Even if domestic revenue is inadequate, the government needs to pay for recurrent expenses, including salaries to its employees, at any cost. Also, the peoples’ demands for development cannot be ignored even at the time of revenue crunch, which means that the government is always in need of cash. In such times, the government normally goes for the option of raising funds through domestic and international borrowing. In short term, such loans work as a source of deficit financing, but if the borrowed fund cannot be utilized properly, the country might enter a debt trap.
Fortunately, our government has been able to pay at least the recurrent expenditure from its domestic revenue. A small portion of development expenditure is also financed domestically, in the form of matching funds on foreign aid-funded projects. Debt is limited to 5 percent of GDP, and cumulative debt is below one third of GDP. Nepal has a good image in the international community in terms of repayment of principal and interest on foreign loans. Also, donors have converted many debts into grants.
Despite all this, the government should not prefer loans to domestic revenue. Loan should be the least preferred option of financing. To upkeep the national economy, increasing tax coverage and compliance should always be the government’s top priority. Debt should be used only after optimum mobilization of domestic revenues. In order to achieve this, reducing tax evasion and increasing tax should precede raising loans.
Tax evasion is normal in every country, but efficient governments can keep evasion to a minimum. There is a great question mark on the efficiency of our government in this regard. The Department for Investigating Money Laundering (DIMI) has been investigating the properties of hundreds of individuals on the premises that these properties could have been accumulated by deceiving the government—without paying tax. A lot of property has no clear source. There is another government unit, Department of Revenue Investigation (DRI), and also IRD’s own investigation unit which should be looking into these issues. Ignoring the presence of these institutional mechanisms, businesspersons have been able to make money using fake VAT invoices, and individuals liable to pay taxes are still out of income tax net.
The government is raising loans from both domestic and foreign sources. At the same time, some individuals are generating properties with a monetary value of more than the amount of loan that the government is raising for deficit financing. We are generating loan because we are unable to collect the receivables, which is not justifiable.
Besides these problems, there is another dark side to national revenue. We have a regressive tax base. More than two-thirds of our domestic revenue comes from indirect sources i.e. VAT, Custom and excise duties. In Nepal, indirect taxes are import based: Tax increases only with trade imbalance or huge imports. These taxes are to be paid by normal people. These are imposed equally on every class of people. Indirect taxes are costs for the people, as they increase the price of goods and services, resulting in inflation. Inflation is equivalent to tax imposed on the poor. Therefore, it is both important and urgent to change the tax structure, apportioning larger contribution to sustainable sources. Unless a direct and progressive tax becomes dominant on the domestic tax base, there will always remain a serious threat to national economy. Income tax can be one of the major direct taxes.
Source: Economic Survey 2011/12, Scale: in Million
Income tax is imposed on incomes and profits. Profit tax on business or investment is imposed on the net income after deducting all allowable cash and non-cash expenses, while tax on individuals’ remuneration is to be paid on income above the exemption limit as per the provision of prevailing law. Income tax is imposed only to those individuals or companies with taxable income or profit. Thus, income tax has been accepted as the most progressive tax. Income tax has been accepted as the best fiscal instrument to use by democratic countries for redistribution of national resources and creation of just and equitable society.
In developed nations, income tax is normally among the top contributors of domestic revenue, followed by other direct taxes. But in Nepal, income tax contributes to only about 20 percent of total domestic revenue and below 25 percent of total tax revenue. Study reports say that up to 40 percent of our economy is shadow economy, which is beyond the ambit of income tax. If underground economy could be brought on record, there is scope of increasing income tax by a good percentage so that it could become a larger contributor without increasing economic activities.
One of the objectives of three years plan 2010/11-2012/13 is to make VAT the top contributor. Annual taxation policy, which comes up with a consolidated fiscal policy of government, has also been in line with the same medium-term plan. This is a transitional objective which might help to maintain fiscal position in the short run, but it ignores other important national objectives. VAT can be increased only by increasing imports or the cost of goods and services. This ignores efficiency and effectiveness in production, or value addition and distribution on the part of producers.
Income tax increases with increased output or income of the private sector and individuals. It is the symptom of increased total and per capita domestic revenue. Income tax can, for now, be increased by increasing tax coverage or discouraging tax evasion, and in the long run, if priority to income tax is backed up by the government’s investment in the productive sector, both economic transformation and generation of larger revenue from sustainable source will be possible.
The government’s preference should shift from loan to, tax and from indirect to direct tax or income tax. It is time the objective of making income tax the top contributor was included in the next periodic plan, so that we will be on the right track to having a sustainable revenue source and achieving an equitable distribution and redistribution of national resources.
Republica Daily, 19 May 2013
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