NBR tax revenue is Tk20,000 crore and non-tax revenues Tk50,000 crore. Note that the revenue GDP ratio is projected to rise from 9.8% in the revised FY23 budget to 10% in the FY24 budget and the tax/GDP ratio from 8.7% to 9% respectively; neither of the two rising by 0.5% of GDP as envisaged in the IMF programme.

The catch here is that the Tk67,000 increase (15.5%) in total revenue and Tk60,000 (16.2%) increase in NBR revenue over the current fiscal year are illusive. NBR revenues fell 12.2% short of the target during July-April this fiscal year. NBR revenue collection in April was 2.3% lower than a year-ago, an ominous deviation from the usual higher collection trend in the last quarter of the fiscal year. A double-digit negative growth in collection from imports, income tax and travel tax led to the drastic fall in April revenues, vastly outweighing 15% growth in VAT collection.

The NBR revenue shortfall in the current fiscal year could be between Tk40,000 crore and Tk60,000 crore, implying the required increase in revenue to reach the FY24 target can easily be order of magnitude high enough to exceed the 0.5 percentage increase in the tax/GDP ratio. Given a 12.8% increase in nominal GDP, tax revenues have to grow by 19.2% to raise the ratio by 0.5 percentage points, assuming a Tk40,000 tax revenue shortfall in FY23. The projected revenue growth from the reduced base in FY23 is 29.3%. The government is far more ambitious than required under the IMF programme.

Most of the additional revenues are projected from VAT, tobacco, and withdrawal of tax exemptions. Measures in VAT are expected to yield an additional Tk20,400 crore followed by Tk5,500 crore to Tk6,000 crore by restructuring tobacco taxation, Tk1,000 crore to Tk1,500 crore from exemption withdrawals, and Tk400 crore to Tk500 crore from EFDs and SDCs. The sum total of the upper bounds of these identified increases amounts to Tk28,400 crore, a number vastly below the projected increase. The rest counts on unforeseen gains from the administrative and policy measures in the FY24 Finance Bill.

Promising administrative measures if not rendered impotent

Out of nearly 90 lakh Tax Identification Number holders in the country, only 32 lakh filed income tax returns last year. The NBR is targeting a 30% increase in return filing in FY24 by reducing return filing exemptions, adding six more services to the list of 38 services requiring mandatory proof of submission of returns, increased use of EFD machines for VAT collection, expanding e-filing, digitalisation of bond use and deploying private agents for tax collection.

The much-talked-about increase in penalty while abolishing the requirement for seeking permission for delayed submission has stayed in the back burner. Some of the measures such as EFD machines have not moved forward despite efforts for years. Innovative measures such as private collection agents can boomerang if corruption permeates their work. An e-filing system has been introduced for taxpayers to file their income tax returns online. These are no good if one still needs the Tax Return Preparer to make the submissions.

There has been some progress for sure. Use of electronic payment system by taxpayers is on the rise. "Taxpayers can now pay taxes easily from their bank accounts directly," claims the finance minister. The Document Verification System (DVS) is in use to verify the accuracy of audited accounts, so far reaching only 146 taxpayer companies. The E-TDS system has been introduced to monitor tax deduction and collection at source. VAT registration, return submission and related other activities can now, in theory, be done online.

Revenue gains from the direct tax reforms are uncertain

The post-tax income enhancing impact of the increase in personal income tax exemption limits by Tk25 lakh to Tk50 lakh in different categories is likely to be outweighed for many by the minimum Tk2,000 tax on individuals to get proof of tax return submission even from individuals with no taxable income. The minimum tax, which violates the no income no tax principle while increasing administrative complexity, is justified by the finance minister as "return of the privileges provided by the state to them". It is tempting to point out state charges for "privileges" that citizens view as their rights!

The progressivity of the PIT regime is likely to fritter. The wealth-based income tax surcharge exemption limit is increased from Tk3 crore to Tk4 crore to "reduce the burden on middle class taxpayers". Wealthy individuals with no income will continue to stay out of surcharge. The 10% surcharge will now apply to individuals with net wealth above Tk4 crore and the 35% will apply to net wealth above Tk100 crore, a major relief to those between Tk50 crore and less than Tk100 crore currently subject to the 35% rate (not exactly the middle class). These measures risk losing revenues by reducing the number of taxpayers in the two rate categories. According to the NBR, only 15,000 taxpayers paid surcharge (Tk600 crore) in FY21.

