The increased tax rates unveiled through the new budget are likely to increase corruption and tax evasion in the country.
--BY SHANT SHARMA
The government has increased the tax burden, replacing the existing 15 percent and 25 percent thresholds with 10 per cent, 20 per cent and 30 per cent income tax slabs, and increasing the excise duties on the import of automobiles and other products effective from the new fiscal year (See box for details on the new tax rates). In an interview given to a national television channel a few days after presenting the national budget in parliament, Finance Minister Dr Yuba Raj Khatiwada defended the tax hike, arguing it was necessary to drive the country's new agenda of prosperity.
But, according to some economists and businessmen, the taxes have been hiked to meet the inflated recurrent expenses of the government that have shot up with the country entering federalism. "More than helping the prosperity agenda, the increase in taxes could undermine private sector growth and increase corruption," says a top businessman preferring not to be named. Available statistics support his speculation.
The finance minister has come up with an annual budget of Rs 1.3 trillion for the next fiscal year that includes Rs. 845 billion for current expenses, up by Rs 145 billion or 20 percent of the revised estimates for the current fiscal year. So, to meet the increased current expenditure, the government has raised the tax burden to Rs 838 billion, higher by Rs 180 billion from the current year’s revised estimate.
Corruption has been allowed a fertile ground to flourish in the country. According to the 2017 Corruption Perceptions Index reported by Transparency International (TI), Nepal’s Corruption Rank averaged 128.08 from 2005 until 2017. Nepal is ranked 128th - out of 176 countries. It is the third most corrupt country in South Asia, according to TI's 2017 report. The 54th Report of Office of the Auditor General of Nepal claims that the amount of cumulative unsettled accounts reached more than Rs 396 billion in 2017, 20.62 percent up compared to that of the previous year.
Tax revenue misappropriation worth Rs 21 billion by the Tax Settlement Commission (TSC), according to the Commission for the Investigation of Abuse of Authority, is under investigation. This is shocking and ruinous as this amount pertains to only around 45 files/cases examined out of nearly 1,046 files. Checks and balances and a thorough supervision and monitoring of the TSC from day one itself could have prevented this situation. The government and political sector’s indifference to the embezzlement cases is alarming.
Similarly, country reports on Human Rights Practices 2013 by the US Department of State identified the severity of corruption in Nepal, stating that, “Corruption existed at all levels of government and police, and the courts remained vulnerable to political pressure, bribery, and intimidation. Although the law provides criminal penalties for corruption by officials, there continued to be reports that officials engaged in corrupt practices with impunity.”
Likewise, according to the World Bank (2013) Code for Nepal, more than one in 10 transactions involved a bribe and almost half of the firms identified corruption as a major constraint; three in five firms were expected to give ‘gifts’ to secure government contracts; and almost one in five firms were expected to give ‘gifts’ to get a construction permit. Given the enormity of corruption, it is suspected that poor people pay up to an estimated 15 percent of their income in bribes while high-income households pay an estimated 8 percent.
Effects of Taxation on Corruption
Research conducted by TI shows that excessive taxation can lead to adverse effects on economic activities. While increases in public resources through taxation can help governments provide more public goods, both quantitatively and qualitatively, these benefits may be offset by negative effects on growth due to higher taxes. A higher tax rate can potentially induce more corruption in an economy by incentivising tax evasion - individuals will have stronger incentives to accept and pay more bribes so as to diminish the tax burden.
Economists argue that, depending on the structure of the economy, the effects of this can be either positive or negative for the economy as a whole. For example, if due to corruption the tax burden on the taxpayer (including the amount of bribes) is lessened then this will free up resources to invest it back into the economy or to increase savings/capital accumulation.
