In a country where the tax-GDP ratio is one of the lowest in the world, policy makers have to be concerned about tax expenditures given that the net benefit to society from this policy is unknown.
In an event organized by the National Board of Revenue (NBR) on January 25, the Comptroller and Auditor General Mr. Muslim Chowdhury asked: "Do you know the total size of exemptions in the economy?" He was referring to tax expenditures--the revenue losses from exclusions, exemptions, deductions, tax rebates, preferential rates, and deferrals. Tax expenditures are measured relative to the normal tax system. Essentially, it is tax money spent before they are collected.
We see news about such exemptions almost on a daily basis. A non-exhaustive inventory of such news in last 12 months includes: Income tax deducted at source on all exports reduced from 1 percent to 0.25 percent; reduction of Advance Income Tax on raw materials imported by cement manufacturers from 5 percent to 3 percent; imports of raw materials of active pharmaceutical ingredients and reagents exempted from 15 percent VAT until December 2025; import duty exemptions provided for imports of several items that are VAT exempt, including inputs for poultry and fish feed, machinery and spare parts for solar panel manufacturers, and vehicles for lawmakers; corporate and individual taxpayers allowed a reduced tax rate of 10 percent on income from jute products; reduced VAT on coal imports from 15 to 5 percent for five years; VAT exemptions provided for the government's fast track projects, Public-Private Partnership projects, business showrooms run by women entrepreneurs, jute-based products, and local suppliers of agricultural machineries.
"Every day you are creating inequality between the rich and the poor by offering new tax exemptions", Mr. Chowdhury added.
I cannot think of a timelier warning. Bangladesh has found it challenging to turn economic growth into revenue growth. Tax revenues, which make up over 80 percent of all revenue, remain below expected for Bangladesh's level of development. Latest NBR data show NBR has missed the target for income tax, VAT and customs revenue collection by Tk 31,507 crores in the first half of FY20. The shortfall constitutes 9.7 percent of the NBR target for the whole year.
Overall, tax expenditures in Bangladesh appear to be very high. The analysis last undertaken by the Bangladesh Bank more than a decade ago estimated it at around 2.5 percent of GDP. This has most likely increased. Special tax treatments for the garments and electricity, together with generous tax holidays and exemptions for special economic zones, are major sources of tax revenue losses. There are a large number of exemptions in the tariff schedule which benefit specific industries, single companies, and sometimes are under nontransparent "special order" labels. An analysis of customs transaction data at the tariff line level by the World Bank several years ago showed that exemptions figure in almost 30 percent of the total number of transactions and 44 percent of total trade value.
These exemptions add up to a significant revenue shortfall. In a country where the tax-GDP ratio is one of the lowest in the world, policy makers have to be concerned about tax expenditures given that the net benefit to society from this policy is unknown. The general perception that well-connected individuals or companies receive preferential treatment under the tax laws severely jeopardizes the integrity and effectiveness of the tax system.
Tax expenditures are a major source of revenue leakage globally. Leakage can run as high as 5–6 percent of GDP even in some advanced countries. In theory, tax incentives are poor instruments for attracting investments while in practice they are highly abused. Incentive lobbyists' counterpoint, that lack of tax incentives puts their clients at a disadvantage because their competitors are giving them, has substantial factual content. A dramatic illustration can be found in Southeast Asia: the Philippines gives incentives because China gives them, Vietnam gives incentives because the Philippines does, Thailand follows the Vietnamese example, thus perpetuating a race to the revenue bottom.
Tax expenditures are difficult to eliminate once they form part of the system. The taxpayers benefitting from these regulations tend to mount resistance to any subsequent attempt at tax reform. The people in power use tax instruments to favor cronies and constituents. Both interest groups and vested interests pressure the people in power to grant excessive exemptions and incentives using equity and investment promotion as the rationale.
The regulations establishing preferential treatment for specific groups of taxpayers in certain economic sectors tend to gain a life of their own through direct or indirect demand. Specific benefits tend to generate direct demand given that they have a significant impact on reducing the tax burden or produce a contagion effect on other groups who clamor for access to the same advantages. The laxity of norms that regulate access to specific benefits in many cases open the door to tax evasion and avoidance. Reducing tax expenditures by phasing out ad hoc and arbitrary tax holidays, exemptions, rebates and such other tax concessions requires a systematic evaluation of the costs and benefits of tax expenditures. The implicit assumption of the status quo is that the net benefit for society is positive for all tax expenditures.
Introducing a systematic process to evaluate tax expenditures is an important step toward improving the effectiveness of this tax policy instrument. It is impractical to conduct a complete evaluation of all tax expenditures currently existing in the system. The tax authorities could start by evaluating the tax expenditures that are presumed to have a 'high' fiscal cost. Evaluations should focus on justifying the intervention and choice of instrument, clarifying the objective sought and its potential beneficiaries, and evaluating the costs and benefits in all their relevant dimensions.
All the new tax expenditure proposals must be accompanied by an evaluation of corresponding costs and benefits. At the same time, moves to eliminate tax expenditures should be based on an evaluation that justifies this decision. In the case of tax expenditures that terminate on a specific date, the decision to extend its effective period must satisfy the criterion that the expenditure has effectively and efficiently fulfilled the objectives sought. The establishment of effective periods for these benefits is an important instrument in managing tax expenditures by allowing opportunities to initiate a political debate on their relevance and impact. Proposals to introduce new tax expenditures should consider the more active use of termination dates. Special attention should be paid to design better the requirements to access this benefit. This would help close off possible avenues to evasion and block the entry of tax payers who should not have access to these benefits.
The author is an economist.