Are tax policies addressing inequality?

Bangladesh's economy has been growing at an average 6 per cent annually for the last two decades. Yet the country has witnessed a spike in income and consumption inequality.

Usually, fiscal policies, particularly those related to tax, are tools that are used to reduce inequality through the redistribution of income.

But in Bangladesh, tax policies are not able to address the issue of inequality as 67 per cent of the revenues are collected through indirect taxes which fall on rich and poor equally irrespective of their income. Besides, exemptions, tax evasion as well as various loopholes in the income tax system reduce the efficacy of the direct tax, according to five economists.

Direct tax is generally progressive in principle as the tax is collected on income. On the other hand, indirect taxes such as value-added tax or supplementary duties tend to be regressive.

"Our statutory personal income tax system is more progressive than the system on the ground," said Zahid Hussain, a former lead economist at the World Bank Bangladesh.

"This is because of various tax rebates and concessions that can be used and abused to evade taxes. So, instead of equalising, our direct tax system is not progressive to the extent it is designed to be."

Although the tax rates under the indirect taxation system are the same for the rich and the poor, the amount paid by the poor is higher in proportion to their income.

Hussain explained the rich and the poor pay the same rate when they buy a product, such as edible oil.

"But a Tk 15 VAT paid against a purchase of Tk 100 by the poor is likely to be a much higher proportion to their income than in the case of the rich. All indirect taxes tend to have this feature."

Rizwanul Islam, a former special adviser for the employment sector at the International Labour Office in Geneva, says tax policy and fiscal policy as a whole can have a significant impact on income distribution and moving towards an equitable and just society.

"As indirect taxes are by nature regressive, a greater reliance on them, as opposed to direct taxes, goes against the principle of equity."

He answered in the negative when asked whether the tax policies and measures taken by the National Board of Revenue (NBR) over the years have been able to address inequality and make economic development inclusive.

"The direct tax-GDP ratio has declined over almost a decade. No attempt has been made to reduce the dependence on indirect taxes and raise the rates of taxes on higher income brackets. On the contrary, the corporate tax rate was lowered."

Islam said some policymakers have started to recognise inequality as an issue only recently.

"Now it is important to move from there to real action. If the government is serious about the matter, it can undertake necessary measures that are well-known."

He suggested raising the tax rates on higher income groups, increasing corporate tax rates, doing away with exemptions that fatten the pockets of the rich, plugging loopholes in the tax system, and introducing wealth and inheritance taxes.

Sadiq Ahmed, vice-chairman of the Policy Research Institute of Bangladesh, said international research suggests that tax policy alone may not have a strong positive impact on income distribution.

"However, a combined tax and expenditure policy package may have significant positive effects in reducing income inequality."

The use of a redistributive fiscal policy is a solution to the rising inequality.

"The best examples of successful use of redistributive fiscal policies come from the experience of countries in Western Europe. These countries raise considerable tax revenues based on a progressive income tax system and combine this with a strong social expenditure programme focused on the poor, the vulnerable and low-income groups," Ahmed said.

By contrast, Ahmed said, the tax system in Bangladesh is not geared to reducing income inequality.

"While there is a progressive personal income tax system in place, due to weak implementation, the rich tend to substantially escape the tax net through various exemptions, tax loopholes, and negotiated settlements with tax officials."

Citing the Household Income and Expenditure Survey 2016, Ahmed said it showed that the top 10 per cent of the population owns 35 per cent of the national income.

Even with an effective tax rate of 10 per cent, tax revenue from personal income taxes should amount to 3.5 per cent of GDP. But actual tax collection from personal income is about 1.4 per cent of GDP, which suggests that the effective tax rate at present is about 4 per cent, he said.

"This is very low and suggests a huge non-compliance."

He said the share of personal income taxes in total taxes is very low at less than 20 per cent.

On the expenditure side, he said, the government policy is to give priority to spending on health, education, and social protection that tends to benefit the poor and has the potential to improve income distribution.

"Despite these good intentions, actual outcomes have not been very positive. Huge shortfalls in tax revenue collections over the past several years have forced the government to cut spending to contain the fiscal deficit."

In Bangladesh, the Gini coefficient is rising steadily. It was 0.36 in 1983-84 and rose to 0.46 in 2010 and 0.49 in 2022.

Selim Raihan, executive director of the South Asian Network on Economic Modeling, said Bangladesh's tax policy is in no way inequality-reducing. "It is rather enhancing."

He said reforms efforts were taken earlier but they were not successful as the beneficiary of the inequality enhancing tax system resisted the change through different ways.

"Tax policy is an important tool for redistribution of wealth. Redistribution is not taking place. Rather money is flowing into the pockets of the rich."

Raihan suggested raising tax on the rich and increasing expenditures on health, education and social protection.

Towfiqul Islam Khan, a senior research fellow of the Centre for Policy Dialogue, said although one of the key roles of tax policies is to facilitate economic and social justice, in Bangladesh, it is overlooked.

"Our overreliance on indirect tax is the primary reason for not opting for more redistributive tax measures."

Khan said the repeated failures to mobilise the targeted tax revenue set in the budget and the tax-GDP being one of the lowest in the world make it even more difficult.

"At the same time, extending direct tax exemptions has been very common. Indeed, the overall tax policy is often a victim of vested groups."