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The Financial Express

The new VAT regime: An appraisal

| Updated: October 22, 2017 06:23:23


The new VAT regime: An appraisal

The Bangladesh budget, 2017-18 has set a uniform rate of value added tax (VAT) at 15 per cent. The finance minister also foreshadowed that this rate would remain in place for the next three years thus ensuring certainty. As a consumption-based tax the VAT is paid only indirectly by tax payers unlike directly imposed income and wealth taxes. So far the VAT regime has been marked by multiple rates for different goods and services, but with the introduction of a uniform rate of VAT as proposed, the application of the new tax law relating to the VAT will be simpler to administer resulting in efficiency gains in tax collection. But the proposed tax law also has an exclusion clause where a number of goods and services are exempted from the VAT. These goods and services are considered to be essential such as food, medicine and education. An estimated 1033 items are in the VAT exemption list. The argument for the exclusion clause is mainly based on the equity argument in view of the regressive nature of the tax. But many items in such an exemption list can always be subject to litigation with a view to expanding the scope of the list.
In a historical context Bangladesh (as most other least developed countries or LDCs) has always relied on indirect taxes to raise revenue; only that the VAT can be considered a more streamlined indirect tax incorporating multiple other indirect taxes. In that context the VAT can be considered a more efficient form of indirect tax. The neighbouring country India is also in the process of introducing a streamlined consumption-based tax, the Goods and Services tax (GST) with effect from July 01, 2017.
The proposed estimated tax revenues are composed of 33 per cent direct income-based taxes while the rest 67 per cent is composed of indirect consumption-based taxes of which 54 per cent will come from the VAT. In effect the VAT remains the single largest source of estimated tax revenue for the fiscal year (FY), 2017-18, at 36 per cent of the total tax revenue. This is quite a high figure for a poor country like Bangladesh where 23 per cent of the population live under the poverty line with unemployment rate officially estimated at 5.0 per cent, amid very widespread under-employment.
Such a high reliance on consumption-based taxes (e.g. VAT, SD and import duty) in general and the VAT in particular is symptomatic of a tax regime incapable of designing and implementing a fair and equitable taxation system. Why it is so remains a mystery to me.
The economic literature on taxation is clearly unanimous on the regressive nature of any consumption-based taxes and more so in poorer countries because the final incidence of such taxes fall on final consumers. A very large proportion of those consumers are extremely poor in Bangladesh and those who belong to the middle-income bracket are not also very well-off financially to afford such a tax. Such a tax like the VAT violates the basic principles of taxation - fairness and equity. 
While from various quarters in Bangladesh, opposition to the new VAT rate has been raised, but there is no reason to believe that the government will be moved by those views because they need the revenue and the VAT is an easy way out given the very narrow tax base. It appears that the government is unable or unwilling to gradually expand direct taxation based on income and wealth. Overall the government has instead been expanding the scope of indirect taxes based on consumption.
The main reason the government can pursue its revenue raising agenda through consumption-based taxes is the lack of consumers resistance to such regressive taxes. Consumers are a very disparate group therefore makes it very difficult for them to press on with their views on the government. Moreover they do not pay a very large amount of tax at a time (like income or wealth taxes) but very small amount at a time spread over the whole year can make it a sizeable amount. Unlike consumers, various industry groups are very well-organised and can exert tremendous amount of influence on the government. This is reflected in a good number of ruling party MPs' demand for favourably reconsidering the proposed for hiking excise duty on the year-end balance of accounts of any individual client of banks. The power of such interest groups, despite the minister's unrelenting stance on this tax, also tells us why any attempts to expand the direct tax (income and wealth taxes) base will face serious opposition from these very groups and also from high income professional bodies.
A number of industry groups are not only benefiting from a very small direct tax base but also in many instances protected by tariffs resulting in consumers having a double whammy. Import and supplementary duties constitute 27 per cent of the estimated tax revenues.
In effect the scope of the Supplementary Duty (SD) has been expanded from 1,250 to 1,666 items with the explicit objective of protecting those industries producing these goods. It was presumably done to protect the public interest but how higher prices to be paid by the public can be in public interest remains another mystery to me. In a further attempt to bolster the RMG industry, the corporate tax has been reduced from 20 per cent to 15 per cent. This differential corporate tax rate will cause more investment to flow in to the RMG industry at a time when the government is presumably striving to diversity the basket of exportable goods. 
The lower income demographic is expected to bear the brunt of VAT as they spend more as a proportion of their income on consumer goods and services. Despite the minister's assurance that the tax will not cause price rises, it is widely believed that it will add to the inflationary pressure. The VAT can adversely affect revenue receipts by discouraging consumer spending which, in turn, can impact on overall spending thus negatively impacting on economic growth.
However, in the final analysis the ultimate impact of the VAT rate will be judged by whether the economy will be able to create jobs for the unemployed and those new entrants into the labour market. It is more important, whether the new VAT regime will boost the economy and encourage both domestic and foreign investment to create jobs. 
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