Accepting the presence of corruption, Joseph Gbewopo Attila, an economist associated with TI,proposes the following: "Let us assume that there is an optimal tax rate of growth for an economy (not taking corruption into account) and an 'optimal tax rate of corruption' – a tax rate at which the effect of corruption on optimal economic growth is zero. Econometric analysis shows that if the tax rate of optimal growth is lower than the optimal tax rate of corruption, then corruption induces an economic growth below the optimal rate. Accordingly, any increase in the tax rate would have a direct negative effect on growth by itself. However, the effect of corruption in this case will mitigate the impact on growth. Conversely, any decrease in taxation will be beneficial to growth, this time implying an adverse effect of corruption. If, however, the tax rate of optimal growth is higher than the optimal tax rate of corruption, the impact of taxation is more negative on growth since it significantly reduces the rate of growth."
Attila further argues that the positive direct impact or the indirect effect through corruption that taxes may have on growth is inhibited by the excessive negative effects. He concludes that, all things being equal, economic growth in economies without corruption is higher than in corrupt economies. However any positive variation in the marginal rate of taxation from the optimum can induce a negative effect on growth which can be mitigated by corruption.
These findings, Attila explains, are based on the assumption that corrupt officials will not adjust the amount of bribes to maximise their own intake rather than the amount of bribe that maximises efficiency in resource allocation in the economy. Another significant problem is that real resources are often wasted in order to keep corrupt deals secret. The cost of rent seeking is often significant, which undermines the equivalency of a corrupt exchange to a competitive allocation of resources. "There is currently a great lack of empirical data and analysis examining the impact of taxation on corruption. More research needs to be done to better understand this relationship and to determine whether remedies to corruption can be found through taxation schemes," he concludes.
New Tax Rates
The minimum income threshold for personal income tax exemption has been kept unchanged at Rs 350,000 and Rs 400,000 per annum, respectively for individuals and couples wherein both individuals and couples are required to pay one per cent social security tax.
Only, those with annual income crossing this threshold will have to pay a 10 per cent tax for the excess amount up to Rs 450,000 while a 20 per cent tax rate has been fixed for the excess annual income amount up to Rs 650,000. Similarly, those with incomes ranging from Rs 650,000 up to Rs 2 million will be levies 30 per cent tax for the excess amount. Meanwhile, those with incomes above Rs 2 million will have to pay an additional 20 per cent income tax.
In case of couples of annual earnings of up to Rs 400,000 will have to pay one per cent social security tax only. However, they will also have to pay 10 per cent income tax for the additional income if the annual income exceeds from Rs 400,000 and is up to Rs 500,000. The rate is 20 per cent for additional incomes above Rs 500,000 and up to Rs 700,000. The rate is 30 per cent for additional annual earnings but up to Rs 2 million. Similarly, for couples earning above Rs two million, an additional 20 per cent income tax will be levied.
Through the new budget, Finance Minister Dr Yuba Raj Khatiwada has also raised the excise duty on automobiles by up to 40 per cent, depending on the engine displacement capacity measured in cubic centimetre (cc). The government had been levying 60 per cent excise duty on vehicles so far. But now, the excise duty on two-wheelers above 150cc and four-wheelers above 1,000cc has been increased. The excise duty on two-wheelers above 150cc to 250cc has been increased by 10 per cent to 70 per cent. Similarly, the excise duty for two-wheelers above 250cc has been increased by 20 per cent to 80 per cent.
Likewise, the excise duty on four-wheelers above 1,000cc to 1,500cc has been increased by five per cent to 65 per cent while the excise duty on vehicles above 1,500cc to 2,000cc has been increased by 10 per cent to 70 per cent. In the same way, the excise duty on vehicles above 2,000cc to 2,500cc has been increased by 20 per cent to 80 per cent while such duty on vehicles above 2,500cc to 3,000cc has been increased by 30 per cent to 90 per cent. Excise duty on vehicles above 3,000cc has been increased by 40 per cent to 100 per cent.
The finance minister has also increased the income tax for telecommunication service providers and internet service providers by five percentage points to 30 per cent. He has scrapped the VAT rebate on the import of mobile phones, oil and ghee.
The excise duty on tobacco and beverages has also been increased. Besides the existing taxes on tobacco products, the government has levied a 25 paisa health hazard tax on every unit of cigarette, bidi and cigar from the upcoming fiscal year. Similarly, Rs 25 per kilogram health hazard tax has been imposed on import or domestic production of chewing tobacco