Problems in New Tax Arrangements and Taxation Reform

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Vidyadhar Mallik
Former Minister, Health  |  Ministry of Finance  |  Former Director General   |  Inland Revenue Department

The first federal government budget indicates that the government has taken a backward momentum in terms of taxation. There has been 5 percent customs buty increment on the impart of agricultural commodities. Such used to be levied also in the part but was abandoned long time back. Likewise, tariffs on the import of many commodities have been increased. To stop illegal imports of goods and commodities, the government should have reduced the tariffs. When government thinks of collecting more revenue by imposing high tariff rates, it needs to be cautious that illegal import of goods will increase due to our open border with India.

Nepal is one of the successful countries in South Asia when it comes to tax collection. We have a high revenue to GDP ratio in this region. It is primarily because of the increase in the economic rate of return in legal trading activities. The government established after the political change in 1990 started decreasing tariffs which also helped in the expansion of the tax net as many traders opted to import goods and commodities through legal channels.

I don’t see any major policy departure in the first federal budget of the country. Instead, the government has taken a backward momentum in taxation. This is an error made by Minister for Finance Dr Yuba Raj Khatiwada while formulating the budget. In the past he has served as the governor of Nepal Rastra Bank (NRB) and the vice-chairman of the National Planning Commission (NPC). Such an experienced economist should have shown good indications. Nevertheless, we are yet to see the impact of the new tax arrangements incorporated in the first federal budget of the country. 

In the late 90s, Dr Khatiwada was in a committee which had proposed several measures for tax reforms. At the time, I was the director general at the Inland Revenue Department. Now, he is going against the agenda by raising the tax rates. For instance, the income tax for the top earning bracket has been increased by only one percent while there is an increment of additional 15-20 percent for earners in the middle income bracket.

Those who used to pay 25 percent income tax are now required to pay up to 36 percent tax. But the increment is only one percent for those who were paying 35 percent income tax previously. In this way, the new tax arrangements are not progressive. 

Several tax concessions not announced in the federal budget speech have also been included in Finance Bill, 2075, which has now become an act. Providing too many tax concessions won’t be helpful to encourage businesses and general individuals. Lowering the tax rates could have been a more productive approach instead. Providing tax concessions to businesses and industries of specific sectors will give a message that the government doesn’t trust the open market and wants businesses to follow its line. This kind of practice is economically harmful in the long term as businessmen will only look to invest in the areas where they will receive tax concessions and will not adhere to product and service innovation, improvement and needs of the consumers. Corporate entities should be given freedom to engage in whatever kind of business they want to invest in by following the rules and regulations.

While formulating and implementing policies related to taxation and economic development, it is important for lawmakers and the people in the government to understand that they are not necessarily the wisest people. In fact, entrepreneurs and investors may be wiser, they keep the wheels of the economy rolling. 

The post-90 period has seen two generations of tax reform in Nepal. The current practices are related to the third generation of tax reform which includes self-assessment practices and removal of barriers between taxpayers and tax officials by optimally utilising the means provided by the information technology. This includes e-filing of tax documents along with e-payment and e-return of taxes.

The past reform initiatives including self-assessment of VAT, establishing green channels for imports at customs points and self-removal system were aimed at reducing the cost of doing business in the country. The government has been putting its efforts towards this end. Taking the reforms in tax policies and the tax administration in parallel has been our approach for the last 12-15 years. This has positively impacted in terms of expanding the tax net and revenue collection.

But corruption in the state mechanisms has hindered the penetration of the tax reform initiatives. Besides, there is sluggishness regarding the applicability of tax laws, rules and regulations, capacity enhancement of tax officials and the ability of tax administration to control tax evasion techniques of corporate houses. It is not that successive governments haven’t wanted to add efficiency in tax administration by creating a neutral and professional workforce. Likewise, creating semi-autonomous revenue authority (SARA) or revenue boards have also been discussed and planned over the years. Nonetheless, these plans haven’t materialised yet. 

 The reforms in tax administration are also related to the improvements in the tax laws. Two decades have passed since the introduction of VAT Act in 2055 BS. Similarly, the Income Tax Act and Excise Act were enacted in 2058 BS. These laws now need amendments to accommodate the world practices to give a new direction to the reform process. Every year, the national budget brings different sections on taxes which can change the administrative system too. It is not a good practice. On the other hand, the government prepares the budget in a secret manner. The budgetary discussions with the private sector bodies are always a one-way communication where the government officials only listen to the suggestions of private sector representatives. I think the government needs to rethink on the traditional budget preparation processes and seek adequate discussions and feedback wherever possible.

The tax policies need to be developed in such a way that cases like the Ncell controversy aren’t repeated. There is also a need to modernize the tax system and make it taxpayers-friendly by incorporating the use of ICT. 

Bringing complex tax systems like Goods and Services Tax (GST) of India will complicate the mechanism. It would have been great if the government had kept low tax rates for daily consumer goods so as to ease the problems faced by people from the low income groups. Such an initiative can also have a positive impact on the doing business environment of the country.

Increasing the rates will not make our taxation competitive. To some extent, it was competitive till the last fiscal year. Besides, the competitiveness of the tax system is not the only factor to assure foreign and domestic investors. A predictable business atmosphere accompanied by political stability and good infrastructure is necessary to ensure investment. The level of predictability will be lower if the tax rates keep changing every year. This is why the realisation of FDI commitments is so low in Nepal. 

It is clearly mentioned in the constitution that citizens don’t have to pay double taxes. Local governments in many areas are levying taxes on movement of citizens from one place to another. The cases related to double taxation have arisen significantly after the implementation of three tiers of government. A state of confusion prevails among the citizens due to the haphazard taxes being levied by the local governments. It is primarily because the tax laws are yet to be enacted to define the role and responsibilities of the government of all three levels in tax collection. 

It will be pragmatic for the local governments to have full authority for collecting taxes and royalties from real estate, construction and natural resources. When we look at countries with federal structure, the central government collects 15 to 20 percent of the overall tax, while the remaining is collected by the provincial and the local governments. In the context of Nepal, almost 85-90 percent taxes are collected by the central government.

The article is based on a conversation with Mallik.

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