Domestic revenue mobilisation in Bangladesh

Domestic revenue mobilisation (DRM) has gained increasing prominence in recent policy discourse in Bangladesh due to several factors, including potential benefits of taxation for development and equity, gaining freedom from long-term dependence on foreign assistance and shifting aid paradigm, fiscal effects of trade liberalisation, and continuing acute financial needs for meeting development aspirations. Currently, Bangladesh collects only about 10 per cent of its GDP (gross domestic product) in tax revenue which is much higher in many other developing countries at similar levels of development. Bangladesh's tax effort index - revenue collection relative to estimated revenue potential - is also low. Bangladesh generates and collects revenues through taxes and other sources; but still it is most in need of revenues, and often faces the steepest challenges in collecting taxes.

DRM creates additional space for sustainable budget expenditures, fosters ownership and reduces dependency on external assistance. When assessing DRM, not only the volume of revenue must be considered (e.g. tax to GDP ratio); the content and fairness of tax policies also matters (e.g. to avoid distortions and inequity).

Globally, it is suggested that countries collecting less than 15 per cent of GDP in taxes must increase their revenue collection in order to meet basic needs of citizens and businesses. This level of taxation is an important tipping point to make a state viable and put it on a path to development. The Addis Ababa Action Agenda of 2015 for financing the SDGs (Sustainable Development Goals) calls on countries to step up their efforts to mobilise domestic resources, recognising that much of the increased public financing to achieve the SDGs needs to be generated domestically.

In the case of taxation, a key policy issue is to recognise that making it easier to pay taxes improves competitiveness. Modern tax systems seek to optimise tax collections while minimising the burden of taxpayers to comply with tax laws. A low cost of tax compliance and efficient tax-related procedures are advantageous for the businesses as well. Overly complicated tax systems are associated with high levels of tax evasion, large informal sector, more corruption, and less investment. Undue burden on taxpayers can occur in connection with the filing or correction of mistakes in tax returns, claiming refunds on taxes, undergoing tax audits, and appealing tax assessments.

The need is also to ensure that the tax system is fair and equitable. The government needs to balance goals, such as increased revenue mobilisation, growth, and reduced compliance costs along with ensuring that the tax system is fair and equitable. Fairness considerations include the relative taxation of the poor and the rich, corporate and individual taxpayers, cities and rural areas, labour and investment incomes, and the older and the younger generations.

The tax effort index captures how much the government would be able to collect in tax revenue given the specific characteristics of the economy, such as the level of development and trade openness by calculating the ratio of the actual tax revenue to the estimated tax revenue that a national economy with some specific characteristics should be able to raise. The estimate of tax is typically obtained using econometric models that predict the tax share using 'tax determinants', such as the agricultural share of the economy, the share of manufacturing or industrial activities, GDP per capita, sum of exports and imports as a share of GDP, inflation, indices of corruption, and governance. The tax effort index then tells what percentage of the potential (estimated) tax revenue is actually collected. In terms of both tax efforts and tax collection, Bangladesh is placed in the 'low' category among the developing countries.

In the fiscal literature, 'tax gap' refers to the difference between revenue collected and what could be collected. However, it is hard to estimate the tax gap for a developing country like Bangladesh. Tax evasion and avoidance, tax exemptions, and inequitable rent-sharing are all significant sources of tax gap. As a result of globalisation, competition between countries to attract capital creates large grey areas in tax legal systems, and transnational corporations (TNCs) make widespread use of aggressive tax planning and transfer mispricing in order to minimise their tax payments. These practices lead to revenue loss for countries like Bangladesh. Further, although these have been proven largely ineffective in attracting foreign investment, tax incentives still result in large revenue losses in Bangladesh. In many sectors, rent-sharing agreements are often negotiated directly between companies and politicians, in a way that is often not transparent and which leads to highly favourable terms for investors at the expense of lower public revenues.

Bangladesh faces extensive political, economic and administrative challenges in closing tax gaps. Tax reform is often difficult due to interest groups who benefit from the existing system. Meanwhile, tax authorities also suffer from weak capacity due to a shortage of skilled staff and the lack of modern infrastructure such as IT systems and property registers. The structure of the Bangladesh economy has also some challenges for taxation given the large size of the agriculture sector, small tax bases, and high degree of informality.

Tax reforms and technical assistance and training to tax and customs administrations can go a long way in raising revenue in Bangladesh. Bangladesh also needs to be more active on the issues of tax evasion and avoidance. Initiatives may also be directed towards signing new tax information exchange agreements along with providing assistance in implementing guidelines on transfer pricing. The South Asian countries may, for example, promote good governance in tax matters and strengthen the fight against tax fraud and tax evasion.

The debate on tax issues at the global level currently focuses on two main agendas: one on increasing transparency and information exchange, and the other on base erosion and profit-shifting (BEPS). The former involves establishing automatic information exchange as the new global standard for cooperation in tax matters and ending legal secrecy of ownership of companies and trusts, especially those based in tax havens. The latter involves a range of potential actions relating to transfer mispricing, country-by-country reporting by transnational companies, international tax laws, standards for international tax treaties, limits on tax planning activities, and the tax treatment of the digital economy. Further, these agendas have been endorsed by the G8 and the G20, thus giving them high-level support and momentum.

Bangladesh can adopt a framework for developing action plans for raising domestic revenues.  The framework can help develop coordination with other actors involved in the area of taxation to ensure coordination and prevent duplication. This will also provide pathways for Bangladesh for greater involvement in global initiatives in developing the domestic revenue system.

The global agenda should promote reforms in the global tax system, ensuring that international tax evasion efforts is accompanied by actions to support tax mobilisation efforts of countries like Bangladesh. There should also be more emphasis on increased financial and technical assistance to support local capacity in tax administrations, that still face great administrative and capacity constraints, and support building/strengthening regional organisations in developing, for example, shared principles on tax exemptions, standard tax regimes for natural resource contracts, and proposals for minimum withholding taxes on dividends paid by subsidiaries of TNCs.

Although there are some successful reforms in the tax system, still there remain many challenges pressing domestic revenue mobilisation in Bangladesh. Dealing with 'hard to tax' sectors, poor administrative capacity, legislative and enforcement obstacles, and other customs-related problems are aggressive challenges that still remain. For moving forward, there need to be comprehensive efforts to reduce the base of informal activities, build administrative capacity, create a secure environment, develop a robust fiscal framework, reform customs operations with effective policy for trade facilitation, and update the tax legislations. 

Mustafa K. Mujeri is Executive Director, Institute for Inclusive Finance and Development (InM)

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