Addressing our growing inequality using fiscal policy

Economic growth with the reduction in poverty and inequality are important development objectives in the policymaking process in Bangladesh. However, over the past decade since 2010, despite high economic growth, the country has been witnessing a rise in the inequality index. According to the Household Income and Expenditure Survey (HIES) of the Bangladesh Bureau of Statistics (BBS), the Gini coefficient of income, which is a popular measure of income inequality, rose from 0.458 in 2010 to 0.482 in 2016. The actual inequality picture is thought to be worse than the BBS's survey estimate, as these household-surveys mostly fail to capture the information from the ultra-rich households. However, despite the data limitation, the growing inequality index suggests that the richer segment of the society has been benefited more by economic growth during the aforementioned period, and the economic growth process has been far from inclusive.

The widening income inequality between the rich and poor in Bangladesh emphasises the need to understand the causes of growing inequality and to undertake appropriate policies to narrow the income gap. A number of reasons can be mentioned as responsible for the rise in income inequality. However, the fiscal policy during the aforementioned period can be considered as one of the major contributing factors that widened the income inequality.

Two major instruments of the government's fiscal policy are very relevant for addressing challenges related to widening income inequality. These two instruments are revenue generation (especially tax and non-tax revenue), and public expenditure on social sectors (especially education, health and social protection).

It is important to mention that, tax revenue occupies more than 80 percent of government's revenue in Bangladesh. However, over the past decade, tax revenue in proportion to the GDP declined and remained well below any international norm. In fact, the tax-GDP ratio now is around 8.6 percent, which is one of the lowest in the world. With such low tax-GDP ratio, the government has very limited ability to spend highly on the social sectors. Furthermore, over the years, the government's efforts to increase revenue from direct taxes (taxes on income and profit) haven't seen much success. Less than a third of government revenue comes from direct taxes. In contrast, the reliance on indirect taxes (value-added tax, import duties, supplementary duties, and different other taxes) and non-tax revenue is huge as more than two-thirds of the government's revenue comes from these sources. As far as the direct tax is concerned, a large number of potential taxpayers, which include many ultra-rich people, remain outside of the tax-net or pay a little amount of taxes. Also, a number of economic sectors, capable of paying taxes, are either fully exempted from paying taxes or enjoy the privileges of paying a substantially reduced amount of taxes.

Two major instruments of the government's fiscal policy are very relevant for addressing challenges related to widening income inequality. These two instruments are revenue generation (especially tax and non-tax revenue), and public expenditure on social sectors (education, health and social protection).

It is also important to highlight here that, as far as the tax policy is concerned to achieve both horizontal and vertical equity, individuals in similar financial circumstances with similar fundamental ability to pay taxes should be taxed at the same rate (horizontal equity), and the individuals in different circumstances with different abilities to pay should not be taxed at the same rate (vertical equity). In Bangladesh, given the culture of tax avoidance, the objective of achieving horizontal equity is compromised. Also, due to the heavy reliance on indirect taxes, the objective of achieving vertical equity is seriously undermined. This has resulted in a tax system which is regressive and inequality enhancing where richer people become the larger beneficiaries of such weak tax system.

Now, if we look at the expenditure side of the fiscal policy, especially public expenditure related to education, health and social protection, there has been virtually no significant improvement in the allocation, in proportion to GDP, over the past decade. In 2010, the public expenditure on education and health in proportion to GDP were 2.1 percent and 0.5 percent respectively, which by 2016 came down to 1.5 percent and 0.4 percent respectively. In 2016, public expenditure on social protection was only around 1 percent of GDP. In all three social fronts (education, health and social protection) in Bangladesh, public expenditure in proportion to GDP is the lowest in the world. Despite that public expenditure on social sectors has been used in many countries to counter widening income inequality, this instrument has not been used judiciously in Bangladesh in the recent decade. Such low public education and health expenditure does not help improve the productivity of workers and is not consistent with the effort to reduce poverty and inequality. One obvious implication of the low public expenditure on education and health is the high degree of out-of-pocket private education and health expenditure in Bangladesh which is one of the major contributing factors behind the growing inequality.

The inequality problem also involves regional disparity in development. While Dhaka and few metropolitan cities have been the major beneficiaries of the development so far, many regions in the country are seriously lagging behind. There are genuine concerns that large discrimination prevails when it comes to budgetary allocation for social sectors and physical infrastructure in Dhaka and few other metropolitan cities over many other regions in the country. With such a regional disparity in the allocation of development budget, the country's inequality situation is deemed to get worse. Also, the government's social protection programmes are very inadequate in addressing pockets of poverty and regional disparity in poverty. Therefore, there is a need for enhanced budgetary allocation for these lagging regions.

One important aspect in the fiscal policy, both in the cases of revenue generation and public expenditure, is the corruption and leakage in the system. The high degree of rent-seeking activities in the public revenue and expenditure systems also contribute to enhanced inequality. Therefore, the need for institutional reforms in the areas of revenue generation and public expenditure is greater than ever.

Dr Selim Raihan is Professor, Department of Economics, University of Dhaka, Bangladesh, and Executive Director, South Asian Network on Economic Modeling (SANEM). Email: selim.raihan@econdu.ac.bd

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