Tax reforms to support economic stability

The economy of Bangladesh is currently standing at a crossroad for many more reasons than one. Inflation since 2022 has been pushing the cost of living up for citizens across the board and threatening the improved standard of living that they had witnessed during the previous decade. As a result, the average inflation during FY23 was 9.02 per cent compared to 6.15 per cent in FY22 and 5.56 per cent in FY21. In October 2023, the general inflation was 9.93 per cent – while the level of food inflation was 12.56 per cent. This inflation and the suffering that it brought is partly attributable to the depreciation of the taka by 28 per cent since summer 2022.

Similarly, the country is also struggling with foreign exchange reserves. Though several measures like curbing imports and providing incentive to remitters were taken, the measures were not adequate in preventing the downslide in reserve since the financial account has turned into a growing deficit due to reversal of flow of capital out of Bangladesh.

The cost of debt servicing is also on the rise lately. In the outgoing fiscal year, the total interest payment cost was Tk 900 billion, which was equivalent to 13.6 per cent of total public expenditure and 20.8 per cent of total revenue for that fiscal year. Compared to FY22, the cost has increased by Tk 192 billion (27.1 per cent).

Owing to the huge depreciation of BDT against USD, the interest payment cost of external financing has more than doubled, from Tk 46 billion (0.9 per cent of total expenditure) in FY22 to Tk 93 billion (1.40 per cent of total expenditure) in FY23. In FY24, the debt servicing cost is expected to rise further.

Also, in recent times there has been a rise in the share of foreign loans on market-based interest rates which are much higher than the loans on concessional terms. The maturity of these loans is much shorter along with a lower grace period. Going forward, this is likely to raise the debt servicing cost faster in the coming years.

Moreover, there has been a record amount of borrowing from the central bank in FY23. Borrowing from the central bank amounted to Tk 980 billion in FY23. Such domestic loans from the central bank are tantamount to printing money and this aggravated the inflationary situation further.

The progress regarding meeting the targets associated with International Monetary Fund (IMF) loan package

Last January, when the IMF approved the US$ 4.7 billion for Bangladesh, it attached a number of conditions to the loan package with the aim of bringing back macroeconomic stability to the economy. Since then, the Bangladesh government has taken multiple initiatives to implement the reforms suggested in the loan package. While in some areas there has been some progress, other areas remain untouched.

For example, the IMF’s tax revenue target for FY23 was Tk 3456 billion (which was much below the original government target) and against that the government managed to collect Tk 3390 billion, falling short of the target by Tk 66 billion. Whereas, the target for net international reserve at the end of September 2023 was US$ 25.3 billion, but it was unofficially reported to be about US$ 18 billion (shortfall of around US$ 7 billion from the target).

Bangladesh is also struggling to implement the banking sector reforms aimed at lowering default loans and non-performing loans (NPL). Similarly, the progress in reducing subsidies by applying a periodic formula-based pricing mechanism for petroleum products might also require some additional time given the already high inflation in the country.

Despite the odds, Bangladesh has taken multiple initiatives towards monetary policy and fiscal policy reforms.

Key monetary policy reforms include: (a) Taking steps to introduce an interest rate corridor system; (b) Allowing the exchange rate to be depreciate under market pressures; (c) Compiling and reporting gross official foreign exchange reserves as per the IMF’s BPM6 definition.

These monetary reforms were long due and economists were calling out to implement them for quite a time now. However, concerns regarding flexible exchange rate and interest rate still persist as the ways they are defined and being implemented are still questionable for a number of reasons and will require a more market-based approach.

In terms of implementing the fiscal reforms, NBR has taken several key activities to mobilise more revenue and these include: (a) increasing tax on property sales and a range of consumer products; (b) withdrawing exemption from some sectors including the mobile phone sector; (c) installing over 9,000 EFD/SDC (Sales Data Controller) machines, with a plan to extend this number to 60,000 by the end of FY24; (d) establishing a Central Risk Management Unit/Commissionerate for Customs; (e) adopting a new income tax law; (f) increasing the ability for tax returns to be submitted online (more than 0.3 million people) have submitted their tax returns online this year).

As a result of these cumulative efforts, there has been a 16 per cent increase in holders of digital taxpayer identification numbers (e-TIN) in FY23. Currently, the number of TIN holders is 9.03 million and 3.3 million of them have submitted tax returns. However, as the ongoing macroeconomic instability keeps on throwing challenges to the economy on multiple fronts, meeting the conditions set by the IMF has become increasingly important, especially meeting the revenue target, not only to ensure the disbursement of upcoming instalments but also to tackle these looming challenges. It’s important to consider the required reforms as a homegrown agenda.

