The Tax Debacle

– This article was originally published by Akash Shrestha in the Himalayan Times on September 2, 2018

In the midst of the recently held BIMSTEC summit and potential implications of it on our economy in the days ahead, tax has been another major headliner across the nation of late. From introduction of new taxes to significant raises in existing ones, all governments seem to be on a spree without necessarily paying due consideration to how the taxpayers are going to prepare themselves for compliance or to how this sort of competition among governments will impact daily lives of their citizens.

What makes tax the go-to instrument?

Everybody understands that all governments need resources to fund their public functions. But is tax the only way to raise money? Certainly not. In public finance, governments can use either austerity measures, or raise debts or thirdly, collect taxes from its citizens for this purpose.

Now austerity, or in other words, reducing expenses by reducing the number or coverage of public functions (and certainly not adding any more) is the first way. Clearly, this is going to be unpopular among both politicians and voters. This is because voters always want more and more government expenditure within their constituency; be it in the name of social welfare or infrastructure projects or extension of health and education services, etc. And politicians are naturally tempted to oblige for that gives them an advantage in the next election season. Especially now, when expectations from local politicians are so high in Nepal, austerity measures are not an option from government’s point of view.

The other option is raising money through debt. This is usually a popular instrument among politicians. This is because when governments raise money through the debt market, current voters do not have to pay off all the debt while they get to enjoy all the benefits of expenditure (a road project, for instance). The politician itself also does not have to clear the debt immediately; in fact, it is highly likely that after a term or two, this burden is transferred to the next government. But again, young governments of federal Nepal are not mature enough to deal with this instrument of public finance. Our experience with migrant bonds have also shown that the citizenry’s absorption capacity is also low when it comes to using this instrument. Furthermore, the Constitutional requires local and provincial governments to go through the federal government to raise debt from the international market. All of these, in the lack of a clear legal framework regarding debts, do not help the current governments much.

This automatically makes tax the last resort for all governments. The Constitution has already assigned some revenue functions to all forms of the government and they are only leveraging this authority.

But is tax raise the only way?

No. At first glance, it appears as though when people pay higher taxes it automatically translates to more fund in the government’s coffers. This also seems to be the guiding principle among our governments at the moment. But a more pragmatic alternative to that is to make sure that more people come into the tax bracket, and this greater number pays perhaps even smaller taxes. To start with, there are so many businesses operating in the shadow-economy. Seven out of ten entrepreneurs are thought to be operating in this shadow economy of Nepal. If only these governments made it easier to register and formalize businesses, simple math tells us that we could already reduce business taxes (that are collected by local governments) by 50% and still generate higher revenues than today. Luckily for the governments, people are not even asking to reduce existing business tax; thus, even more money!

More importantly, raising taxes disregards a fundamental way in which people perceive taxes. There is no refuting that people will be generally happy to pay taxes to the government to enable it to deliver basic (and quality) public service to the people. But it is also necessary to understand that when people feel that the government is taking away more and more of their income in the name of taxes thereby reducing their disposable income by the month, they will be tempted to find ways to hide their income to lessen their tax liabilities. This tendency arises for a simple reason that all humans have wants, or a longing to raise their own standard of living; and to the extent possible, they will look to fulfill them.

What kind of tax, then?

The answer is a low and flat tax. When taxes are low, fewer people will attempt to avoid them. Also, when they are flat, meaning a certain percentage of income irrespective of the size of income, it is easy for people to calculate and comply. From the government’s perspective also, it is easy to administer and monitor. Basically, everybody gains.

It is at this point that the federal government’s action could also be criticized. The federal government has maintained that taxes have only been increased for those who earn more. But the problem with progressive tax is that in the minds of taxpayers it acts as a punishment or a fine for earning more. In most cases, people earn more by doing better what they do. In any case, a person who earns a million rupees pays more in taxes than one who earns a hundred thousand when each pay even only 10% of their income. This already follows higher the income, the higher the tax liability principle.