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Bangladesh at a crossroads

  • Published at 09:42 pm November 24th, 2019
Tax evasion is holding our economy back Bigstock

Taxation and representation will largely determine the success of our middle income aspirations

At the heart of any democracy is the idea that a social contract is created between citizens and the people who are chosen to represent them.

From a public finance perspective, this is commonly viewed as an exchange of “taxation for representation.” In Bangladesh, these two concepts (taxation and representation) will largely determine to what extent the Vision 2021 goal of becoming a middle-income country can be achieved.

From an economic perspective, Bangladesh is in an enviable starting point -- the IMF estimates growth at an annual rate of around 7.5% through 2024, poverty rates have reduced significantly over the past five years, government debt is amongst the lowest in the world, and export markets are booming. With this impressive growth, the government is well placed to achieve their ambitious ‘Vision 2021’ goal, however some important barriers exist which still need to be overcome. 

One of these is the collection of taxes.

In 2016, the government only managed to collect around 8% of GDP in tax revenue, well below its neighbours, and ranked 84th out of 94 emerging market economies in terms of collection capacity. This underperformance ranges across all tax bases and can be attributed to several factors including a large informal sector, high levels of tax evasion and avoidance, a lack of credible enforcement mechanisms, inefficient and un-transparent tax collection procedures, and confusing/outdated tax laws, all of which will need to be tackled if Bangladesh is sincere about transforming into a middle-income economy.

For example, income tax revenues in Bangladesh only made up around 0.8% of GDP in 2016, despite an unemployment rate of 4.3, compared with income tax revenues of 2.3% of GDP in India, who had a higher unemployment rate of around 6.1%.

Similarly, corporate tax revenues in Bangladesh only made up 1.6% of GDP, half of those collected in neighbouring India (3.2% of GDP). With millions of labour force participants, and thousands of companies not paying any taxes, both of these tax bases have a ways to go to reach their true potential, which will require further developing a professional and integrated formal sector. 

Creating a professional, inclusive formal sector with efficient, centralized and accountable tax collection systems should allow the government to increase their tax capacity closer to 20%. 

However, the government will need to convince tax-payers that they will receive benefits from their representatives -- the social contract in Bangladesh has been fractured by persistent and systematic corruption, leaving potential taxpayers weary of what benefits they will accrue if, and when, they do pay. According to Transparency International, Bangladesh ranked 149th out of 180 countries in 2018 for corruption.

The most recent 2019 IMF Article IV report highlights “vulnerability to corruption” as being an inhibitor to Bangladesh becoming a middle-income country. An environment of graft and impunity makes it difficult for law abiding citizens to justify paying taxes, which they may perceive as going into the pockets of unscrupulous officials rather than financing much needed social infrastructure and development projects.

The government appears to be taking genuine initiatives to stamp out corruption, but transformative end results remain to be seen. Meaningful anti-corruption reforms will be more challenging than making a handful of high-profile, media friendly arrests. This will require bold leadership willing to restructure the public sector, including public banks that benefit from government support despite high levels of non-performing loans, limited levels of transparency, and an overall lack of accountability. 

The good news is the overall fiscal position of the Bangladesh government is well placed to flourish. Gross debt levels are low by comparative standards (around 35% of GDP) and the debt path is sustainable (unlike many other developing economies that are currently in debt distress). 

This favourable debt position should allow the Bangladesh government to access capital at relatively low rates once more robust tax bases are established and credible measures are taken to stamped out systematic inefficiencies and corruption. 

The fiscal space created by additional tax revenue and the ability to borrow at low rates will provide Bangladesh with an unprecedented opportunity to finance and foster continued growth and development into 2041, when the intention is to progress from a middle income to a developed economy.

Sustained growth can be further consolidated by investing in high quality education for the relatively young population and adopting an open and genuinely competitive bidding process for public sector projects which deliver the highest value for money, and are open to scrutiny from Bangladeshi citizens and the international community. If done properly, Bangladesh could find itself developing very quickly with tangible results similar to the Asian Tigers.

In short, a revived credible and sustainable social contract in Bangladesh will be an important key for unlocking the door to prosperity and development. This will require incentivizing a large informal sector to join the formal economy through the creation of clear and simple tax laws and efficient centralized tax collection process.

High levels of tax evasion and avoidance can be overcome by demonstrating a commitment to taxpayers, ensuring that tax contributions will finance development projects for the betterment of all Bangladeshis, and by enforcing credible and objective punishment mechanisms for those who continue to evade their tax liabilities.

An excellent way to signal such a commitment would be a thorough overhaul of inefficient or unnecessary public sector institutions which have burdened government finances for too long. All of this will require bold, difficult, and sometimes unpopular, decisions from the government but will be looked back on as building the foundations for a modern and developed Bangladesh.

Mike Seiferling is an assistant professor of Public Finance, University College London. He can be reached at [email protected]