Nepal is least developed and land-locked country,
situated between two neighboring economic powers India and China. These two
neighboring countries are trying to achieve two digit economic growth rates but
our growth rate is still less than five percent. Our economy is characterized
by high population growth rate 1.4 percent (CBS, 2011), low GDP growth rate 4.5
percent (Budget Speech, fiscal year 2010/11), low per capita income is $ 490
(CBS, 2011) and low rate of capital formation. Now about 25 percent of the
total population has remained below the absolute poverty line (CBS, 2011). Many
infrastructure of economy are failed due to decade insurgency, like other
developing countries in the world. Nepal has been suffering from resource
constraints, massive poverty, rapid growth of population, increasing frictional
and seasonal unemployment and poor infrastructure despite over five decades (56
years) planned development efforts.
Prime concern of every nation of the world is rapid
economic development and Nepal is no exception to this. A lot of money has to
be spent to achieve maximum national objectives. Either to pay regular
expenditure or to do development works, government required revenue. To
mobilize and utilize all the available resource and to achieve maximum national
objectives, government required large amount of revenue. Total expenditure is
increasing at faster rate than increase in total revenue. The problem of
bridging this gap has become the main issue in the country. The source of
government revenue can be classified into two categories: External source and
internal sources. External source consist of Bilateral and Multilateral Grants
and Loans. External source are uncertain, inconvenient and not good for the
healthy development of the nation in case of high dependency because they have
be too paid after a certain time. If foreign loans are not mobilizes properly
or misused, it becomes burden for the country and it can push the country into
debt trap crisis. So it is better to mobilize internal sources rather than
depending upon external sources. In our country Nepal, the budget deficit is
mainly fulfilled by the external debt. But we are not able to mobilize the debt
in appropriate manner. It is said that our country is pushed into debt crisis
at present situation. The outstanding public debt reached almost 60 percent of
the GDP; the debt serving ratio accounts for about 4 percent of GDP and the
per-capita loan is almost Rs. 9000…..public sector debt is more alarming … As
the misuse of borrowed funds and decision making is wide spreads with regard to
project all over the nation, other things remaining the same, there are
symptoms of Nepal steadily falling into debt trap (Sharma, 2004)
Tax
is the compulsory contribution to the government and made without reference to
a particular benefit received by the tax payer (Goode, 1984). It is personal
obligation to pay tax and there is no direct relationship among tax, benefit
and individual taxpayers.
The
prime objective of taxation policy is to promote economic growth, equity,
stabilization and efficiency. These objectives are closely related to the
economic development of a country. Therefore, the developing countries have to
accelerate their economic growth rates, to achieve this goal, the government
needs various types of resources and huge financial as well. Two types of
resources are undertaken i.e. internal and external; both are mobilized by the
government. However, the internal sources are more preferable to external one
for sustainable economic development.
The
internal source consists of tax and not-tax revenue. The tax revenue is
received as compulsory payment where as the remaining is conditional. The
non-tax revenue includes duties, fees, penalty, fines and forfeitures, receipts
from sales and rent of government property, principal repayment, donation and
miscellaneous income. The tax revenue includes both direct tax and indirect tax
such as income tax, sales tax, custom duty, excise duty, revenue from land and
house registration etc. Hence, tax revenue is major sources of the internal
revenue as well as the macroeconomic fiscal instrument of the government.
In
the context of Nepal, the share of non tax revenue is very low as compare to
the tax revenue in our total revenue structure. The contribution of non-tax revenue is 10.90 percent and tax
revenue is 89.09 percent in total revenue collection in last fiscal year
2010/11 (Economic Survey). So there is no particular better alternative
solution of taxation, it is a key instrument to bridge the resource gap and for
resource mobilization but there is greater need of improving tax structure in
Nepal.
Thus,
there is a greater need of improving tax structure in Nepal. This need becomes
more appreciable when we see the higher tax ratio to GDP in developed country.
This has generated the strong believe among the economist that the present tax
ratio in Nepal is very low that can be increased substantially and would be a
solution of resource problem. Moreover, how this ratio can be raised and in
what magnitude the present tax structure is able in raising revenue becomes a
subject matter of study.
