Tax-GDP ratio falls to 7.30% in FY23 – is the informal sector worth a look?

In Bangladesh, the informal sector remains a hidden blessing. It fuels economic growth, creates jobs, but avoids responsibility. Informal sector is not all about low-income people. It includes people with taxable incomes, but largely stays out of the purview of direct tax because of cash transactions. Can a nation reach its full potential when a significant portion of its transactions remain undocumented?

A microcosm of the larger issue can illustrate considering Al-Amin's 20-seater tea stall in the corner of Dhaka at Dharmikpara, Konapara, overflows with customers every evening. Unfamiliar with tax filings, he operates his business without contributing to the formal tax system. Meanwhile, across the street, Mr. Abrar (not his real name), a junior banker, diligently files his taxes as a formal sector employee.

They earn the same per month, yet worlds apart. Mr. Al-Amin's story exemplifies a central challenge for Bangladesh's development: the thriving yet untaxed informal sector. Someone has to pay tax as his or her salary goes to a bank account and the other with similar or higher income does not have since he or she earns in cash. Isn't it an instance of tax inequality?

This situation, replicated across countless businesses in our local areas, contributes to the challenges highlighted in the Monthly Report on Fiscal Position by the Ministry of Finance for January 2024.

It shows that the tax-to-GDP ratio for Bangladesh, a key indicator of a nation's ability to fund its development priorities, has dipped to 7.30% in FY23 from 7.54% in FY22 and 7.64% in FY21. This decline can be attributed to tax revenues growing at a slower pace compared to the expansion of the economy.

Deepening the plight, Bangladesh is sinking to the bottom of South Asia's tax-to-GDP ratio league table. The OECD data showed, while the Maldives (17.7%), Bhutan (10.7%) and Pakistan (10.3%) soar with double-digit ratios, we lag far behind. Compared to economic powerhouses like France (48.1%), Norway (44.3%), and the United States (27.7%), the gap is vast. Even in the competitive world of apparel export markets like Viet Nam (18.2%), Cambodia (18.0%) and Indonesia (10.9%), we are falling behind. It is time to ask: What is holding us back, and how can we rise to the challenge?

The burgeoning informal economy, characterised by undocumented transactions escaping formal taxation, is a major factor in this equation among all other issues. While tax revenue has increased, it hasn't kept pace with the rapid expansion of the economy, leading to a relative decline in the tax-to-GDP ratio.

As the Bangladesh Bureau of Statistics (BBS) revealed, in FY23, Bangladesh's nominal GDP rose 13.07% to Tk44.90 lakh crore from Tk39.71 lakh crore a year ago; while tax revenues rose 9.36% to Tk3.27 lakh crore in FY23 from Tk2.99 lakh crore in FY22, Ministry of Finance data showed.

Changes in the tax-to-GDP ratio are driven by the relative changes in nominal tax revenues and nominal GDP. From one year to the next, if tax revenues rise by more than GDP (or fall by less) the tax-to-GDP ratio will increase. Conversely, if tax revenues rise by less than GDP, or fall further, the tax-to-GDP ratio will fall.

The Prime Minister's Private Industry and Investment Advisor Salman F Rahman also noted that the ratio declined compared to the previous year. "We need to change our tax regime as our tax-GDP ratio is the lowest in South Asia," he told an event in Dhaka on Thursday. He finds something wrong with the NBR's policy. "The policy that the NBR has been following does not really deserve praise; if it did, our tax-GDP ratio would not be decreasing."

Unfortunately, the NBR has been taxing those within the tax net more, while those outside the tax net are left untouched, Salman pointed out.

Dr Debapriya Bhattacharya, distinguished fellow at the Centre for Policy Dialogue (CPD), refers to the "gap in GDP estimates", which makes it hard for the NBR to chase the "miraculous target" it is given.

"Revenue has not increased in proportion to GDP. Those who are supposed to pay taxes are not paying. There is a lack of efficiency and corruption in tax administration," he told economic reporters in Dhaka on 7 May.

Considering Bangladesh's low tax-to-GDP ratio, an International Monetary Fund (IMF) mission team also recommended last Wednesday that tangible tax policy and administrative measures should be incorporated into the FY25 budget to augment tax revenues by 0.5% of GDP.

In a nation of 1.2 crore people having Tax Identification Number (TIN), only a small fraction steps up to fulfil their civic duty. As the NBR unveils, only 37 lakh individuals fulfilled their tax obligations last year, leaving a chasm of unmet responsibility.

This disheartening statistic reflects not only poor participation but also points to systemic flaws on the part of the NBR to effectively engage taxpayers.

Informal employment rules Bangladesh

No official statistics capture the size of the informal economy in Bangladesh. But a startling truth emerges: more than eight out of ten of the 2022 workforce work informally in the country. Could this be a window into the shadow economy's true size?

The BBS data revealed that of the around 70.47 million people employed in Bangladesh, 84.9% or 59.80 million are engaged in informal employment in 2022. Particularly in the locality, the informal employment in rural areas was 46.64 million (88.2%) while in urban regions it was 13.16 million (74.8%).

Finding a path forward

To raise tax revenue in Bangladesh, a multi-pronged approach is needed, from exploring new revenue streams to reforming the tax collection process. Making tax filing simpler and more accessible for informal businesses could encourage them to enter the formal sector. Expanding filing options through upazila offices can increase the taxpayer base.

Filing income-tax returns without the assistance of agents or lawyers is not so easy for the common people. Tax return submission is now mandatory for many services. Even for zero tax, one has to pay a tax lawyer Tk2000 as fee to process the tax file. The imperative is clear: the NBR has to work on simplifying the online filing process and making it mobile-friendly afterwards, which can significantly improve convenience and encourage timely submissions. Such advancements could not only enhance convenience but also inspire more timely submissions, ultimately benefiting both taxpayers and the revenue system as a whole.

For the government, data is king. Integrating data from financial institutions like banks and MFS can help identify tax-payable businesses within the informal economy. Simultaneously, promoting digital payments through incentives encourages traceable income records.

Elevating the tax-free income threshold for individuals is essential to uphold their purchasing power. However, merely adjusting tax rates on higher income brackets may not suffice. Introducing additional income brackets can serve as a transformative step, not only offsetting revenue loss but also fostering greater equity in our society.

Streamlining tax administration with automation and dedicated high-income units can improve collection efficiency.

The path forward is not solely about collecting taxes. Building trust is paramount. People need to be convinced that the quality of health, education and public transport services are worth whatever taxes they are paying. Communicating how tax revenue translates to improved public services, especially in areas dominated by the informal sector, fosters a sense of shared responsibility.