The corporate tax rates are unchanged after consecutive cuts in the last three budgets. The benefit from the reduced corporate tax rates are muted by limits on cash transactions for eligibility. The tax rate at source from land registration (outside Rajuk and CDA) will increase, source tax refunds on manganese (steel production raw material) will be reduced presumably by lowering source tax rate and source tax on locally produced 33 to 500 KV cables will be rationalised (read reduced).

Some revenue gains can be expected from the increased travel tax and the "environment" surcharge on multiple cars. The proposed increase on foreign travel could yield significant revenues, assuming this will not impact the propensity to travel too much by reducing what the FM calls "unnecessary foreign travel". An environmental surcharge, based on CC and KW, ranges from Tk25,000 to Tk3.5 lakh per vehicle to be collected during the registration and renewal of a second car.

Indirect tax changes will yield revenues but nourish inflation and inequities

Tax hikes are proposed on a range of commodities such as mobile phones, tableware, kitchenware, tissue papers, ballpoint pen, dates, cashew nuts, carbonated beverages, non-fortified basmati rice, face wash, adhesive/glue, sandpaper/abrasive cloth, sandwich panel products, raw materials for cement, polypropylene staple fibre, LPG cylinders, cigarettes, cigarette paper, sunglasses, fridges, fans, LPG cylinders, lifts, escalators, electric panels, and software. The "Lilliputian" list of rate decreases includes sweets, fuel oils, ethylene glycol (a raw material for polyester fibres and for antifreeze formulations), and several raw materials of cancer and diabetes drugs, rebates offered for the local production of electric switches and sockets and reduction in advance taxes on several agricultural machinery. On balance, therefore, the indirect tax hikes will stoke price increases.

Inequality may worsen as well. Indirect taxes are considered regressive because they fall equally on the rich and poor, regardless of their income. For instance, both the rich and the poor pay the same amount of tax when they buy a litre of diesel. This means indirect taxes take a larger percentage of income from low-income earners than high income earners, given the same quantity of indulgence. Since the latter is often not true, indirect taxes are more evenly distributed when measured relative to expenditure. But they still affect the poor more than the rich.

Still way to go on reforms

Maintaining stability in imports of raw materials and consumable items, easing the existing dollar and energy crisis are prerequisites but not sufficient for achieving projected revenue increases. Tax policy and administration reforms need help to get traction. The help has to come from moving forward initiatives already underway more speedily. For instance a new Customs Act, incorporating international best practices, has been work in progress since 2014. According to the finance minister, it was "sent for vetting on 19 January 2021 and legislative wing completed the vetting on 15 March 2023." Yet there is no timeline on when it finally will get to see the light of the day. The finance minister says, "very soon".

The government deserves kudos for sketching the empirics on the proximate causes of the low tax/GDP ratio. The Medium-Term Macroeconomic Policy Statement 2023-24 to 2025-26 reports 36% of GDP was excluded from direct taxes in FY19, costing 2.6% of GDP in revenues. "No VAT is collected on goods and services on almost 50 percent of GDP." No customs duty was collected on 42.3% of total imports in FY21.

The finance minister in his speech quoted NBR's estimate that Direct Tax Expenditure alone (including rebate, tax holiday, exemptions from taxable income etc.) was equivalent to 3.6% of GDP in FY22. The Fund and many others see this as an opportunity to raise revenues. The finance minister sees it as a subsidy and wants it to be recognized as such in the budget accounts (which by the way is at best a complicated idea). It seems, tax expenditures, like beauty, are in the eyes of the beholder!

Rationalising direct tax expenditures naturally warrants a prominent place in the overarching strategy of shifting the tax burden from indirect to direct taxes. More data and more analysis are all good, but policy paralysis is not.

Zahid Hussain is a former lead economist of the World Bank Dhaka office