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Rethinking fiscal policy in the era of fiscal dumping

Muhammad Mahmood | Published: April 22, 2017 20:59:28 | Updated: October 17, 2017 03:28:05

Rethinking fiscal policy in the era of fiscal dumping

There has been strong push over the last thirty years or so for the state to create business-friendly economic environment to stimulate sustained economic growth. In most developed countries, especially in the USA successive administrations went on to outdo one another not only to sweep through market liberalisation but also financial and business deregulations. Most developed countries still relies on direct taxation which includes personal income tax, corporate tax and tax on other sources of income and savings. They together constitute almost three-quarters of tax revenues and indirect taxes which largely include value added tax (VAT) and excise duties and other supplementary duties on consumption. 
Now the debate centres around corporate tax rates which are considered as an another instrument to regain, in the case of USA, and for others, to enhance competitive advantage in the global market. What Trump is trying to do now in the USA is corporate tax rate cut (from 35 per cent to 15 per cent) which most European countries already embraced for a considerable period of time in varying degrees. Oddly enough a new study of more than half of very profitable US firms listed in Fortune 500 firms found that over an eight year period these firms actually paid 21.2 per cent effective corporate tax when under the current tax regime the corporate tax rate is 35 per cent in the USA.
It is almost like a drive for to fix a near zero corporate tax rate to attract major multinationals to locate their headquarters. At the same time in most developed countries we are witnessing the gradual scaling down of social welfare safety net by drumming up the case for fiscal prudence through balancing the budget. The current focus to achieve that objective is on cutting expenditures than on raising revenues. Now there is headlong drive into fiscal dumping in most developed countries. This signals the gradual breakdown of social contract based on bargaining around tax. 
We start from the premise that taxes enable the capacity of the state to fulfil its responsibilities and they form one of the central arenas for conducting state-society relationship. Taxes also give the state its social character as the state shapes the balance between accumulation and redistribution. There has also been long-standing relationship between taxation and governance.
It can also further be argued that the social contract between the state and its citizenry based on trade-offs centred around taxation and public expenditure foster-representative democracy and enhances accountability between the state and its citizenry. Therefore, how taxation will confer benefits or not on the society depends on in the way the state and the society negotiate revenue raising and that is only possible in a representative democracy. 
On the economic front, one of the main challenges of our times is the rise in income inequality which has now taken a complete global dimension encompassing both developed and developing countries. Under the dominance of the neo-liberal doctrinaire view (also known as the Washington Consensus) there has developed a convergence of the economic policies of a "good tax system" which is broad based with low marginal rates. Such a tax regime can broaden the tax base only by expanding the scope of consumption-based taxes while reducing the tax burden of the rich with lower marginal income tax rates (which, it is argued, will eliminate or reduce incentives to avoid and evade tax). Such a tax system obviously disputes the well-established principle that progressivity is central to equity and fairness in a taxation system and further emphasises such a principle is no longer the valid criterion of taxation.
All these have caused a complete paradigm change for a developing country like Bangladesh. In its drive to achieve growth through industrialisation calls for a capital-friendly taxation system. That is reflected in widespread use of tax incentives including tax exemptions for domestic capital. At the same time the need to attract foreign direct investment (FDI) also requires to create a business-friendly environment that enables them to operate in their own ways. Multinational corporations (MNCs) are more sensitive than other businesses to the tax rates that apply to them. 
Competition between developing countries for FDI can lead to a race to the bottom resulting in MNCs imposing their own terms and conditions including the "protection of investors" clause which will enable them to sue the state under private arbitration courts bypassing the public tribunals available to all. This may also involve altering domestic economic policy which may limit the capacity for democratic governance. In effect the combined forces of domestic and foreign capital may pose a serious threat to representative democracy as we have seen already happening in advanced industrialised countries like the USA.
Bangladesh has a very narrow tax base and widespread tax exemptions and incentives, special tax regime for state-owned enterprises, inefficient (often also corrupt) tax administration have resulted in the low tax to gross domestic product (GDP) ratio which stands at around 10 per cent. The same for the neighbouring country India stands at 17 per cent. Direct taxes constitute only about 30 per cent of total tax revenue and less than 1.0 per cent of population pay income tax. Tax reforms over the last decades have not changed anything much because the problems associated with the taxation regime in Bangladesh is systemic. Indirect taxes such as value added tax (VAT), import duty, supplementary duty, etc., are the main sources of revenue. In a country where a third of population live in extreme poverty amid declining real wages in the rural sector, such consumption-based taxes with their regressive effects have serious implications for the fairness of the tax system, its social acceptability and the ability of the government to redistribute income and to create an environment which will foster equality of opportunity.
Taxation is central to the current development agenda for all developing countries, including Bangladesh, and also the central component of state building. But there is also the missing reciprocal link between tax, public and social expenditure and that calls for vigorous public debate which is again only possible in a representative democracy. As Joseph Schumpeter noted taxes not only helped create the state, they helped to form it. 
The continuing heavy reliance on import tax for revenue generation poses a very serious challenge for further trade liberalisation with consequent implications for achieving developmental goals. Given the existing state of income inequality in Bangladesh, the situation demands taxing the rich more heavily than the poor; but the politico-economic power of the rich often allows them to thwart any fiscal reform that would increase their tax burden. To make the tax system fair, equitable and transparent, attaining an optimal income tax system for revenue generation has now become a critical issue for Bangladesh. 
In this context a minimum rate of corporate income tax is also of crucial importance. This is also further justified as a means of reducing large economic rent earned by large business enterprises in most sectors of the economy. Such policy measures will bring about progressivity to achieve a certain degree of equity and fairness in the tax system. Overall the main base for taxation should start to move from consumption to income. 
This is now time for all of us to undertake in earnest the political discourse on economic policy direction, especially in matters of public expenditure and the structure of income-based taxes including minimum rates of corporate income tax. Revenue demands always foster reform of tax systems. But the imperative for pursuing fair and sustainable development goals for a country like Bangladesh also calls for a fair and equitable taxation system. Only through such a taxation system the country can meet demands for investments in public services, infrastructure, health and education. But "the difficulty lies not so much in developing new ideas as in escaping from old ones'' - as John Maynard Keynes said. 
The writer is an independent economic and political analyst.
muhammad.mahmood47@gmail.com
 

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