Despite the recent signs of progress, more significant fiscal reforms are needed to support economic stability. Though multiple initiatives have been taken to raise revenue, yet the tax revenue target set for FY23 by the IMF has been missed by Tk 66 billion. National Board of Revenue (NBR) has put forth significant efforts in the outgoing fiscal year. Despite that, for meeting the IMF prescribed tax revenue target of FY24, 20.40 per cent tax revenue growth is required and if the revenue target set in the national budget is to be met, the required rate of growth is even higher, almost 33 per cent.

In contrast, the revenue collection trend of the past years shows that on average the revenue collection grew by around 12 per cent year-on-year since 2018. With the ongoing restrictions on imports and the diminishing growth outlook, mobilising revenue at a more than 20 per cent rate will be virtually impossible.

To meet the tax revenue target set for FY24 by the IMF and the national budget, the required rate of growth is around 21 per cent and 33 per cent respectively.

Making the fiscal reforms is not only a key factor for securing future IMF loan payments, but more importantly it would also drive economic growth as the country faces a series of challenges.

PRI’s recent analysis shows that raising additional personal income tax has promising impacts on growth, poverty and inequality. According to the results of simulation analysis, raising an additional tax-GDP ratio of 2-percentage-points (ppt) from personal income taxes and redistributing it in the form of additional spending, would increase the real GDP by 0.51 ppt and reduce the poverty rate of households belonging to the lowest quintile by 4 ppt. Without expanding government expenditure, Bangladesh will not be able to provide basic civic services like health, education and quality infrastructure which are essential for economic growth.

There are several areas that policymakers could prioritise for raising more revenue

Raising more tax revenue from personal income tax.

l To achieve this, it is crucial to work towards increasing TIN registrations and also to boost existing TIN holders’ compliance. The government may look into the idea of establishing a universal registration system that is connected to the NID system in order to expand the number of people who possess TINs. Similar systems are in place in the UK, where citizens’ activities are tracked across all economic spheres using a single, unique identification number known as their national insurance number. This number is also used for taxation and state social protection support (such as pensions, unemployment benefits, child care support, etc.) purposes. All of the information is visible, synchronised, and readily available with such a system. In addition to that, a national campaign could be run across the country for TIN registration. This will help bring more people, especially those who are living outside the main cities, under the tax net.

l NBR must establish and monitor a central database for all taxpayer-related information. Paper-based tax files located at the circle level must give way to central electronic data files. Full automation of tax administration and minimising human intervention will be key to increase tax collection and reduce corruption of tax officials.

l Measures like making it mandatory to submit proof of tax return for availing government services and availing online tax return submission have helped in increasing compliance in recent days. These efforts need to be continued in future as well to increase compliance. But at the same time, these tax certificates should be directly provided to taxpayers upon electronic request of submission. There shall be no collection of money to get the tax return submission certificates.

Reduce indiscriminate tax exemptions: According to an estimate by the NBR, tax exemptions are expected to be equivalent to Tk 1,782 billion (3.5 per cent of GDP) based on the projected GDP size in FY24 budget. Reviewing these exemptions on a case-by-case basis could significantly decrease this percentage.

Expanding the VAT net: The original 2012 VAT law aimed to expand the VAT net by reducing the number of exemptions and making it easier to administer the system. Resorting back to the original 2012 VAT law and properly implementing that has the potential to increase revenue by 0.6 percentage points of GDP each year.

Reforming state-owned financial and non-financial enterprises: This will help in improving their financial performance by implementing a hard budget constraint, improving the pricing policies for SOEs, and strengthening corporate governance. The net fiscal burden of SOEs is large and has been increasing rapidly since FY16, from 1.5 per cent of GDP in FY16 to a peak of 3.1 per cent of GDP in FY20. In FY21, non-financial SOE assets amounted to 17 per cent of GDP, but the average return on assets was only 0.58 per cent. A 10-12 per cent rate of return on these assets can potentially generate a revenue equivalent to 2 per cent of GDP for the government.

Dr Ahsan H Mansur is Executive Director, Policy Research Institute of Bangladesh (PRI). Dr Mohammad A Razzaque is Director, PRI Study Centre on Domestic Resource Mobilisation (PRI-CDRM).

The piece is based on the research conducted by PRI-CDRM.