In
such background, there is urgent need of new policy, program and political
solution, so that we can enjoy political stability, good governance, stop
corruption, utilize all the available resources and get a high rate of GDP
growth. Thus keeping these all in mind, this present study seeks to review the
structure of taxation during the study period and attempt is made to estimate
responsiveness and productivity finding elasticity and buoyancy coefficient to
analyze how much increase in tax revenue due to automatic action of
built-in-elasticity effect and some due to the effect of discretionary change
of Nepalese tax system
Statement of the
problem
To what extent, it is possible to
improve the revenue mobilization from the existing structure and responsiveness
of Nepalese tax system? This is of course, the subject matter of this study.
However, before going to this analysis it is important to know the key issue
that is the inherent problem in the Nepalese tax system.
Nepalese taxation system is
suffering from different inherent problem like increasing resource gap,
dominant of indirect tax to total tax revenue, dominant of tax revenue in total
revenue, low responsiveness and productivity of tax yield, growing reliance on
foreign loans, low tax-GDP ratio, weak tax administration, low level of voluntary
compliance, narrow tax base, high tax rate, inelastic tax system, wide spread
tax evasion and frequent change in tax rates.
In
Nepal, resource mobilization is still poor that does not cover the requirement
of the government. Nepal has facing the serious problem of resource gap.
Internal and external borrowing fulfills the gap. This has been one of the
major fiscal problems of Nepal. The resource gap is widening continuously with
the total increment of total expenditure in respect to the total revenue
collection. The resource gap Rs.797.2 million in fiscal year 1975/76 was
further widened to Rs.16.40 billion in fiscal year 2010/11 (Economic Survey).
To bridge gap between expenditure and revenue: internal and external loans are
based in Nepal’s case; because there is increasing reliance, especially on
foreign loan for deficit financing so that increasing outstanding debt the
repayment of principle and interest are also increasing each year and again
necessities for further borrowing. Hence, our economy is circumscribed by debt
trap. Therefore, special emphasis needs to be given to mobilize internal
resource in order to meet the resource gap. Despite the various measures
adapted by Government of Nepal to boost the revenue collection then still
exists substantial gap between revenue and expenditure
Tax
and non-tax revenue is major source of internal revenue. Tax structure of Nepal
is massively dominated by indirect tax. Indirect tax is regressive in nature,
which is not justifiable on the ground of equity and progressiveness but there
is dominant role of indirect tax revenue in Nepalese total tax revenue. The
contribution of indirect tax and direct tax to total tax revenue is 79.40
percent and 20.60 percent respectively in Fiscal Year 2010/11 (Economic
Survey). So that it has been a problem to bridge gap between the rich and poor,
as Nepal is dependent in indirect taxes.
The
tax administration in Nepal is very weak. There is a lack of specialized
revenue service while a revenue group was created within the Nepal
administration service in 1992/93. There is still a long way to go in order to
develop a specialize revenue office, lack of physical facilities and incentives
provided for revenue officials are limited. The situation of local tax administration
is very worse. Thus, the base of Nepalese tax system is very narrow both
legally as well as administratively.
The
level of voluntary tax compliance is very low. The tax conscious has yet to be
developed among the Nepalese. This may be due to the illiteracy complicated tax
procedure, the low cost of non-compliance etc.
Thus,
resource mobilization will be justified only when there would be no increase in
the tax rates and legal base. Internal resources are mobilized by improving
efficiency of tax administration. This requires identifying the potential range
of taxation and expenditure that would be apparatus to reduce the resource gap.
Trends in external and internal borrowings must be examined to understand the
overall impacts of resource mobilization on narrowing down the resource gap
Objective of the Study
The main objectives of the study
are:
a) To
examine the trends of resource gap in Nepal.
b) To examine productivity and responsiveness of
Nepalese tax system by estimating elasticity and buoyancy coefficient during
the period from fiscal year 1990/91 to 2010/2011.
Review of Literature
Theoretical Review
Tax is defined as a compulsory
contribution to the government made without reference to a particular benefit
received by the taxpayer. The primary purpose of taxation is to divert control
of economic resources from taxpayers to the state for its own by households and
enterprises but influences the allocation of economic resources, recognizes
social costs that are not reflected in market prices, and affects the
distribution of income and wealth (Goode, 1984).
The relation between taxation and
economic development has long been a matter of concern to policy makers. The
primary purpose of taxation is to divert control of economic resources from
taxpayers to the state for its own use or transfer to others. Taxation not only
restraints total spending by households and enterprises but influences the
allocation of economic resources, recognizes social costs that are not
reflected in market prices and affects the distribution of income and wealth
(Bird and Oldman,1990).
