Ostensibly to drive its agenda of prosperity, the federal government has increased the tax burden. In reality, the taxes have been increased to finance the inflated recurrent expenses, undermining the prospect of private sector growth. The federal budget outlay of Rs 1.3 trillion for the next fiscal year includes Rs 845 billion for current expenses, 20 percent more than the revised estimates for the current fiscal year. As a result, the government has raised the tax burden to Rs 838 billion, higher by Rs 180 billion or 27 percent from the current year’s revised estimate. It has also increased planned domestic borrowing from Rs 145 billion to Rs 172 billion. This will likely crowd out the private sector from the loan market. In addition, as the government's recurrent expenses continues to expand—it consumes almost 57 percent of the total budget—investment on development-related activities is likely to shrink to 32 percent over the next three years.
Nepal's tax-to-GDP ratio is already one of the highest in South Asia and is similar to that of emerging market economies. In addition to the stated tax revisions, experts believe that there are multiple clandestine taxes. The federal tax policies go hand in hand with attempts to promote exports, regulate the market, and monitor the private sector, which, given the challenges of corruption and bad governance, may serve instead to deter the private sector and constrain the free market. The situation has been made worse by the fact that the cost of development investments, as reported by state watchdog agencies, is already massively bloated by corruption and bad governance.
The federal budget has targeted a growth rate of 8 percent in the next fiscal year, which requires massive investment from the government, the domestic private sector and global investors. Taxes, however, are like a double-edged sword. Even as they contribute to government coffers and raise the prospect of public investment, they can also constrain the investment from the private sector, especially at a time when foreign investors are already sceptical of the government's policies. How the private sector can participate in government-driven policies and generate investment will, to a large extent, depend on politics and the logic of a political economy. The tax policies at the different levels of government have undermined the relationship between the citizens and the state. As is apparent from multiple news reports, individuals and businesses have started questioning whether the different levels of government can deliver services in return for the taxes collected. The provincial and local governments are under pressure to generate resources and the easiest way out for them has been to raise taxes. The manner in which tax policies are being adopted by the governments appear ad hoc and motivated by a false sense of self-entitlement, without taking into consideration the quality of public service and the impact on growth, investment and equity. Another example of the mistrust between the government and the businesses was reflected in the tussle over the issue of a revised calculation method regarding capital gains tax (CGT) on the sale of bonus and right shares. As stock traders boycotted trading, the government had to take a step back.
The federal budget, while having good intentions and policies, fails to send a positive message to the private sector. Some of the positive steps include exemption of social security tax for individuals participating in the contributory provident fund, a contributory pension system for public servants, requirement of licensed brokers in real estate transactions and not so significant changes in existing corporate taxes. Such policy changes were also promised in the previous years, and if implemented, would constitute a significant improvement. At present, the primary challenge is to stop tax avoidance and prevent corruption, which has greatly bloated the cost of economic development.