Overcoming the low tax trap

Bazlul Khondker and Abu Eusuf | Published: May 28, 2017 20:43:13 | Updated: October 22, 2017 05:25:03

Bangladesh is set to introduce the new value-added tax (VAT) system from July 01, 2017 known as the VAT and the Supplementary Duty ACT, 2012. This reform has been considered necessary to raise revenue to improve the country's tax effort (tax to GDP ratio) and resource for development financing. The original VAT system, which was introduced in 1990, is consumption-based implying that all goods and services produced within Bangladesh and supplied from outside for consumption purposes would be taxed. Main differences of the new VAT system over the existing one are the following: 

  •  The truncated base (15 per cent VAT was applicable to a reduced value added base effectively reducing the VAT rate to less than 15 per cent) is abolished; 
  •  Tariff values (i.e. administratively set prices of products - different from the market prices) applicable for selected goods and services is removed; 
  •  Supplementary duties have been replaced by VAT; 
  •  A wider range of services will come under deduction at source;
  •  The new system provides for tax credit/tax adjustment for VAT withheld at source. It also provides for tax credit for whole sellers and distributors/retailers for Advanced VAT paid at the import stage;
  •  List of exemption has been narrowed;
  •  Abolishes the excise-type "account current" system (Under the "Account Current" system, taxpayers engaged in manufacturing activity are required to make advanced VAT payments before clearance of goods from factories); taxes would be payable at the time of return submission; 
  •  Taxpayers will be able to carry forward their tax credits for six months by recoding those through regular VAT returns. After this period, if they fail to adjust against their VAT liabilities, the excess amount of tax paid earlier will be refunded to the taxpayers as refunds;
  •  VAT data base will be electronically managed and stored centrally, including the engagement of an out-sourced company. Allows for central and electronic (online) submission of VAT returns and central return processing; 
  •  Modernises VAT payment system by allowing for payment of VAT through electronic bank transfers, credit cards, and certified bank cheques;
  •  Provides for carrying forward and adjusting the excess VAT paid earlier against future tax liability. 

Like any other reform, VAT reform has also created concerns and confusions among the economic agents - namely producers and consumers. Since producers are more organised in Bangladesh, their voices have been loud in this context. Some of the key concerns are: producers will have to pay more taxes under the new system; new system would lead to increase in the general price level; and the VAT rate is high in Bangladesh. This paper tries to address some of concerns.
DEVELOPMENT CONTEXT: Two important developmental goals in Bangladesh are to eradicate extreme poverty and attain the status of upper middle-income country by 2030. Among others, high economic growth is a key pre-requisite. The economy of Bangladesh is expected to break the 6.0 per cent growth trap in this current fiscal by posting economic growth in excess of 7.0 per cent. Following this upward trend, the economy is expected to achieve the 8.0 per cent growth in the final year of the 7FYP - i.e. 2020. Thereafter economic growth will remain stable and in excess of 8.0 per cent in 8th plan and reaching 9.0 per cent in the 9th plan. High and stable economic growth will have salutary implications in raising average income and also help reduce poverty. Attaining higher would require higher level of investment of around 39 per cent of gross domestic product (GDP) by 2030. This will be a huge challenge and to a large extent reliant on revenue mobilisation.
Review of revenue trends of the Sixth Five Year Plan (SFYP) suggests that the targets set for revenue generation (i.e. total revenue target as per cent of GDP) were not achieved during the plan period. Revenue performance was reasonably better in the first two years of the Plan period when the revenue targets under the budget in taka terms were surpassed. Average revenue growth rate in the SFYP was 17.9 per cent. The target growth rate set out in the 7FYP is 23.9 per cent - 6.0 percentage points higher than the SFYP. Attaining 23.9 per cent revenue growth rate during the 7FYP also suggests revenue effort (tax/GDP ratio) would increase from 10.5 per cent in 2016 to 15 per cent in 2020. The tax effort is expected to increase to 17.2 per cent at the end of 8th plan and 19.3 per cent in the terminal year of the 9th plan contingent on full implementation new reforms both in the VAT and income tax fronts.
Although the National Board of Revenue (NBR) has never attained such stiff targets before (i.e. 24 per cent revenue growth and tax effort in excess of 14 per cent), this also provides an opportunity for the country to overcome the low tax trap. On this issue 7FYP argues that "the Seventh Five Year Plan revenue projection presents an opportunity for Bangladesh to break out of the 10-12 per cent of GDP (gross domestic product) that it has been stuck in recent years. The 4.0 percentage point increase in revenue in relation to GDP over a 5-year period, while ambitious in the Bangladesh context, is quite possible if we review the revenue performance of other developing countries. Many developing and most middle income countries have already done it and certainly Bangladesh can do it, despite its unimpressive track record on this front."
IS VAT A COST-PRICE FACTOR FOR BUSINESS? VAT is a tax on consumers and business people pass on the burden of VAT to the consumers.  Below is an example of all stage VAT. VAT is levied at 15 per cent rate. Total VAT to the consumer is TK. 900. It is collected as different stages. Since it is passed on to the final consumer, for business VAT is not a cost price-factor. The rate is 15 per cent at every stages and it not taxed twice. 
As illustrated in Table-I, none of the business enterprises pay any amount of VAT. At every stage of production, processing and distribution, the business enterprises simply act as tax collectors (on behalf of the tax department). At every stage, the business enterprises get credit for what they paid at the time of purchasing the inputs, and the amounts received by the businesses at different stages of the production and distribution chain are exactly the same as the amount which they would have got in the absence of the VAT. In a proper VAT system, the full amount of the VAT is passed on to the final consumer, which is Taka 900 collected by the retailer at the point of final sale to the ultimate consumer.  
Dr. Bazlul Hoque Khondker is a Professor of the Department of Economics, University of Dhaka. He can be reached at bazlul.khondker@gmail.com
Dr. M. Abu Eusuf is a Professor and Chairman, Department of Development Studies & Director, Centre on Budget and Policy, University of Dhaka. He can be reached at eusuf101@yahoo.com


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