Taxation is
used as the main policy instrument for transferring resources to the public
sector. It can also assist in creating an atmosphere within which the private
sector operates in conformity with national objectives. From the efficiency
viewpoint, it can be said that taxes provide the best means of financing the
bulk of public expenditures (Shende, 2002). Equity, efficiency, and
administrative feasibility are the three major principles of tax design of any
economy. For developing countries the most important role of taxation is to
mobilize the resources for development. As an instrument of resource
mobilization, its principal function lies in raising the volume of public
savings to be used for capital formation consistent with the growth of saving
in the economy as a whole. The quantitative role of tax policy for the
mobilization of development finance may be considered in two aspects: static
and Dynamic (Tripathy, 1978).
While designing the tax policy, the
widely accepted principle is the principle of equality. It implies that those
with equal abilities to support government, should pay equal amounts and that
those with unequal abilities, should pay different amounts bearing a reasonable
relation to their abilities. The former aspect is often called horizontal
equity, the later vertical equity; the equality aspect of taxation is directly
concerned with ability-to-pay principle, which is primarily a matter of
economic capacity that can be measured by income, wealth or consumption (Goode,
1984, Musgrave, 1959, Due and Friedlander, 1994, Musgrave and Musgrave, 1989).
The
proposition of Hicks and Josep says that direct tax minimizes tax burden more
than indirect tax. So, direct tax is superior to indirect tax. But in
industrialized/developed/ advanced countries, direct tax (such as income tax)
is superior. In developing and underdeveloped countries, indirect tax is
appropriate than direct tax. In those countries, the income level of people is
very low. The source of income is not fixed but changed with time. Most of the
people live in subsistence level. Therefore, to impose direct tax is not
justifiable. Direct tax is easily felt. It increases dissatisfaction among the
people. That is why; in those countries indirect tax is important source for
collecting tax. This indirect tax is included in price of the commodity, its
burden cannot be directly felt and hence there is less possibility to increase
dissatisfaction among people. Luxurious goods and the goods, which are
injurious to the public health, should be taxed at high rate, normal goods
should be taxed at medium rate and necessaries should be free from tax.
Luxurious
Goods: High Rate Tax
Normal
Goods: Medium Rate Tax
Necessary
Goods: Low Rate Tax /No Tax
But
structure of indirect tax should be changed along with the change of economy.
In order to analyze the effect of indirect taxation on the attainment of the
goals of developing economies, J.F.Due has given a development model and
according to this model, there are four dominant goals in most developing
economies:
a) Acceleration
Growth
b) Attainment
of an accepted pattern of income distribution
c) Efficient
allocation of resources and
d) Price
stability
These goals can be attained by the
means of governmental revenue and government expenditure structure. Government
can formulate tax policy and government expenditure policy as to achieve these
goals or objectives. In most of the developing counties government is still
regarded as the primary instrument to achieve these goals or objectives.
This
model says that the rate of economic growth defined as the annual increase in
per-capita real income is function of its five determinants and economic growth
in affected by these determinants.
i.e
t, r, v )
Where,
Y
= economic growth
t
= the technological change
r
= increase in quality and quantity of other resource
v
= general environment
The
actual coefficients of these determinants will vary-with the circumstance of
the country and are difficult to ascertain with accuracy (Due and Friedlaender,
2002).
The
two popular concepts frequently used by researcher and academicians in
measuring the responsiveness and the productivity of taxes in a tax system are
the concept of 'Elasticity and Buoyancy'. The tax elasticity and the buoyancy
of a tax system are commonly known as automatic stabilizers. If a tax system is
elastic (i.e the value of elasticity is more than or equal to one) then the tax
system is called stabilized and there is no need of any corrective action by
any external authority for the smooth functioning of the tax system (Dahal,
1983)
Empirical Review
Vito Tanzi (1976), in his article “The sensitivity if the Tax Yield of
the U. S. Individual Income Tax and Tax Reforms of the Past Decade” on the IMF
staff paper has written that his study
estimate three coefficient: (i) Elasticity and flexibility of taxable
income (TI) with respect to adjusted
gross income (AGI), (ii) Elasticity and flexibility of tax revenue (T) with
respect to adjusted gross income (AGI)
and (iii) Elasticity and flexibility of tax revenue with respect to
taxable income (TI). He concludes that in between 1963 increased largely
because of change in the rate structure. The elasticity of T with respect to TI
rose over the period from about 1.1 to 1.2. This led to increase in the
elasticity of the T with respect to AGI from about 1.4 (in 1963) to about 1.5
(in 1972). It implies that the erosion in the real value of the basic exemption
and of the standard deduction associated with a continuous of the recent
inflationary pressures and the consequent possible decline of the elasticity of
TI with respect to AGI should not have of an effect on the overall elasticity
if the tax . In the absence of further tax reform, the tax yield should
continue to growth at a much faster rate than nominal income.
