ANALYSIS OF THE TAX STRUCTURE AND RESOURCE GAP IN NEPAL

The objective of this chapter is to estimate the trends and magnitude of resource gap in Nepal for last two decades, and analyze the contribution of different tax and non-tax revenue to the total revenue collection. The overall tax ratio and tax levels have been examined. Separate treatment has been given to direct and indirect taxes. In case of direct tax the contribution of income tax and other taxes to direct tax and total tax revenue has been analyzed. Similarly, in case of indirect tax the contribution of custom duties, sales tax/VAT and excises duties to indirect tax and total tax revenue has been analyzed.  The average tax rates or tax effort ratio, total revenue- GDP ratio and total tax revenue-GDP ratio and marginal tax rates or flexibility coefficient has been estimated.  

Concept and Trend of Resource Gap in Nepal

One of the major ways of increasing domestic savings is to increase the government revenue. However, due to various reasons, what the government estimates to spend is not cover by the government revenue. The difference between government revenue and expenditure is known as Resource Gap. Another concept of resource gap is: savings minus investment. However, the present discussion has been concentrated to meet the objective of the study, on the first type of resource gap is also known as budget deficit. It is quite easy to say that a budgetary deficit is simply the excess of public expenditure over public revenue. However, in practice, the concept admits of many variations and yields widely divergent measures of budgetary deficit. There is also a good deal of confusion due to the fact that as yet there is no fixed correspondence between a selected measure and the name assigned to it. A given measure of deficit may be referred to by different names, and similarly, a given term may be used to represent different measures of budgetary deficit. The existence of such a large number of measures is explained by the fact that each measure has analytical and policy relevance, and there is no single measure which may be universally preferred over all others for all time to come. There is no single “correct” measure to opt for. As the World Development Report (1989) of the World Bank says, the choice of the “correct” measure would depend upon the purpose of analysis.

Before we take up alternative measures of deficit spending and illustrate them, it will be useful to present a break-up of the receipts and disbursements of Government of Nepal into relevant categories and sub-categories in an appropriate and usable form. 

The different types of resource gap have been defined as follows:

A)  Resource Gap (RG₁): This is the difference between expenditure and revenue. It is also known as Fiscal Deficit.

RG₁= Total Government Expenditure –Total Government Revenue

Here, Revenue includes total tax and non-tax revenue and total expenditure includes both regular and development expenditure. The concept of RG helps us to know the government’s capacity to finance the nation’s expenditure.

B)  Resource Gap (RG₂): This is the difference between expenditure and revenue plus foreign grant. It is also known as Budget Deficit.

RG₂= Total Expenditure – Total Revenue - Foreign Grant

Here, foreign grant includes both bilateral and multilateral grants.

C)  Resource Gap (RG₃): This is the difference between expenditure and revenue plus foreign aid (grant, loan) plus internal borrowing. It is also known as Overall Deficit.

RG₃= Total Expenditure – Total Revenue - Foreign Aid (Grant and Loan) - Internal

Borrowing

A conceptually right way of measuring deficits is to look at the change in the public sector's net worth (assets minus liabilities). In practice, however, such a measurement is quite difficult, in most countries. The difficulty lies in the valuation of public sector assets. Partly due to this problem, the conventional deficit measure captures the change in public sector liabilities. In the conventional way of measuring deficits, the inflation-corrected, consolidated public sector deficit is the most comprehensive and correct measure of public deficit. It represents the total excess of expenditure over revenue for all government entities (Bhatia, 1994).

Lack of sufficient resources is the major obstacle for planned development programs in a developing country like Nepal. Nepal has been experiencing massive resource gap in her finances. This has been primarily due to the lop-sided growth of government expenditure vis-à-vis revenue generation from domestic sources (Agrawal, 1998).

Table 4.1 provides the picture of growing resource gap in Nepalese economy. As shown in the table, resource gap has been increasing rapidly. In the FY 1990/91 the resource gap (RG₁) was Rs. 12820.3 million and FY 2010/11 reached to gap was Rs. 95544.7 million. After consideration of foreign grants the resource gap (RG₂) reached Rs.10655.5 millions in FY 1990/91 and further widened up to Rs.49622.5 million in the FY 2010/11. Similarly, after consideration of foreign loan and internal loan the resource gap (RG₃) was surplus in the fiscal years 1990/91, 2004/05 and 2010/11 Rs.153.9, 157.7, 4968.9 million respectively, and all other years resource gap is deficit in last two decades.7

Structure of Total Revenue

Government collects revenue from different sources. Basic sources of the Government Revenue are classified into tax and non- tax revenue and tax revenue has been playing dominant role in total revenue structure. Nepalese economy is characterized by a low revenue performance in contrast to the growing public expenditure and so, revenue growth is not matching the pace with the expenditure growth. The composition of the Government Revenue from fiscal year 1970/71 to 2010/11 is presented in table 4.2.

