Tax gap: A concern for macroeconomic management

Bangladesh's tax-GDP ratio is one of the lowest in South Asia. Studies show that high tax rates, multiple tax rates, the complexity of tax laws, corruption among taxpayers and collectors and inefficient tax authorities are the main causes of high tax evasion in this country.  As many as two-thirds of the eligible taxpayers evade taxes here. 

So why do people evade taxes? Tax evasion occurs when individuals deliberately do not comply with their tax obligations. However, tax compliance can be improved by cuts in tax rates, simplifications of tax laws, removing loopholes in the tax system and proper processing of information available under the annual information return.  

It is also important to educate the people and their elected representatives about tax laws and create a taxpayer-friendly environment so that they pay their due taxes, and feel proud by contributing to nation-building. 

Over 85% of the total employment is informal and the income generated by the operators of this sector, in many cases, is not officially captured in the tax net of the NBR.

Many firms often prefer to remain informal to avoid the regulatory complexities that come with formalisation. As a result, the informal sector also forms a greater percentage of tax defaulters. 

Again the state-owned enterprises (SoE) in Bangladesh, the public sector entities and projects do not pay tax in the proper amount and on time. Because of that, there has been a huge amount of tax dues returnable to the national exchequer through NBR.   

How to examine and cure this? An important way to examine the size of the tax gap in a country is to analyse the size of its underground economy and its influencing factors. 

The size of the underground economy is directly related to the institutional infrastructure that mainly includes the intensity of government regulation, establishment and implementation of laws, judicial independence, size of effective tax rates, effective provision of public goods or services, and effective protection of property rights. 

It is generally believed that the higher the level of government regulation, the greater the size of its underground economy and hence a greater tax gap. Similarly, when there is over-regulation, an alternative relationship is created between the size of the underground economy and the size of the official economy. 

Some believe that higher tax rates can raise higher tax revenues. And thus the government can provide higher levels of public services by attracting more companies and individuals out of the underground economy. They believe this will result in a healthy balance of high tax rates, high taxes, high public services, and a small-scale underground economy. 

On the other hand, the low-tax countries – as they do not have enough income to provide high levels of public services – form a vicious balance of low tax rates, low taxes, low public services, and a high-scale underground economy. 

In the above-mentioned healthy balance, the tax gap is relatively small while in the vicious equilibrium, the tax gap is relatively large.

It is also argued that a sustainable and efficient tax system must be based on perceived fairness and goodwill response to taxation of the government. And also it must be connected organically with the provision of public goods or services. 

When the taxpayers will see that their interests and preferences are reflected in political procedures and political decisions and the provision of public services is also efficient, taxpayers will stay in the official economy and fulfil their tax obligations. Tax revenues will increase while the tax gap will narrow. 

The extensive exercise of voting rights in tax affairs will significantly increase taxpayer compliance. The deeper the taxpayer participates in political decision making, the higher the tax contract performance efficiency and tax compliance get. 

Some powerful tax evaders believe that they have uncovered new interpretations of the law that show that they are not subject to being taxed (not liable).

In this premise, the tax regime in a developing economy like Bangladesh must have the following five important characteristics. 

(1) Political participation: The wide participation of taxpayers in the political decision-making process is an important guarantee for establishing social taxation and good customs. 

(2) Responsibility and transparency: The government should have a legitimate duty to use tax revenues. Also, the procedures for providing public goods or services should be transparent to the taxpayers.

(3) Perceivable fairness: In a reasonable and effective tax system, taxpayers can perceive themselves as being treated equally and justly. With regard to tax incentives or tax exemptions, if taxpayers perceive that they are being treated unfairly, their tax willingness will inevitably decline. 

(4) Effectiveness. The government should have the ability to transform the gradually increasing tax revenues into higher levels of public goods or services and enhance political stability. 

(5) Sharing a prosperous political commitment: The national taxation system should be closely linked with the national goal of promoting economic growth. Promoting economic growth is one of the strategic goals that the government has promised to taxpayers. The government can promote the realisation of this strategic goal through taxation.

The author is former Secretary to the Government and former Chairman, NBR, mazid.muhammad@gmail.com 

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.