The announcement, made well ahead of the presentation of the proposed national budget for fiscal year (FY) 2016-17, about imposition of the value added tax (VAT) across the board at a uniform rate of 15 per cent, stirred up a concerted negative response from the business community, represented by the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI), the Bangladesh Shop Owners Association and the Business Unity Forum. But hardly any response to this issue was made by the consumers' advocacy organisations or any other public interest organisations. The roll-out of the new VAT policy (The Value Added Tax and Supplementary Duty Act 2012) was scheduled for July 01.
The core issue here appears to be tax treatment of small businesses who have enjoyed special tax treatment called package VAT (turnover tax) under the earlier VAT laws. The Value Added Tax and Supplementary Duty Act (VATSDA) was legislated a few years back. Now its implementation has been proposed to be put on hold for one more year, that is, until the beginning of the fiscal year (FY), 2017-18 in the wake of strong opposition from the business community.
Under the new rule - albeit still an ad hoc one, there will be provision for VAT exemptions for small enterprises, having annual turnover up to Tk 3.0 million. The VATSDA does otherwise provide for no such exemptions.
To get a better grasp of the current controversy, it is important to understand the nature of VAT as a source of revenue. A value added tax is a consumption tax, imposed on goods and services that are consumed and are usually collected at the points of purchase. It is a tax that is levied on the market value of a product or service at each stage of production or distribution. For example, if a shop buys a shirt for Tk 300 and sells it for Tk 400, a tax will apply to the value added= (sell price - purchase price or revenue - input costs). In this case, it would be a tax on TK 100 (difference between the two prices). At the uniform rate of VAT at 15 per cent, the tax bill will then come to TK 15.
Any consumption-based tax as the VAT is, is considered regressive as lower income consumers spend proportionately more on consumption than people belonging to the higher income bracket if such a tax is imposed across the board without any exemptions or rebates. This is why there is opposition to VAT on the equity ground (one of the basic tenets of taxation). Furthermore, there is the issue relating to what extent the consumption tax that i.e., VAT can be extended; if it is increased it may adversely affect the revenue receipts by discouraging consumer spending. This in turn will reduce tax revenue. As the tax is proportional to consumption for all income groups, whatever the rate some basic consumption bundle composed of daily necessities must have be bought and only discretionary spending will respond to the higher rates. As such this makes it thoroughly regressive. This runs afoul of the efficiency criterion (another tenet of taxation). The VAT revenue is also very responsive to the business cycles that weakens the very reason for imposing such a tax. One of the reasons for introduction of such a tax is because of income tax being very sensitive to the business cycles.
Furthermore, a consumption tax like VAT exempts incomes generated through interest and dividend payments and also capital gains but an income-based tax does not. Therefore, the VAT as a consumption-based tax tends to create further income inequality.
Many economists also argue that in making a choice between an income tax and a consumption tax, "temporal neutrality" criterion needs to be considered. The relevance as much as capacity of any tax measure to achieve this should be examined while deciding the taxation options. Ability to achieve temporal neutrality enables a tax regime not to cause any change in spending habits or misallocation of resources that sends wrong signals to the market. There is always a strong likelihood that a consumption tax like that of VAT can just do both of that. However, such a regressive tax can be made progressive if mitigating elements such as exemptions, rebates and deductions can be incorporated into a consumption tax regime. This is why even in the member-countries of the Organisation for Economic Cooperation and Development (OECD), there are a large range of exemptions such as food, health care, medicine, education and educational materials. These are generally included in the exemption list and all inputs are tax deductible or rebates are granted.
Under the provisions of the VATSDA, the VAT rate is set at a uniform rate of 15 per cent in Bangladesh but there are also referential rates on services making it rather a complex consumption tax regime. Sellers of goods and providers of services do in effect become tax collectors without getting any remuneration for doing the job. That requires these business establishments to maintain detailed revenue and tax records. This can be a problem for small and micro business establishments to maintain such records as many of them are family or only mum-and-dad-run business establishments. Therefore adding further costs to the business operation not only erodes profitability but also can cause death of these business enterprises.
Tax enforcement in Bangladesh is considered to be seriously compromised as a result of the prevalence of corruption. The VAT compliance requirements entail a significant amount of time, efforts and substantial volume of paper work, thus, making it very expensive for small enterprises. To put it simply, the VAT compliance requirements add substantial costs to a small enterprise operation without any countervailing compensation from the government. The tax officials also exercise substantial discretionary power in determining the tax payable, thus, making it prone to corrupt dealings. On all these accounts, the ultimate cost burden of compliance borne by the small enterprises is quite substantial. As a result, it quite often leads to business closures. In view of the reality of this situation, the government needs to listen to the views of the concerned circles very carefully in their desire to redesign and implement the consumption-based tax (VAT) laws.
The writer is an independent economic and political analyst.