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On June 07, Finance Minister AMA Muhith presented the budget for the fiscal year 2018-19. The minister assured the nation that the country is firmly on course to a higher economic growth achieving 7.8 per cent gross domestic product (GDP) growth during the coming fiscal year. The benefits of growth have also been assured to reach the poor and vulnerable sections of the population among other beneficiaries of growth in the country. He even alluded to the vision of a happy and prosperous future for the country to be achieved by 2041.
However, the budget has already generated a very widespread debate and discussions within the country, much of which are not very supportive of the minister's assertions. The budget has largely been described as a business as usual one, nothing new or innovative, let alone radical, in its approach as reflected in both of its incomes and expenditures sides. Some even went so far as to say that the budget was designed to serve the special interests of certain powerful groups as reflected in the concessional tax benefits accorded to them as well as massive handouts without subjecting them to any form public scrutiny. Some others highlighted the government's increased outlays for social security which would benefit the poor and the vulnerable in the society, implicitly arguing that the government is making efforts to address the issues of rising income inequality and poverty. But critics of the argument, while welcoming the increased expenditure of social security, argue that the increased reliance on consumption-based taxes will erode that benefit and further exacerbate income inequality and poverty.
A budget being an annual financial statement, it provides incomes and expenditures for the year under consideration. It is also a comprehensive plan of actions to achieve policy objectives set by the government for the year ahead. The proof of the pudding is in the eating and that requires an examination of the budget both on incomes and expenditures sides.
We start with the premise that taxes enable the capacity of the state to fulfil its responsibilities and they form one of the central arenas for conducting state-society relationship. Taxes give the state its social character as the state shapes the balance between accumulation and redistribution. There has been a long-standing relationship between taxation and governance. It can further be argued that the social contract between the state and its citizenry based on trade-offs centred around taxation and public expenditure fosters representative democracy and enhances accountability between the state and its citizenry.
The reliance on revenue continues to be on consumption-based taxes such as value-added tax (VAT), import duty and supplementary duty, accounting for 58 per cent of tax revenue in the current year's budget. In a country where a third of population live in extreme poverty and declining real wages, both in rural and urban sectors, and rising income inequality, such consumption-based taxes with their regressive effects have serious implications for the fairness of the tax system. Also its social acceptability and the ability of the government to redistribute income and to create an environment which will foster equality of opportunity remain a matter of serious concern.
Furthermore, a consumption tax (VAT) exempts incomes generated through interest and dividend payments and also capital gains but an income-based tax does not. Therefore, a consumption-based tax (VAT) tends to create further income inequality.
Public borrowing accounts for 26 per cent total income in this budget. Overall, the level of debt in Bangladesh has been rising over time. But the ratio of external debt to GDP is on the decline while the ratio of domestic debt to GDP is rising. Increasing share of domestically held public debt enable the country to use domestic resources to service it; in fact, domestic payment of debt involves only a transfer of income from Bangladeshi taxpayers to Bangladeshi bond holders. However, if tax payers and bond holders are different people that will lead to income redistribution causing income inequality. But servicing external debt will require sacrificing resources in the form of reduced consumption. About 75 per cent of external debt Bangladesh owes to two institutions - The World Bank (WB) and the Asian Development Bank (ADB).
Direct taxes constitute only about 30 per cent of total tax revenue and less than 2.0 per cent of population pay income tax. Tax reforms over the last decades have not changed anything much because the problems associated with the taxation regime in Bangladesh is systemic. More problematic is when direct taxation system is marked by differential rates as happened in this budget to reduce corporate tax rate for banks and other financial institutions. The logic advanced was that this would reduce the lending rates thus stimulating investment. The bank lending rates are based on a variety of factors not on tax alone, and in particular, factoring in the risk factor arising from loan defaults - a phenomenon rather very widespread in Bangladesh.
It is now widely recognised that the commercial banking sector, in particular state-owned banks in Bangladesh, has serious liquidity problems. In effect, these banks can be described as 'Zombie banks'' and are in need of continuous flow of recapitalisation out of public money for their day-to-day survival. If sweeping measures are not taken now, it will create serious problem for Bangladesh Bank also, threatening the very monetary stability of the country. Reducing the tax burden of the rich (e.g. large bank share-holders and the like) with lower marginal income tax rates or corporate tax rates (which, it is argued, will eliminate or reduce incentives to avoid and evade tax) will only further lead to increased income inequality. Such a tax system obviously disputes the well-established principle that progressivity is central to equity and fairness in a taxation system. Such a principle is no longer a valid criterion of taxation in the present days.
In the country's drive to pursue economic growth through industrialisation, the key mantra is to create a capital-friendly taxation system. That is reflected in the widespread use of tax incentives, including tax exemptions for domestic capital. At the same time the need to attract foreign direct investment (FDI) also requires to create a business-friendly environment that enables them to operate in their own ways. That is clearly evident in the present budget. Corporate tax rates have been reduced for a number of industries and the dominant ready-made garment (RMG) industry still continues to enjoy a much lower rate of corporate taxes despite a very nominal increase in the rate in this budget.
The domestic manufacturing sector, including the RMG industry, benefits from tariff protection. The use of tariffs is quite widespread and Bangladesh is the most protected country in the South Asian Region. Import and supplementary duties account for a quarter of total revenue receipts for the budget year 2018-2019. The continuing heavy reliance on import tax (tariff), along with supplementary duties, for revenue generation poses a very serious challenge for further trade liberalisation with the consequent implications for achieving developmental goals.
Bangladesh has a very narrow tax base. Besides, widespread tax exemptions and incentives, special tax regime for state-owned enterprises, and inefficient (often also corrupt) tax administration have resulted in the low tax to GDP ratio which stands at around 11 per cent. Tax enforcement in Bangladesh is considered to be seriously compromised as a result of the prevalence of widespread corruption.
The very extreme income inequality and poverty that exist in Bangladesh call for the rich to be taxed more heavily than the poor. But the economic and political power of the rich often allow them to thwart any fiscal reform that would increase their tax burden. To make the tax system fair, equitable and transparent, attaining an optimal income tax system for revenue generation has now become a critical issue for Bangladesh. More fundamentally, how taxation will confer benefits or not on the society depends on the way in which the state and the society negotiate revenue raising - and that is possible only in a representative democracy.
Muhammad Mahmood is an independent economic and political analyst.