What is Taxation ?

Taxation is the primary means of domestic resource mobilization in all economics including Nepal. It is also an effective instrument to bridge up the gap between required revenue and expenditure in turn enables to reduce the external dependency. However, the finding of the reveals that level of taxation is very low in Nepal. Further, increasing fiscal deficit, insufficient revenue generation, substantial distortion in the economic incentive, inequality and weak tax administrative is the major problem of Nepalese tax system, which is the result of poorly designed and functioning tax system.

The review of Nepalese tax reform and policy reveals that Government of Nepal focused on more restrictive, regulative and protective policies to meet the basic needs of people including other various goals viz. revenue generation, maintaining equality, growth and stabilization of the economy. However, these policies have been replaced by a more liberal open market oriented policies based on the distinct feature of globalization, liberalization and privatization after the restriction of democracy in 1990. Now, the emphasis is given in broadening the tax base, rationalizing the rate structure and improving the tax administration. 

Taxation is not only the instrument of getting higher revenue but also the medium of eliminates undesirable effect in the economy and introduces the desirable effect. In the sense taxation is considered as having two weapons in one hand.

The tax effort and taxable capacity of Nepal reveals that the degree of exploitation of potential base is low as compare to other least developed counties. Major findings of the analysis of the data from fiscal year 1990/91 to fiscal year 2010/11 are summarized as below:

1. Nepalese Government Expenditure is increasing at the faster rate then the increase in revenue. Therefore, resource gap has existed in Nepalese economy and it is increasing trend. Resource gap in fiscal year 1990/91 was Rs. 12820.3 million and it has extended to Rs. 95544.7million in the fiscal year 2010/11. Increasing trend of resource gap indicates that it is necessary to mobilize additional domestic resource.
2. Government revenue is the composition of external revenue and internal revenue. Tax and non-tax revenue are the major source of the internal revenue. There is dominant share of tax revenue in Nepalese revenue structure. The contribution of tax revenue to total revenue ranges from 73.08 percent to 86.86 percent during the study period. Similarly, the contribution of non-tax revenue to total revenue ranges from 13.14 percent to 26.92 percent. The average contribution of tax revenue and non-tax revenue to total revenue were found to 79.14 percent and 20.86 percent respectively throughout the study period.
3. Nepalese tax revenue is the composition of direct tax and indirect tax. There is dominant role of indirect tax in Nepalese total tax revenue structure. Average contribution of direct tax and indirect tax revenue to total tax revenue are 24 percent and 76 percent respectively over the study period. Indirect tax is considered to be regressive in nature and hence, we are depending upon the regressive tax system.
4. The tax-GDP ratio of Nepal is not found satisfactory compare to other developing countries. Tax-GDP ratio in fiscal year 1990/91 was only 7.04 percent and has gradually increase and reached to 14.45 percent in fiscal year 2010/11.
5. Major components of direct tax revenue were house and land registration fees and income tax. The share of income tax revenue to total direct tax revenue has been dominant role over the study period and its contribution ranges from 53.63 percent to 85.14 percent.
6. Major components of indirect tax revenue were custom duties, sales tax/VAT and excise duties. Out of various components, custom duties had occupied first position and sales tax/VAT second position up to fiscal year 2003/04. But after this year VAT occupied the first position and custom duties remained second position.
7. In most of the revenue heads, actual revenue was lesser then estimated revenue. This implies that our estimation system was over ambitious.
8. The elasticity coefficient of different revenue heads are very low and ranges from 0.43 to 0.69 but coefficient of export duties is even negative (-0.20). Less than unity value of elasticity coefficient indicates that Nepalese revenue heads are inelastic and automatic growth of revenue is not sufficient to fulfill the required fund of the government.
9. The negative elasticity of export duties (-0.20) shows that the automatic mechanism has negative impact. The negative association of export duties implies that every one percent increase in national income decrease the export duties by 0.20 percent.
10. The buoyancy coefficients of different revenue heads are higher to compare the elasticity coefficient. The buoyancy coefficient ranges from 1.02 to 1.61 for different revenue heads except export duties (0.85), which indicates that, export duties are not buoyant but others revenue heads are buoyant.
11. This high buoyancy but low elasticity of all major tax and non tax revenue heads signifies the additional government efforts of changing the base and the rate structure to increase revenue.

International Context

Singhania and Gupta (2011), has studied the “The Measurement of Tax Elasticity of India” during the period from 1991/92 to 2009/10. This study shows that elasticity coefficient of tax revenue is 0.99 and buoyancy coefficient is 1.19.

Rao (1979) published a book “The Responsiveness of the Indian Tax System” during the period 1960/61 to 1973/74. He found that the built-in flexibility (elasticity) 0.833 for the first period 1951/52 to 1957/58 and 0.8271 for the second period 1960/61 to 1973/74.

Fauzia Mukarram(2001), has studied the “Elasticity and Buoyancy Coefficient of Major Tax in Pakistan” He found that elasticity coefficient of total tax revenue, Direct Tax  and VAT are 0.64, 1.13 and 0.99 respectively and buoyancy coefficient are 1.0, 1.61, and 1.51 respectively.

Ahmed and Mohammed (2010), has studied the “Determination of Tax Buoyancy: Empirical Evidence from Developing Counties” during the period 1998 to 2008. This study shows that coefficient of tax buoyancy of developing countries are as follows.

