Bold taxation but conventional expenditures

The FY26 Budget follows a largely familiar trajectory in a shifting political environment. The Interim Government (IG), operating outside traditional political constraints, has crafted a budget that mirrors past strategies rather than signalling significant structural reforms. Even in extraordinary circumstances, the economic and political forces guiding fiscal policy remain unchanged – limiting the scope for transformational changes. The IG faces a paradox: it is positioned to act without immediate electoral pressures, yet the rigidity of the system restricts its ability to make bold fiscal changes.

The budget attempts to satisfy conflicting priorities. We demand fiscal prudence but refuse to curtail legacy commitments. Revenue needs to increase, yet taxation remains sensitive to public sentiment. Deficits must be contained without sacrificing expenditures. The public desires more investments in social services like education and healthcare, without undermining crucial spending on transport, energy, and infrastructure. These expectations create an inherent contradiction that policymakers struggle to resolve.

Feasible optimism

Tradeoffs are a fundamental reality, no matter how unwelcome. The FY26 Budget seeks to balance feasibility with desirability – a necessary tension to ensure both economic stability and political acceptability. The most credible measure of feasibility is whether the budget can meet financing constraints, while desirability reflects the interests of various stakeholders.

Economic recovery is fragile. GDP growth is projected at 5.5%, improving from FY25's provisionally estimated 4%, yet falling short of the IMF's optimistic 6.5% forecast. Historically, the government's projections have aligned with IMF estimates, making this divergence on the downside noteworthy. On the other hand, the government seems more optimistic than others about growth this fiscal, projecting it at 5%.

Inflation is expected to decline from 9.05% in May 2025 to 6.5%, but this hinges on stable global commodity prices, a soft US dollar, and a balanced foreign exchange market, among others. Without external stability, achieving this inflation target would be challenging.

Beyond GDP and inflation, the broader economic outlook requires careful management of risks, particularly fiscal deficits, revenue shortfalls, and banking distress.

Difficult math 

Expecting to achieve the Tk5,64,000 crore revenue target (9% of GDP) is unrealistic. Bangladesh has historically struggled to exceed Tk3,75,000 crore (FY23). Current fiscal constraints make exceeding Tk4,00,000 crore in FY25 difficult. No feasible set of structural revenue reforms alone can meet the target. 

A 40% revenue growth when the size of the economy is projected to grow 12.4% implies a tax revenue buoyancy factor of 3.2. Based on global studies, long-term revenue buoyancy tends to hover around one, meaning revenue grows proportionally with GDP. However, short-term buoyancy estimates are often lower, suggesting limited automatic stabilisation power of revenues. Even getting close will require extraordinary success in recovering and cashing assets from home and abroad. 

The deficit target of Tk2,26,000 crore (3.6% of GDP) is achievable without causing additional macroeconomic stress. However, macroeconomic risks remain elevated. Any upside deviation from the target could intensify pressure on interest rates, exchange rates, and inflation.

The Tk1,01,000 crore net external financing goal (approximately $8.3 billion) is feasible due to pipeline investment projects and expected budgetary support from development partners. This mitigates inflation and crowding-out risks, but it increases external debt burdens on future generations. The bank credit dominant Tk1,25,000 crore in domestic borrowing risks reducing private credit availability unless bank deposit growth rebounds. The government's debt-to-revenue ratio is already high. Budgetary outlays on debt services exceed the combined outlays on education and health.

The expenditure target is oversized. Comparisons with FY25's original budget size say very little about achievability. The most optimistic revenue outlook for FY26 is around Tk5,00,000 crore, considering the revenue measures. If the government limits the deficit to target, total expenditures must then necessarily remain within Tk7,26,000 crore. Even at this level, past implementation experience suggests actual expenditures may fall even below the financially feasible amount.

Expenditures broadly as usual

The structure of the total Tk7,90,000 crore (12.7% of GDP) government expenditure is largely unchanged. Improving public services and investments is easier said than done, given the rigidity in budget allocations. Recurrent expenditures dominate two-thirds of the budget, while capital expenditures make up the remaining third – a distribution persisting for decades. Non-development expenditures is Tk5,60,000 crore, with major allocations earmarked for debt servicing, employee related expenses, subsidies, and contingencies (banking reforms).

