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The need for three-tier tax reform

Dhiman Chowdhury | Published: January 22, 2017 19:57:47 | Updated: October 18, 2017 11:15:11

The need for three-tier tax reform

One vital area of good governance in a country is its taxation system. Bangladesh now stands at the bottom of tax revenue compared with the rest of the world. Tax-GDP (gross domestic product) ratio is currently around 10.5 per cent compared to India's 16 per cent, Indonesia's 13 per cent, Vietnam's 24 per cent, Thailand's 18 per cent, Myanmar's 11.6 per cent, Pakistan's 12.4 per cent, South East Asian average of 16 per cent, OECD (Organisation for Economic   Cooperation and Development) average of 34 per cent, and the world average of 27 per cent. This article deals with direct taxes of the central government which include personal income tax, corporate tax, capital gain tax, wealth tax, inheritance and gift tax. It suggests reform at three stages. 
In Bangladesh, compared to other countries, existing tax rates for wealthy people are low; secondly, actual collection of taxes even  where tax rates are higher, is low; and thirdly, taxes such as wealth tax, wealth transfer taxes like inheritance tax and gift tax are absent.
FIRST TIER: REGIONAL COMPARISONS: Corporate tax rate is kept low compared to personal income tax rate around the world. Corporate profits, if given the chance for reinvestment, help growth of the economy. But corporate profits other than reinvestment can be misused mostly through excessive executive remuneration in the form of bonus, share, share options and other perquisites which are used for empire building. To curb this greed and self-interest, personal tax is kept higher compared to that of corporate tax rate. In Bangladesh, this theory of taxation is not followed rather the opposite is in practice although some good changes are now taking place. For example, top personal tax rate has increased from 25 per cent to 30 per cent plus top surcharge of 30 per cent on the tax payable but these are still much below the rates of developed, emerging and neighbouring countries. 
Top personal tax rates for people with ability to pay are historically low in Bangladesh. It is now 30 per cent compared to India's 33.61 per cent, Pakistan's 35 per cent, Vietnam's 35 per cent, Thailand's 35 per cent, Asian average of 28.9 per cent, OECD's 42.3 per cent. In India, there is surcharge on companies at 7.0 to 15 per cent for higher income but there is no such surcharge in Bangladesh. An alternative can be progressive tax rates instead of a flat rate. Capital gain, which mostly goes to the wealthy, is also taxed low in Bangladesh at 15 per cent compared to 20 per cent in Vietnam, India and Thailand,  30 per cent in Indonesia, 25 per cent in  China, 28 per cent in UK, 30 per cent in Sweden, 25 per cent In Germany, and 38 per cent in France.   
SECOND TIER: COMPLIANCE AND GOOD GOVERNANCE: Personal income tax collection as a percentage of GDP in Bangladesh is only 0.88 per cent compared to India's 2.29 per cent, Thailand's 2.4 per cent and Indonesia's 2.9 per cent. Even countries with lower top personal income tax rates of 16 per cent to 25 per cent which are lower than our 30 per cent have higher collection. Personal income tax collection as a percentage of GDP is 2.78 per cent in Hong Kong, 2.29 per cent in Singapore, 2.62 in Bhutan, 1.87 in Nepal and 1.06 per cent in Laos.
Although our corporate tax rates are higher compared to other countries, corporate tax collection as a percentage of GDP is 2.33 per cent compared to India's 3.62 per cent, Thailand's 5.15 per cent, and Indonesia's 5.58 per cent.  Tax on capital gain from shares is exempt. House property which can be shown vacant or not rented is not taxed. In UK, capital gain tax on property transfer is 4.36 per cent of total direct tax whereas in Bangladesh it is 2.34 per cent. Income from house property, which is an important source of wealthy people, is poorly taxed. Tax deduction at source (TDS) from rented institutions is TK 2250 million or 0.01 per cent of GDP. If this TDS is say 40 per cent of total (national total TDS is 57.62 per cent of total tax revenue) then this tax should be TK 5625 million or 0.04 per cent of GDP compared to Nepal's 0.15 per cent.  
THIRD TIER: FUTURE POTENTIAL: Most of the tax around the world comes from the wealthy people and this is not punishing them but because they have the ability to pay. There is need for increase in our capital gain tax. In OECD, marginal personal income tax rate has increased from 41 per cent in 2011 to 43.2 per cent in 2014. Capital gain tax increased in France from flat rate of 24 per cent to 45 per cent graduated rates, in Italy from 12.5 per cent to 20 per cent, in Japan from 10 per cent to 20 per cent, in Korea from 38 per cent to 41.8 per cent and in UK from 18 per cent to 28 per cent.
Wealth tax is unpopular because it is imposed on stock of net wealth. Popular taxes are imposed not on stock but on its flow or income. And therefore wealth tax has been repealed in most countries around the world. To remove this problem of stock and flow, many scholars are arguing for a 'modified wealth-income tax'. Here, the sum of wealth tax and regular income tax shall not be higher than a certain percentage of regular income, say 40 per cent of regular income or a higher marginal tax rate in line with other developed and developing countries. This method takes into account both stock of wealth and flow of income. This method will also raise more revenue than currently received surcharge. Suppose, income is TK100, top marginal tax will be 30 per cent or TK30 and top surcharge of 30 per cent of this tax will be TK9.0. But 'modified wealth-income tax' will be a maximum 40 per cent of TK100 or TK40. 
There are also other alternatives to the unpopular wealth tax such as wealth transfer tax like inheritance and gift tax. In Bangladesh there is gift tax law but collection from this source is zero. Indian gift tax (until 1998) has been converted into income tax from 2004. The donor pays income tax on the gift received after exemptions such as gifts to spouse and siblings and gifts as inheritance. We do not have an inheritance tax but Philippines, Thailand and Vietnam have recently introduced this tax. Inheritance tax is increasing in the UK, with the collection of BPS4.7 billion or 0.25 per cent of GDP in 2015-16, a growth of 22 per cent over 2014-15.
In Belgium, to reduce the criticism against inheritance and gift tax, legal reserve of the spouse and other family members is maintained. The spouse with one child has half of the estate as legal reserve and the other half is disposable portion. For two children the legal reserve is two-third and for three children it is three-fourth. Also, to sustain family business, transfer of business and companies are exempt from tax, only a registration fee of 3.0 per cent of the fair market value for spouse and 7.0 per cent for other persons is charged. Germany also has a similar such a plan. 
Dr. Dhiman Chowdhury is Professor of Accounting, University of Dhaka.
dhiman_chowdhury@yahoo.com
 

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