Nepal has been undertaking considerable tax reforms for more than two decades but has been less effective in widening the tax base.
---BY KP PRASAI
The domestic revenue mobilization in developing countries has gained increasing prominence in the fiscal policy debate in recent years. This is due to several factors, including the potential benefits of taxation on state building; long term independence from foreign assistance and the shifting aid paradigm; trade liberalisation; and the continued acute financial needs of developing countries. Donor agencies have increasingly recognised the central role of taxation in ensuring sustainability and ownership in the development process. International donors are increasingly aware that taxation is the only viable strategy to exit from foreign aid dependency in the long run. The need to increase domestic revenues has become even more demanding since the global financial crisis of 2008. The crisis has implied a decrease in capital flows to developing countries, including trade, remittances and aid.
Developing countries have significantly liberalised international trade, often with the strong encouragement of aid donors and international organisations. Taxes on exports have been dramatically decreased and often eliminated in many developing countries, while taxes on imports have decreased substantially and may be reduced further. The process of trade liberalisation therefore may imply substantial revenue losses in developing countries. It is therefore important to strengthen the capacity of countries to raise revenue from domestic sources to replace potential losses from trade taxes and reap the potential benefits of further integration with the global economy. Therefore, domestic revenue mobilization has a crucial role in fiscal policy implementation particularly in the least developed countries (LDCs) like Nepal where the demand for public funds is very high. Nepal has been undertaking considerable tax reforms for more than two decades but has been less effective in widening the tax base, simplifying and strengthening tax administration, initiating good governance, improving compliance and modernising the economy that could help increase the tax coverage. Due to these reasons, Nepal has been suffering different problems such as the lack of revenue surplus for development activities and dependence on foreign grants and loans leading to a growing resource gap. Revenue growth is not maintaining pace with the expenditure growth. Although the government revenue mobilization has improved since the early 1990s, it is still less than the government expenditure leading to the situation of budget deficit. This shows that resource gap is one of the major macroeconomic problems of Nepal’s economy.
Composition and Trend of Total Revenue
The total revenue consists of total tax revenue and non-tax revenue. Since the country’s revenue mobilization has recorded high growth each fiscal year, Nepal’s total revenue (TR) to gross domestic product (GDP) ratio has reached the highest among South Asian countries and is at par with emerging market economies. The country’s total revenue increased significantly from 8.9 percent of GDP in FY 1990/1991 to 24.8 percent in FY 2018/2019 (Figure 1). A key factor for the improvement in domestic revenue collection has been a huge inflow of remittances which jumped from 1.77 percent of GDP in FY 1990/1991 to 25.38 percent in FY 2018/2019. This has fueled imports and consumption expenditures, yielding revenue gains especially in VAT, excise duty, and customs duty. The imports of goods and services and the consumption expenditures stood at 40.95 percent and 79.52 percent of GDP respectively in FY 2018/2019.
In order to understand the growth pattern of taxation properly, it would be desirable to examine the share of total tax revenue (TTR) to GDP. The share of tax revenue went up from 6.7 percent of GDP to 21.9 percent during the period from FY 1990/1991 to FY2018/2019. It remained almost stable for more than a decade from FY 1994/1995 to FY 2005/2006. However, the ratio increased continuously from FY 2006/2007 to FY 2018/2019 (Figure 1). According to IMF, the improvements in Nepal’s tax-to-GDP ratio might be somewhat overstated because of underestimation of GDP caused by the use of an outdated base year.
The share of non-tax revenue (NTR) has hardly increased from 2.1 percent of GDP in FY 1990/1991 to 2.9 percent in FY 2018/2019 (Figure 1). The non-tax revenue has almost stagnated as a percentage of GDP in Nepal. It is because most of the public enterprises which are the major contributors of non-tax revenue have been incurring losses and the other sources of non-tax revenue are also not performing well, causing the dismal performance of non-tax revenue.
Composition and Trend of Total Tax Revenue
Of the two types of taxation, direct and indirect, the latter has always been an important part of any tax system. Domestic indirect taxes are the major source of revenue for governments in low-income countries like Nepal. These taxes are applied to large sections of the population and are relatively easy to administer. Thus, considering the limited potential of direct taxes, revenue largely depends on indirect taxes like VAT and excise duty. More resources can be raised only through the exploitation of indirect taxes. Indirect tax is a major source of tax revenue in Nepal. The role of indirect tax is high in Nepal because of a poor tax administration.
The share of the direct and indirect tax revenue to GDP has been increasing each passing year. The share of the direct tax revenue (DTR) reached 6.9 percent of GDP in FY 2018/2019 while it was 1.1 percent in FY 1990/1991. Similarly, the indirect tax revenue (ITR) to GDP ratio was 5.5 percent in FY 1990/1991 and increased to 15.0 percent in FY 2018/2019 (Figure 2). This indicates that the contribution of both direct and indirect taxes to the GDP has been increasing continuously.
Composition and Trend of Direct and Indirect Tax Revenue
Under the category of direct tax revenue, the share of income tax (IT) is increasing. Among the components of indirect tax revenue, value added tax (VAT) is the largest source of government revenue in Nepal. The share of customs duties (CD) is declining while that of excise duties (ED) is increasing. Compared with alternatives of indirect taxation (customs duty and excise duty), the VAT has more revenue potential. The VATrevenue increased from 1.96 percent of GDP to 6.97 percent during the period from FY 1990/1991 to FY 2018/2019. Over the same period, income tax revenue climbed to 5.6 percent of GDP from 0.6 percent while excise duty revenue increased from 1.0 to 3.5 percent of GDP. Taxes on international trade, that is, customs duty increased marginally from 2.5 percent of GDP in FY 1990/1991 to 4.4 percent in FY 2018/2019 (Figure 3). The process of trade liberalisation will make trade taxes even less important in the future as Nepal has to comply with international commitments as a member of WTO, BIMSTEC and SAFTA.
Nepal’s revenue collection has been increasing rapidly in recent years with high growth rate. Part of this growth can be attributed to the government’s reform programmes. However, another signifi cant factor behind the growth is remittance- fueled imports and consumption expenditures. As a result, the fast revenue growth registered in recent years is likely unsustainable. The major challenge for the government is to make the revenue mobilization sustainable without putting anymore burden on taxpayers. To meet this challenge, the government needs to raise the competitiveness of Nepali industries and invite foreign investors into the production sectors of the economy where we can generate more income, employment and output which will ultimately help to mobilize the potential revenue. Further, the trading community which is fl ourishing because of remittances should shift their businesses towards establishing manufacturing industries which will improve the country’s taxable capacity. Moreover, there are major issues in Nepal’s tax system including a weak tax administration and execution capacity, high tax rate and narrow tax base, low tax compliance, large size of economic activities operating in the informal sector of the economy, tax evasions, rampant corruption and low taxpayer morale which all need to be addressed properly and urgently to strengthen domestic resource mobilization. Finally, the Nepal government should earn people’s confi dence and trust in the tax system and provide better services to the taxpayers.
(The writer is at the Faculty of Economics, Apex College)