VAT hike might plug fiscal deficit, but can consumers afford it?

In a decision that is rather unusual in the middle of a fiscal year, the government has decided to raise the value-added tax (VAT) on 43 goods and services to 15%.

Additionally, taxes on restaurants, clothing stores, and commodities like cigarettes, medication, detergent, and soap will also be raised. Air travel is not being spared either. 

This means less eating out for foodies, and less foreign trips to Bangkok or Kuala Lumpur, and more window shopping. But is this a good way to reduce our fiscal deficit? 

VAT has long been a cornerstone of Bangladesh's revenue, accounting for its biggest source. ]The International Monetary Fund (IMF) has emphasised raising VAT, highlighting that Bangladesh's tax-to-GDP ratio remains one of the lowest globally. 

The National Board of Revenue (NBR) claims that the VAT hike will result in a "one-off" inflationary effect. However, there are concerns that this could worsen inflationary pressures in the short term, especially as Bangladesh is already grappling with high inflation rates (hovering around 11% in November 2024)​.

The increased VAT on services and non-essential goods will likely push up prices in the broader economy​ because the VAT was already quite high from the last fiscal year, when the previous government was trying to balance the fiscal deficit. 

Md Lutfor Rahman, a former NBR member, told TBS, "In the past, VAT hikes in the middle of the fiscal year have occurred, but it was in one or two cases. I am not aware of such a sudden, large-scale VAT hike. The abrupt hike will create further pressure on consumers. A Tk10 VAT hike could increase the price of goods by Tk30 in the market," he added.

"VAT is the biggest source of revenue in Bangladesh because our tax policy and administration has been historically poor in collecting income taxes. This is why the government is looking to VAT to raise the revenue needed to reduce the deficit," said Jyoti Rahman, Director of International Affairs at the Sydney Policy Analysis Center, adding, "VAT imposition will raise prices of the affected goods, and therefore there will be a one-off effect on inflation. However, we need to balance that against the broader macro policy context." 

Professor Mustafizur Rahman, a distinguished fellow at the Centre for Policy Dialogue (CPD), believes the government should prioritise increasing direct tax (income tax) collection rather than raising VAT to boost revenue. 

"Increasing VAT affects all consumers. VAT collection can be improved by reducing evasion, not by simply raising the VAT rate. VAT should be unified and that consideration should be given to whether a rate lower than 15% would be more manageable for consumers," he said.

The IMF's advice often forms the basis of fiscal policy adjustments, especially in countries like Bangladesh, which depend on foreign loans. The IMF has recommended VAT hikes as part of its ongoing $4.7 billion loan program to stabilise the economy and improve revenue generation. 

However, it is crucial for Bangladesh to balance IMF prescriptions with local realities. The IMF itself has pointed out that while VAT is effective in raising revenues, it needs to be part of a broader reform strategy that includes better tax administration and broader revenue sources​.

Expressing dissatisfaction with the decision to raise VAT based on IMF advice, Lutfor Rahman further commented, "Letting others handle your own domestic issues never leads to progress."

Rather than relying on immediate VAT hikes, the government should explore other avenues to raise revenue, such as improving compliance and addressing tax evasion. 

The NBR fell short of its revenue collection target for the 12th consecutive year in 2024. Last year, the FY24 target of Tk394,530 crore, set as part of an IMF loan program, was missed. And among the three segments, the NBR witnessed the highest growth in VAT collection, due to persistently higher inflation and exchange rate volatility. 

Jyoti Rahman believes the whole situation should have also been handled better. 

"In the first instance, the need for the additional revenue in the current fiscal year needs to be better articulated. The reality is that Bangladesh has been operating without a budget this fiscal year. Sheikh Hasina fled in the fifth week of 2024-25, and whatever fiscal framework was announced by her government in June 2024 has no credibility," said Jyoti. 

"The interim government should have announced a supplementary or emergency budget at the earliest possible time. Notwithstanding the very difficult conditions faced by the interim government, a supplementary budget should have been feasible by November-December," he further added. Such a supplementary budget would have clearly made the case for VAT hikes. 

"In the longer term, as we head to the election, all major political parties, think tanks, and commentators should propose various ways to raise revenue," he remarked. 

"The Bangladesh Bank governor has repeatedly said he would prefer to see the public sector borrowing from the banking sector to be much lower than what was budgeted in June 2024. This would help with stabilising the banking sector, allowing the monetary policy to keep the exchange rate stable and reduce inflation," Jyoti Rahman added.  

"We need to consider the VAT increase against this backdrop. If the additional revenue helps reduce the government's deficit financing need, that will help reduce inflation," he opined. 

A staggering 85% of wealth in Bangladesh is concentrated within only 10% of the population. This wealth disparity points to a critical flaw in the country's tax system, which relies heavily on indirect taxes like VAT, rather than more progressive forms of taxation. 

From that perspective, a broadening of direct taxes — especially on the wealthy — could reduce the regressive nature of VAT and create a fairer tax system. 

Studies show that progressive taxation, where higher income groups pay a larger share of their earnings, is more equitable and efficient than relying solely on VAT​. But it will be difficult for the NBR to bring about radical changes in the tax regime under the interim government. 

"Tax administration capabilities to raise these taxes need to be built. More importantly, we need political consensus for these taxes. It is hard to see an interim administration building such political consensus," said Jyoti. 

An NBR press release on 4 January reads that along with VAT, various steps are being taken to widen the tax net as well, including gradually moving away from the culture of income tax exemption.