Nearly two-third of the budget comprises non-discretionary spending, leaving only one third for strategic allocation. Interest payments alone amount to Tk1,22,000 crore. Employee-related expenditures continue to rise, with government salaries and allowances increasing annually by 6%-8%. Notable in this year's budget is a "special benefit" for government employees. The budget retains subsidies with slight reductions. Food, agriculture, energy, exports, and remittances will continue to be subsidised. 

The budget's allocation for social safety nets used to be inflated due to the inclusion of programs that are not social protection per se. This budget reduces the number of social safety programs from 140 to fewer than 100, of which 38 specifically target the extreme poor. Despite a nominal increase in social protection allocations, rising poverty levels significantly outpace the intended growth in beneficiaries. Innovative reforms addressing safety net inefficiencies remain largely absent. A "Dynamic Social Registry" system is supposed to be introduced to minimise safety net leakage and corruption hopefully informed by similar efforts that failed in the past.

The Annual Development Program (ADP), set at Tk2,30,000 crores, prioritises investment in transport, energy, health and education. However, the execution remains problematic. Many sectors struggle to utilise their allocations effectively. No new major development projects are supposedly introduced, aside from keeping the Matarbari Deep Sea Port, Dhaka Metro Rail and Rooppur Nuclear Plant.

Unusually courageous tax reforms

Increasing revenue intensity through greater mobilisation of direct taxes is the strategic imperative. This is essential to navigate the implications of Trump tariffs and prepare for graduation from the Least Developed Country list of the United Nations in November 2026, a transition that demands a reduced reliance on trade taxes. Those who already pay taxes honestly remain incentivised when the focus of revenue enhancement centres on tackling tax evasion and reducing unequal treatment of equals via exemptions. This budget takes some decisive steps in the desired direction but does not go far enough perhaps for political economy reasons.

The progressivity of the Personal Income Tax (PIT) rate structure has increased. The PIT exemption limit is raised from Tk3,50,000 per annum to Tk3,75,000 from July next year, a measure that benefits all taxpayers and reduces government revenues. To counterbalance revenue losses, the budget increases the rate on the next slab of Tk3,00,000 from 5% to 10% and lowers the level of income taxed at highest 30% rate. Bank deposit exemption threshold has increased from Tk100,000 to Tk300,000 per account annually and minimum allowable deduction for salaried individuals is increased from Tk4,50,000 to Tk5,00,000.

The budget does not extend the tax concession for "certain" sectors set to expire on June 30, 2025, and existing Statutory Regulatory Orders allowing long-term tax exemptions or reduced tax rates for "certain" other sectors are revoked. These sectors are integrated into the standard tax net paying 20% Corporate Income Tax (CIT) rate while non-listed firms will be taxed at 27.5%. Previously, the industry enjoyed a flat 15% tax rate. In contrast, apparel exporters continue benefiting from preferential treatment, with general factories taxed at 12% and green factories at 10%, perpetuating horizontal inequities between similar enterprises. 

The controversial undeclared money whitening facility is tightened considerably, although not fully scrapped. Among the significant reforms is the increase in tax rate and the abolition of the no question asked provision.

The budget aims to widen the existing tax gap between listed and non-listed companies from 5% to 7.5%. Tax rates for non-listed firms remain at 27.5%, while listed firms see a reduction from 22.5% to 20%. The conditions for enjoying the reduced tax rate are relaxed. Listed companies are now required to conduct only their earnings transactions through banking channels, while previous conditions for expenditure and investment transactions have been lifted. AIT on securities is reduced from 0.05% to 0.03% and corporate tax rate on merchant banks is reduced from 37.5% to 27.5%. 

The revenue impact of measures to support the stock market could go either way. The tax incentives may reduce the burden on the incumbent players, but rejuvenating stock markets requires a lot more, especially removing the sludges in the regulation of initial public offerings, which currently take between 1.5 to 2 years, and ensuring compliance with existing laws.