During this period, the total revenue of the government increased from Rs. 459.7 million in FY 1970/71 to Rs. 199818.7 million in FY 2010/11 with an average annual growth rate 16.30 percent. The magnitude of total tax revenue increased from Rs.359.6 million to Rs. 172777.6 million during the same period with an average of 16.38 percent per annum. Similarly, the total non tax revenue increases from Rs. 64.1 million to Rs. 27041.1 million during the same period with an average annual growth rate of 17.19 percent per annum. This clearly shows that the average annual growth rate of total tax revenue is marginally smaller than total non tax revenue during the period of forty-one years (Table 4.2).

The annual average contribution of total tax revenue to total revenue during the period of forty-one years from FY 1970/71 to 2010/11 was 80.18 percent while that of the total non tax revenue was 19.82 percent.  In between the period of forty-one years, the contribution of total tax revenue to total revenue was highest during FY 2009/10, which was accounted as 86.86 percent and the contribution of tax revenue to total revenue was lowest 73.1 percent during FY 1991/92 (Table 4.2). Similarly,  In the period of forty-one years, the contribution of total non- tax revenue to total revenue was highest during FY 1991/92, which was accounted as 26.91 percent and the contribution of non-tax revenue to total revenue was lowest 13.14 percent during FY 2009/10.

The contribution of non-tax revenue is 13.53 percent and tax revenue is 86.47 percent in total revenue collection in the fiscal year 2010/11 (MOF, 2012). This scenario indicates that the role of tax revenue is very important in revenue mobilization of Nepal to meet the growing Government expenditure.

The structure of total revenue in figure 4.2 obviously indicates the increasing contribution of tax and non-tax revenue in total revenue.

Overall Tax Ratios or Tax Levels (1970/71 to 2010/11)

Tax rates or ratios are best known as determinants of tax levels. The tax performance of any country can be partially evaluated by employing these ratios. Tax ratios are also referred to as “tax-effort” or “tax-burden”. However, it is a very comprehensive device to measure the level of taxes and provides an opportunity to study the composition and direction of individual taxes. Tax ratios give firsthand knowledge of the tax level and facilitate a basis for international comparison.

The international comparison of taxes and their levels has been a fascinating area for researchers. In this connection, the work of the International Monetary Fund (IMF) and World Bank (WB) is appreciable. According to their findings, the tax ratios in poor countries are very low compared to the richer ones. The fundamental reason for the difficulty the poorer countries have in raising public revenue is their reluctance to levy adequate sums through income tax (WB, 1989).  

Taxes on foreign trade are more popular because of administrative ease, although it may have serious long-run effects on the economy if higher taxes are imposed on some commodities. In a country with a small volume of foreign trade, tax ratios could be increased by introducing multi-point sales tax. In other cases, the result will be high inflation. Nevertheless, in most of the developing countries, the foreign trade sector has contributed significantly to the tax structure.

In measuring the tax effort ratios, most of the countries have used Gross National Product (GNP) instead of Gross Domestic Product (GDP). However, in this study, GDP data have been used. In the tax structure of Nepal, the ratio of total revenue with respect to GDP is very low as compared with other developing countries. Table (4.6) clearly shows that the level of taxes and its ratios during the period from 1970/71 to 2010/11 increased slowly.

The total revenue effort ratio in Nepal during the period from 1970/71 to 2010/11 was 10.06 percent per annum on an average. The total revenue effort ratio increased from 5.14 percent in FY 1970/71 to 16.03 percent in FY 2010/11 (Table 4.6). During the study periods, the annual average growth rate of total revenue has been greater than that of the GDP growth rate, as a result of which, there is an increasing trend in the total revenue effort ratio. Similarly, the total tax effort ratio in Nepal during the period from 1970/71 to 2010/11 was 8.05 percent per annum on an average. The total tax effort ratio increased from 4.43 percent in FY 1970/71 to 13.86 percent in FY 2010/11 (Table 4.6). During the study periods, the annual average growth rate of total tax revenue has been greater than that of the GDP growth rate, as a result of which, there is an increasing trend in the total tax effort ratio.