A lot has been said and written about this year’s budget. At first glance the story seems very familiar.
Unrealistic GDP growth expectation, large budget deficit, lots of bank borrowing, high risk of private sector crowding out. That is of course just the economic commentary.
Budgets being an exercise in political economy, there is, not surprisingly, a political equation too.
This is a budget by a very self-aware Government that is keen to demonstrate that things are heading back to normal. Hence the overwhelming focus on boosting private sector confidence and enhancing the investment environment.
That focus is coupled with a motivation to deliver infrastructure projects, especially big ticket items like the Padma Bridge, deep sea port and others. Again, part of the motivation stems from the need to address political damage the Government endured in its last term over Padma Bridge corruption allegations.
But to be fair, the Government probably also genuinely believes that delivering big infrastructure projects is good for the economy. It perhaps explains why one of the Government’s first acts after 5 January (s/election?) was to announce six big priority infrastructure projects.
This Government is not the first to believe (or imagine) that delivering big projects are vote‑winners, and it won’t be the last. That said, economic policymaking is not without its trade-offs, and this budget has a couple of big ones.
First of all, expenditure on subsidies has been reduced by about 20% (Tk 6,000 crores) in this budget compared to last year’s. Agricultural subsidies have remained unchanged at Tk 9,000 crores, and fuel subsidies have been cut in real terms. Both those developments imply a fall in agriculture and fuel subsidies as a proportion of GDP.
Subsidies and government rice procurement largesse (through a price floor) are the two primary means of income redistribution in Bangladesh, especially given relatively low social safety net expenditure.
In that context, the fact that the Government is cutting subsidies and redistributing less income to rural ‘constituents’ to save money to invest in infrastructure is big news. You will be hard-pressed to find a similar example of large cuts to subsidies in the last decade or so.
In any case, it is welcome news. There is ample evidence to suggest that the Government’s subsidies are not well-targeted and are constantly rorted by special interest groups.
The Government did not of course make that hard choice on its own. It was under pressure from the IMF to cut subsidies as part of the IMF’s loan conditions.
Nevertheless, if this budget is the first of a series of budgets that continuously reduce wasteful spending on subsidies and invests savings in infrastructure, it will indeed be a new and important development that can have potentially positive impacts on private sector investment and job creation.
The second important measure undertaken by the Government was the decision to cut the corporate tax rate for non-publicly listed companies from 37.5% to 35%. It is a modest reduction that will probably not have a huge impact on private investment in the short run. But it certainly won’t hurt either.
More importantly, if this tax cut is based on the premise that corporate taxes in Bangladesh are too high and are poorly designed, and that tax reforms are needed to boost private investment as well as to incentivise tax compliance and raise revenue intake, then this modest tax cut is a good start.
Here is an example of how our poorly designed tax code is preventing the Government from raising more revenue. There are reportedly 100,000 registered companies in Bangladesh, but only 2% of those companies file tax returns.
First of all, it is hard to imagine that there are only 100,000 registered businesses in a country of 160 million people. But even if that number were true, the 2% compliance rate is unacceptably low but not inexplicable, especially when the difference between corporate and personal income tax rates is taken into account.
The tax rate most private businesses pay will soon become 35%, as proposed in the latest budget. The tax rate most individuals pay is either 10% or 15%, which are essentially the two lowest tax brackets (see table below).
Now, imagine yourself as a successful small business owner who has done well running a shoe retail shop at Elephant Road. As a sole trader you probably paid a personal income tax rate of 10% or 15%. You are now interested in growing your business by becoming a private limited company that will manufacture shoes and then sell them through your shop.
Making that transition from being a sole trader to a private limited company will mean that the tax rate you will have to pay will jump from 10-15% to 35%.
What incentive do businesses have to grow or comply with the tax code if faced with such draconian tax policies? Absolutely none whatsoever.
If the Government is going to take away one-third of your income if you form a private limited company, you are more likely to remain a sole trader. That partially explains the low number of corporate registrations.
And if you are one of those ambitious ‘don’t-give-a-damn-about-the-government’ type, you are likely to register your private limited company but not comply with the Government’s rules.
The fundamental question at play here is as much as about people’s sense of fairness, as it is about honesty.
People who do not comply with the tax code are not all fundamentally dishonest or corrupt. Many simply find it unfair, and non-compliance becomes a form of civil disobedience for them.
In a society where contemporary culture and identity is partly based on generation after generation of civil disobedience, from Nazrul to Noor Hossain, you can’t just expect people to roll over and start doing everything the Government tells them to do.
That is not an argument for no taxes or no Government, but just that civil disobedience is a part of the low tax compliance story. The Government needs to think more carefully about the signals it sends out with its tax policies and the behavioural economics underpinning its tax policy regime.
A starting objective for tax reforms ought to be to have a corporate tax regime that reflects ground realities in Bangladesh. Most Bangladeshi businesses start out as sole proprietorships and slowly graduate to become small, family-controlled private limited companies.
The standard corporate tax rate should reflect the small business nature of most private limited companies, and the tax rate should really come in below the highest personal income tax brackets.
We are talking about middle class folks here who run small businesses and live a decent life, but by no means consider themselves to be the richest members of our society. The tax rate they pay should reflect their aspirations, and ought to be lower than the highest personal income tax rates paid by the wealthiest. This essentially implies an SME tax rate of around 20%.
From an efficiency point of view, tax reform should also focus on consolidating the ridiculous number of curve-outs for different types of businesses such as banks, mobile operators and cigarette companies.
The end-point could be a consolidated tax rate for ‘larger’ corporations at a regionally competitive level of between 30-35%. This will put Bangladesh on par with regional competitors, such as Sri Lanka, Myanmar and others, when it comes to attracting foreign investment.
It essentially implies a two-tier corporate tax structure, where small businesses pay a lower tax rate of 20% and ‘larger’ businesses pay a higher tax rate in the low-30s.
What would these reforms mean in terms of the Government’s total tax revenue intake? Well, an accurate answer requires serious economic modelling.
But if tax compliance rises amongst small businesses and the corporate tax base broadens as a result, it is reasonable to think that the Government’s corporate tax revenue intake will actually increase.
That way, the Government can have its cake and eat it too.
Nofel Wahid is an economist.