Government data reveals that in FY22, tax exemptions amounted to approximately Tk 3 lakh crore, or about 7% of GDP, equivalent to 87.5% of the tax-GDP ratio. The potential revenue productivity of reduced exemptions is therefore large if they stick. Exemptions are withdrawn from garments, mobile phones, electronics, home appliances, toiletries, LPG cylinders, elevators, refrigerators, air conditioners, compressors, locally produced cotton yarn and man-made fibre and several raw materials used in construction and rubber production. 

Environmentally friendly industries, particularly producers of electric bikes and biodegradable products like plates made from leaves, flowers, and stalks, will receive preferential tax treatment as will ice creams, sanitary napkins, packaged liquid milk, ballpoint pens, and aircraft lease rentals for passenger transport. Raw materials for sanitary napkins and diapers, hospital bed manufacturing equipment, and active pharmaceutical ingredient (API) production retain VAT exemption until 2030. Cigarette manufacturers will face turnover tax increased from 3% to 5%, and the supplementary duty on imported cigarette paper has surged from 150% to 300%. 

The techno economics of some of these (APIs, sanitary napkins) are easier to understand than others (ice cream, aircraft lease). Tax at source on commissions for supplying essential commodities is reduced from 1% to 0.50%.

Denting anti-export bias in tariffs

The above, on balance revenue increasing reforms in domestic taxes, gains greater significance when the net revenue losses from trade tax reforms are considered. Trade tax reforms are crucial to align Bangladesh's protectionist policies with global standards and correct the anti-export bias to incentivise export diversification. Impending LDC graduation and tariff negotiations with the US and the rest of the world have increased the time sensitivity of these reforms. Bangladesh has 7,500 tariff lines based on Harmonized System codes, many of which are subject to disproportionately high import duties. Over a hundred products have government-mandated tariff values and minimum prices. 

The existing six-tier customs duty structure is increased to 7 by introducing a new tier at the rate of 3%. There is also a new 40% supplementary duty rate, alongside the existing twelve-tier structure. These are steps in the wrong direction. 

The budget adjusts tariffs and removes minimum import prices. It completely withdraws import duties on 110 products and supplementary duties on 9 products while reducing import duties on 65 products and supplementary duties on 442 products. 

All of these, needed to downsize the protection rate to reduce the anti-export bias of tariff policy, are revenue losers. Some of the losses will be made up by the removal of existing tariff values and withdrawal of minimum values. In some cases, import duties are replaced by higher VAT and Advance Income Tax to recover lost revenue.

Incentivising compliance

Property registration taxes have been reduced and deed values are aligned with actual market rates, moving away from outdated mouza rates. The minimum tax for first-time tax return filers is reduced to shrink the large gap between tax return filers and tax payers. To curb excessive discretion among customs officials, the valuation of imported goods is shifting toward importer- declared values, a long-standing demand of businesses. Nevertheless, adequate safeguards are needed to prevent misuse by fraudulent businesses.

Tax evasion continues to thrive due to the discretion afforded to tax officials amidst the complexity of varied tax rates. A study by the Centre for Policy Dialogue (CPD) found that corporate tax evasion alone accounted for Tk1.13 trillion, out of the estimated Tk2.26 trillion. Only 9% of registered companies submitted income tax returns, doubling the tax burden on compliant businesses, and 68% of individuals with taxable incomes do not pay income tax. 

A meaningful reduction in discretion would require further simplification of the tax framework. Increased automation in tax administration is widely recognised as a strategic necessity where meaningful progress is few and far between.

The limits of expectations

Is it conceivable that an almost Tk7.9 trillion budget can actually be usefully delivered? Aspirationally, speaking, a positive answer depends on how the budget is delivered: how revenues are raised (more direct taxes, reduced evasion, more new tax payers), how the deficit is financed (cheaper external financing), and how expenditures are repurposed towards critical public services and socially desirable investments. 

Will this happen in FY26? No is probably a winning bet! How much progress the IG can make within a single year in implementing transformative budgetary reforms is uncertain. The recent experience of resistance to the ordinance separating tax policy from tax administration speaks volumes about the power of the status quo and how distractive narratives can undermine a reform on which there is consensus! Organised pushback to corporate tax tightening, tariff liberalisation and removal of VAT exemptions should surprise none!

Zahid Hussain is a former chief economist of the World Bank's Dhaka Offic