Nepalese Context

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

Mani Nepal (1995), in his studies “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. 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. 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.

Shakya (2005), has studied the “Structure and responsiveness of Nepalese Tax System” during the period from 1976/77 to 2002/03, further this whole sample period was divided into two sub period (i) from 1976/77 to 9190/91 and (ii) 1991/92 to 2002/03.He found the elasticity coefficient of total tax revenue of whole period is 0.618 and period (i) 0.587 and period (ii) 0.669. At the same time the buoyancy coefficient of the whole period is 1.140 and period (i) 1.148 and period (ii) 1.128.

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. 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.

JBR (2008), has analyzed the “structure and responsiveness of tax yield in Nepal “ during the period from FY 1968/69  to FY  2001/02, further  this whole sample period was divided into  two sub period from (i) FY 1968/69 to FY 1984/85 and (ii) FY 8519/86 to FY 2001/02. He found the elasticity coefficient of total tax revenue of whole period is 0.539 and period (i) 0.596 and period (ii) 0.639. At the same time the buoyancy coefficient of the whole period is 1.14 and period (i) 1.32 and period (ii) 1.20

From above discussion, we conclude that an elasticity coefficient of most of the tax revenue was less than unity, but buoyancy coefficient was greater than unity. In our present study also we find out that elasticity coefficient of different tax revenue is less than unity ranges from 0.43 to 0.69, but coefficient of export duties is even negative (-0.20). Similarly the buoyancy coefficient of different tax revenue is greater than unity ranges from 1.02 to 1.61, except export duties (0.85). Thus, our study shows the reliable, valid and significant information in present taxation system in Nepal.

Conclusions

Nepal is one of the least develop countries. Nepalese economy is suffering from ineffective, effortless and over ambition plans, programs and policies. The Government needs huge amount to achieve maximum objective of nation. Lack of sufficient financial resource is the main constraint for the economic development of Nepal. Nepal has been facing the serious problem of resource gap and higher dependency on foreign loan. Resource gap has been increasing at a faster rate than the increase in revenue. Grants and loan as well domestic borrowing are not considered as the permanent solution to fulfill the gap. In our total revenue structure, the share of non-tax revenue is very low as compare to tax revenue. The share of non-tax revenue is not increase in short run. Hence, tax is the best solution to bridge up the resource gap and improvement in tax structure is need.

Increasing the tax revenue is not an end in itself, rather it  is a means  to meet the fiscal imbalance, reduce inequality of wealth and income, and make proper allocation  of resources and incentives to work and invest, which would  lead to increase in productivity, and hence, the national income. Thus, raising revenue is only one of many goals and a tax system must be administratively feasible. Moreover, the equality principle cannot be neglected and the tax system must be directed not to misallocate resources. All these goals cannot be achieved simultaneously, so tax reform is a matter of trade-offs.

Given amount of revenue can be obtained with higher tax rates, but if the tax base is narrow, it leads to higher chances of tax evasion. So, broadly-based taxes are supposed to be useful with smaller rates. As increased revenue is necessary to enhance and strengthen overall domestic resource mobilization, mere upward adjustment in the rates, or even the introduction of new taxes, may not be able to ensure desirable increase in revenue. 

The most unfortunate feature of the structure of taxes in Nepal is that it has been erratic and unstable in policies, base and rate. Further, the low automatic response of Nepalese tax system can be explained by the existence of narrow base, different in tax rates and exemption limits.

Most of the elasticities of different tax heads are less than unity for the period from 1990/91 to 2010/11. This is indicative of poor responsiveness and productivity of tax yield with respect to GDP. The significance of elasticity in the tax system is that it is a crucial determinant to siphon-off automatically the increasing portion of national income into public exchequer without additional effort. The primary factors responsible for low tax elasticity in Nepal’s tax structure can be attributed to the following reasons: (1) Agriculture, the biggest sector of the economy, contributing 36 percent of the GDP, which is still a subsistence sector that falls outside the jurisdiction of taxation; (2) Blanket exemptions in the industrial sector with a series of tax shelters in conjunction with numerous ad hoc exemptions and deductions: and (3) Government inability to drive for effective internal resource mobilization.

The analysis of structure, productivity and responsiveness of Nepalese tax system also showed that one of the most significant tax reform measure adopted by Government of Nepal is the implementation of broad-base VAT in fiscal year 1997 and it is quite satisfactory performance. However, this improvement is not at all substantial enough to address the issue of increasing fiscal imbalance in the country. As a whole, the above analysis shows deficiency in every aspect of Nepalese tax system viz. tax efforts and taxable capacity, structure of individual taxes and their base, administrative feasibility, equity, sustainability and tax payer’s compliance etc. As a result the elasticity of taxes is very low both individually and collectively compared to their respective buoyancy, indicating that some revenue growth seems possible only through discretionary changes. However, this approach can not cumulative impact or initiate a self-sustaining process of revenue mobilization, for they are constrained by various political, social and economic factors. Further, the result also disclosed that the low elasticity of majority of individual taxes have to be explained in terms of their low rate of response. i.e. the factor which would fall mostly within the control of tax authorities, indicating the administrative inefficiency and regressive nature of Nepalese tax system.