V.G. Rao (1979), published a book “The Responsiveness of the Indian Tax
System” (1960/61 to 1973/74) has studied the responsiveness of Indian tax
system during the period 1960/61 to 1973/74. He examines of the aggregative
union and states tax structure and of selected individual taxes with respect to
change in national income and their closest bases. He found that the built-in
flexibility 0.833 for the first period 1951/52 to 1957/58 and 0.8271 for the
second period 1960/61 to 1973/74.
Dahal (1983), has studied various aspect of Nepalese
tax structure for the period 1952/53 to 1981/82 in general and 1964/65 to
1981/82 in particular. In this period
the overall elasticity of the total
revenue equals almost unity (1.01), for indirect, it is marginally
higher than unity (1.02) compared with the elasticity of direct tax (0.68)
and the elasticity of tax revenue is
0.92 reflecting the tax system less responsive to change in income. But the
buoyancy coefficients for the same time period are 1.54 for total revenue, 1.52
for the tax revenue, 1.63 for indirect and 1.23 for direct taxes. Among the
individual taxes the elasticity of sales tax is highest (1.96) followed by
income tax (1.38), import duties (1.05), export duties (0.77), and land tax
(-0.04). The buoyancy coefficient for sales tax is again highest (2.56)
followed by the excise duties (2.23), income tax (1.86), import duties (1.79),
export duties (1.14) and land tax (0.31) .These figures imply that the
inelasticity of taxes in the tax structure of Nepal is primarily concentrated
on land tax, export duty, import duty, excise duty and to some extent on income
tax.
Guru Gharana (1993), published an
article “Weakness of the tax policy and tax structure in Nepal” has found that
the elasticity coefficient of total revenue is 0.495 for the period 1974/75 to
1983/84 and 0.581 for the period 1974/75 to 1988/89. For the same period, buoyancy
coefficients are 1.365 and 1.281 respectively. Except for contract tax (1.898)
and sales tax (1.053) the elasticity of remaining taxes i.e. customs, excise,
income, hotel, entertainment, land revenue etc. are either extremely low (for
below unity) or negative where as the buoyancy of all taxes except land revenue
are above unity. This high buoyancy but low elasticity shows that the
government is engaged in imposing high rates on a few taxed commodities and
regressive nature of the tax system.
Mani Nepal (1995), in his study
“Structure and Responsiveness of Nepal’s Tax System” and examined Nepal’s
overall tax structure for the period 1968/69 to 1992/93 measured responsiveness
and productivity of tax yields, identified major problems of Nepalese taxation
and provided appropriate tax policy recommendation. His study indicate that the
overall elasticity of total revenue on Nepal’s tax structure for the study
period is 0.64 elasticity coefficient for tax revenue, non-tax revenue, direct
tax, indirect tax are:0.511, 1.135, 0.135, 0.614 and 0.4756 respectively. As
the elasticity of selected group of taxes other than non-tax revenue are less
then unity, the tax system as a whole could not be considered elastic and
responsive to national income. Elasticity of indirect taxes (0.61) is almost
four times than that of direct tax (0.14), which is, the greater challenges for
the Nepalese Fiscal authorities who wants to increase the share of direct
taxes. We are mostly depending upon indirect tax, which is regressive in
nature. Similarly the overall buoyancy of total revenue is 1.209 and that of
total tax revenue, non-tax revenue, direct tax, indirect tax and income tax are
1.163, 1.1415, 1.001, 1.210 and 1.197 respectively. This high buoyancy and less
elastic of total tax revenue are attributed to the additional government effort
to raise the tax revenue. On the basis of the suggested recommendation and
earlier analysis, he developed a tax mechanism model which gives the summary of
the overall tax mechanism in an economy.
