The government's recent move to increase value-added tax (VAT) on 43 goods and services has raised two key questions: will it generate enough revenue to avoid a huge budget deficit and will it further stoke an already high inflation?

After the finance adviser assured that the VAT hike would not impact price pressures, the National Board of Revenue (NBR) yesterday reiterated that there would not be any impact on inflation.

The revenue board, in a press release, also mentioned a potential budget deficit if revenue collection remains sluggish.

The revenue authority linked the risk to tax cuts on eight essential items to cool off red-hot inflation, which the NBR said has reduced revenue collection largely.

Beyond these concerns, businesses and economists have expressed reservations about the effectiveness and timing of the VAT increase.

Regarding effectiveness, businesses anticipated that the VAT hike will slash their sales, ultimately reducing fund flow to state coffers.

On the timing, economists said that the VAT increase comes at a time when people are struggling with inflation above 9 percent for nearly two years.

The VAT hike is being linked to the conditions of the International Monetary Fund (IMF) for its ongoing $4.7 billion loan programme for Bangladesh. Besides, the NBR has an urgency to increase government revenues by an additional Tk 12,000 crore to streamline collections.

The NBR yesterday said that the revenue administration had to come up with the "special measures" to expand the VAT net and rationalise rates and amounts of excise and supplementary duties.

However, economists maintain that this move could still stifle consumer spending, leading to lower revenue earnings as individuals already face rising living costs.

They said the government should not rely on VAT hikes as an easy toll to boost revenue collection, but instead focus on increasing direct taxation.

As part of its $4.7 billion loan programme for Bangladesh, the IMF advised the government to rationalise tax exemptions, improve compliance with tax laws and implement reforms in tax measures to enhance domestic revenue collection.

Bangladesh has one of the lowest tax-to-GDP ratios globally. This low revenue collection compels the government to resort to costly borrowing from both domestic and foreign sources.

Under a single VAT rate of 15 percent, various items will be included, such as medicine, restaurant services, residential hotels, sweets, biscuits and branded clothing.

For instance, residential hotels may have to pay 15 percent VAT, up from the current 7.5 percent. Consumers of branded clothing may also face a higher rate of 15 percent, compared to the existing 7.5 percent.

"The intention behind raising VAT was to boost revenue collection. But the ultimate outcome will likely be disastrous," said Khalid Mahmood Khan, co-founder of Kay Kraft, a retailer of fashion wear, accessories and home textiles.

He predicted a massive decline in overall sales. "A large portion of our customers come from middle-class families. They are not affluent. Ultimately, this VAT increase will lead them to cut back on their purchases," Khan commented.

He believes the government should instead focus on expanding VAT coverage, as many businesses remain outside the tax net.

According to the Fashion Entrepreneurs Association of Bangladesh (FEAB), nearly 5,000 companies operate in the fashion industry across the country.

"A large part of them are small and medium entrepreneurs," said FEAB President Syed Md Azharul Hoque.

"Our restaurant was severely impacted during the July-August protests. We are still striving to recover," said Imran Hassan, general secretary of the Restaurant Owners Association.

"Amid inflationary pressures, people are already hesitant to dine out. If the government raises VAT in this situation, it will harm our business," he added.

Hassan said the association will write to the NBR and the finance adviser and hold a press briefing to protest the decision. "If our demands are not met, we, along with the sweets and other affected sectors, will go on strike," Hassan added.

Small and medium enterprises (SMEs) will face another challenge with the standard VAT rate as the ceiling for VAT-free turnover is being lowered from Tk 50 lakh to Tk 30 lakh.

Consequently, businesses with annual turnover exceeding Tk 30 lakh will now fall under the VAT tax net.

Moreover, the VAT rate for businesses with turnover between Tk 30 lakh and Tk 50 lakh will be increased to 15 percent, up from the current reduced rate of 4 percent.

Initial lists indicate that VAT on medicine at the trading stage may increase to 3.0 percent from the existing 2.4 percent.

However, Finance Adviser Salehuddin Ahmed said that this VAT hike would not fuel inflation further. "The items are an insignificant part of the basket for the consumer price index," he said on Thursday.

Ahmed believes that the VAT hike will not impact the prices of essential commodities, citing the government's waiver of all import duties on essential goods.

Towfiqul Islam Khan, a senior research fellow at the Centre for Policy Dialogue, said policymakers should not view inflation solely as a statistical figure. "It represents the cost of living, which directly impacts all segments of society," he said.

"We do not oppose the unitary VAT system, but concerns exist regarding its timing and implementation. Given the current circumstances, this is a highly sensitive issue," he added.

Khan also said that when it comes to scrapping tax exemptions, the NBR often relies on VAT as a convenient tool for revenue collection due to its administrative simplicity.

"However, greater emphasis should be placed on income tax," he said. "The NBR should also prioritise addressing VAT evasion."

Rizwan Rahman, former president of the Dhaka Chamber of Commerce and Industry (DCCI), said, "The government should focus on reducing its expenditure rather than pursuing overly ambitious revenue targets."

"If the NBR attempts to meet these unrealistic targets, increasing taxes will not contribute to a more favorable economic climate," he said.

"Hiking VAT on 43 goods and services is not inherently wrong. However, implementing it at this time, amid soaring inflation and a historically low business climate, would be unwise," added Rahman, who also serves as the managing director of ETBL Holdings Ltd.