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A news item in the Financial Express of February 21 drew my attention where the business leaders called for cutting corporate tax progressively by 5, 7 and 10 per cent respectively over three years beginning 2018-19. They also asked for multistage VAT (value added tax) rates for different types of businesses. The term multistage is not all that very clear to me, whether it means multiple rates of VAT for different industries or different rates of VAT for different stages of value adding process for different industries. Their demands also include for the government to take effective measures to recover non-performing loans (NPL) and rightly recognise that the very high level of NPL is the reason for current high interest rates. But they then went on to make the most spectacular demand for the government to bring down interest rates to a single digit level, not the market. How any government can do that is not known to me. Such a demand made on the government by a representative body of business enterprises is rather very unusual. I have not seen such a lack of confidence by an organisation representing free enterprise business interests in a competitive market system. This may be indicative of a market system somehow not functioning as it should be.
The organisation I am referring to is the Dhaka Chamber of Commerce and Industry (DCCI). The DCCI argued that cutting the corporate interest rate would enable business enterprises to invest in staff development and training and research and development (R&D). So far as staff development and training and R&D expenditures by the private sector in Bangladesh are concerned, they appear to be practically close to nothing. They also claimed that tax savings thus generated would contribute to the infrastructure fund. But I am not quite clear how that can be done or organised by an individual business enterprise or by their representative body like the DCCI.
But the clamour for corporate tax cut is quite common among countries all over the world. In reality tax minimisation by corporate bodies is integrated into their business strategy and business enterprises do not see anything wrong in adopting any tax minimisation scheme. In most other countries the reasons for corporate tax cuts are justified on the ground that it would stimulate investment and therefore jobs and wages. But intriguingly the DCCI did not say that such tax cuts would boost investment. I think in the case of the DCCI, why it does not say so needs further inquiry. However, DCCI President did point out that Bangladesh slipped down the Ease of Doing Business Index from 65th out of 155 countries in 2006 to 176th out of 189 countries in 2019.
The taxation system in Bangladesh has remarkably been proved to be very resistant to change. More remarkable is the very vigorous persistence of resistance to any broad tax reform. Therefore, the DCCI's attempt at some modest change in the corporate tax rates - however modest that might be, can be seen as an encouraging sign without getting into the merits of such a change.
The existence of an informal economy (estimated at equal to one quarter of GDP) in Bangladesh also makes it more difficult to make full coverage of the economy for tax collection. The main reason for the existence of an informal economy is the result of higher fixed costs of entry into the formal economy in developing countries like Bangladesh for those who are involved in legitimate economic activity.
The corporate tax base can be defined in a variety ways, but the criterion most used is to include all types of income derived from normal equity including economic rents. In Bangladesh, all income earned by a company doing business whether resident or not is taxable. The corporate tax regime in Bangladesh is marked by differential rates varying between 45 per cent for tobacco and 15 per cent for ready-made garments (RMG). The tax rates also differ between publicly traded or non-publicly traded companies within the same sector but no such distinction is made with respect to RMG and tobacco. Such a corporate tax regime with differential rates is a recipe for serious misallocation of resources negatively impacting on building a more diversified economic base. Under such a corporate tax regime, no wonder the RMG industry has become the shining light of the economy overshadowing all other industries whether in agriculture, manufacturing or services.
In essence the corporate tax system in Bangladesh is characterised by a large range of exemptions, incentives and special regimes with discretionary power given to tax collectors to interpret them. In fact this is also the case with the taxation regime itself. All these open up opportunities for both tax payers and tax collectors to bargain over the distribution of economic rents resulting from manipulating the system. "Economic rents'' created under such circumstances is a synonym for corruption. The bargain over the rent remains within the framework of social power structure and thus does not create any vibes which may lead to upsetting the power balance in society. That remains the key to maintaining stability of the system.
In a country like Bangladesh, where the government has to cope with fiscal deficits, raising revenue remains as such the most important objective of taxation. Fiscal adequacy has always been the most important taxation principles among others, such as neutrality, equity, efficiency, certainty and simplicity. Fiscal adequacy signifies that the sources of revenue should be sufficient to meet demands of public expenditures. Therefore, one problem with any tax cuts is that when Bangladesh budget remains in deficit (the budget deficit for 2018-19 stands at 4.9 per cent of GDP) which means the government is not collecting enough tax revenue to pay for the services it is currently providing even when the country is achieving a high growth rate almost close to 8.0 per cent. Also there is no estimates given for the proposed corporate tax cuts but whatever that cost might be it would make a further hole in the budget.
The tax revenue collection in Bangladesh has been much well below the level of countries having the similar stage of economic development as reflected in one of the lowest tax/GDP ratio (11.5 per cent in 2018) in the world. The narrow tax base, widespread exemptions including discretionary exemptions which foster corruption and administrative inefficiencies are the key factors that contribute to the low tax/GDP ratio. Even the existing taxation system with significant flaws is also seriously compromised. Furthermore, even with a headline corporate tax rate of 25 per cent (in India it is 35 per cent) which is fairly comparable to other comparable countries, how many companies actually end up paying that amount of tax? Not many apparently. Now it has become imperative to ensure people do not circumnavigate the tax system to avoid paying taxes that are due to them.
In Bangladesh, the tax burden is also not shared by those who are legally required to pay tax. Also in Bangladesh, it is well recognised that resistance to tax reform largely comes from the corporate sector including small businesses and shop owners who are very well organised and exert significant influence in the policy making process in the country. Secondly, the tax administration itself has vested interest in maintaining the status quo because the existing system benefits tax officials enormously at the expense of maximising tax revenue. On the contrary, consumers being a very disparate group of people are not organised for their voice to be heard. However, in the context of the demand for corporate tax cut, one key issue also needs to be answered: will the tax cut also make country's businesses more competitive?
Muhammad Mahmood is an independent economic and political analyst.