Timsina (2007), published an article
“Tax Elasticity and Buoyancy in Nepal: A Revisit” and studied elasticity and
buoyancy coefficients during the sample period 1975 to 2005 in which she took
the principles objective of the study as to introduce the concept of elasticity
of tax, to estimate the elasticity and
buoyancy of tax in Nepal for the period, to seek the difference between
buoyancy and elasticity of tax in Nepal, -to investigate whether the results
obtained through traditional approach and the partitioning approach are similar
of different and, -to ensure whether or not the tax system in Nepal is elastic.
She found that elasticity coefficient of total revenue, total tax revenue,
excise duties, import duties, income tax, and VAT are 0.59, 0.51, 0.49, 0.54,
0.41 and 0.55 respectively and buoyancy
coefficient are 1.14, 1.12, 0.98, 1.05, 1.37 and 1.15 respectively.
Research Methodology
Taxes for the
purpose of present study are taken to mean any compulsory payment without any
direct quid-pro quo. Accordingly, revenue sources of government of Nepal, as
are shown under the heading of custom duties, excise duties, import duties,
sales tax (VAT: under the sales tax or VAT, contract tax, Air flight tax, hotel
tax, entertainment tax has been taken and before 1997 VAT is called sales and
after VAT itself) which was considered as indirect tax. Whereas income tax,
land tax, registration tax are taken as direct taxes. Remaining sources of
revenue like fees, dividend, and penalty, fine are considered as non-tax
revenue.
To attain the
objective of this study consider eleven different categories of revenue heading
including tax revenue and non-tax revenue. The following eleven tax heads are
taken as dependent variable which
are regressed with a single independent variable GDP(Gross
Domestic Product) and their component while estimate elasticity and buoyancy coefficient .
Dependent
variables Independent
variables
1.
Total Revenue (TR) Total
GDP (at current price)
2.
Tax Revenue (TXR) Total
GDP (at current price)
3.
Non Tax Revenue (NTR) Total GDP (at current price)
4.
Direct Taxes (DT) Total GDP (at current
price)
5.
Indirect Taxes (IDT) Total
GDP (at current price)
6.
Income Taxes (IT) Total
GDP (at current price)
7.
Sales Tax (ST) Total
GDP (at current price)
8.
Custom Duties (CD) Total
GDP (at current price)
9.
Import Duties (IMD) Total
GDP (at current price)
10.
Export Duties (ED) Total
GDP (at current price)
11.
Excise Duties (EXD) Total
GDP (at current price)
Source of Data
Most
of the data used in this study are secondary data published by such as various
issue of "Budget Speech" and, “Economic Survey”. The other sources of
data are various publications of CBS, NRB and WB reports .This study is based
on the time series data for the Nepalese Economy from 1990/91 to 2010/11.
Measurement of Responsiveness of Taxes
In
order to estimate elasticity and buoyancy accurately it is necessary to
separate discretionary changes from the tax revenue series. Experts have used
several methods to separate automatic and discretionary changes in tax revenue
systems. For the effective use of the other methods suitable data on legal tax
bases and simple tax structure for necessary adjustments are not available in
Nepal.
There are
various methods like, Constant Structure Method, Divisia Index, Dummy Variable
Method and Proportional Adjustment Method. But due to the nature of data of
developing countries, we mostly preferred Proportional Adjustment Method. In
this method there are three another method, these are Prest method, Sahota
method, Chand and Chellia method. In present study, SAHOTA METHOD has been used
to separate the discretionary changes from the tax revenue series due to its
simplicity. This is accompanied in two steps. Firstly, a preliminary series of
adjusted tax yields is prepared by subtracting from the actual yield.
For
each year, the estimated amount attributed to the discretionary change in that
year. Secondly, the “adjusted” series
thus obtained is further refined
by using the formula given below to form
a "final" series which
excludes the continuing impact
of each discretionary change on
future years so that the elasticity of a given tax structure in the base
year may be established.
Symbolically,
Where,
ITt = Adjusted or net tax yield at
time t
ITt-1=Adjusted
or net tax yield of previous year (t-1)
Small businesses may be able to use this credit in place of the alternative minimum tax (AMT).
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