Policy brief

31001 | November 2011

Ahsan H. Mansur, Mohammad Yunus

and Biplob Kumar Nandi

An Evaluation of the
Tax System in
Bangladesh

In brief • Tax systems in Bangladesh suffer from weaknesses in both tax administration and
policy.
The weaknesses in the tax system and tax administration have contributed to the very
low level of tax collection in Bangladesh, undermining the government’s capacity to
provide necessary public services.

• Modernization of VAT, income tax and customs administration would go a long way
in enhancing tax revenue in Bangladesh. Tax administration should be geared toward
providing taxpayers’ services.
Modernization of tax administration will be the key to realize revenue potential
in Bangladesh. Outdated tax administration based on geographical basis (circles),
absence of coordination among the three main wings (VAT, Income tax, and customs)
of the National Board of Revenue (NBR), lack of computerization, and reliance on
physical control instead of accounts, are the major factors contributing to the failures
in tax administration.

• The New VAT Act must eliminate existing distortions like truncated base, tariff
values, account current and tariff values. Reforms on the direct tax systems should
aim at reduction of exemptions/deductions and tax holidays, taxation of capital
gains, and harmonization of corporate and individual income tax rates to improve
equity and efficiency of the direct tax system.
Despite some improvements, the current VAT Law has characteristics excise type and
should be eliminated to have a modern accounts-based VAT system. The direct tax
system suffers from a narrow tax base, horizontal and vertical inequity, and strong
scope for evasion.

Ideas for growth

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 Policy Motivation

Accelerating Bangladesh’s economic growth to the targeted 8% as envisaged in the

Government’s Sixth Five-Year Plan (FY11-15) over the medium term, would require
massive public sector investment in power generation and distribution, construction
of roads, bridges and expressways, and other infrastructure. Quality coverage of
public service delivery (health care, education, agricultural extension services etc.)
would also need to be improved and broadened. Without a substantial increase in
domestic public resources, adequate and quality public goods cannot be provided to
foster the target economic growth.

Project Summary

The present work reviews the official documents of the NBR to gauge the current
practices associated with administration of the tax system in Bangladesh. It also
compares the outcomes with best practices dictated by theory or as evident in other
countries with similar levels of social and economic development.

Policy Findings

“Without a sub- Though recent VAT performance seems to be quite buoyant, a VAT effort index at
stantial increase in only 0.48 implies that Bangladesh is well below its potential. The estimate shows
domestic public re- that Bangladesh’s potential for higher tax revenues, given its VAT productivity,
sources, adequate and exceeds actual tax collection. Lower tax efforts in VAT collection reflect mainly
quality public goods weaknesses in tax administration coupled with identified deficiencies in tax policy/
cannot be provided system. Deficiencies include a narrow tax base, multiplicity in effective tax rates,
to foster the target and administrative inefficiency involving truncated-base VAT system and excise-
economic growth.” type administrative practices (declaration of prices, input-output coefficients, tariff
values, account current etc.).

The current individual income tax law separates different types of income for
administrative purposes since most tax revenue is received through withholding at
sources. The continued use of certain allowances provides scope for tax avoidance
mechanisms.

The generous tax rate for capital gains and de facto exemption of agricultural
income creates horizontal inequities. Broadening the base of the income tax by
eliminating special treatments would improve the horizontal equity of the tax, and
make it fairer for all types of taxpayers.

Even though the statutory Bangladesh corporate income tax rates are broadly in
line with the neighboring countries, except for somewhat higher rates for financial
institutions and telecom companies, numerous exemptions and tax holidays and
depreciation allowances erode the tax base. Non-compliance and tax holidays
compromise the vertical and horizontal equity of Bangladesh’s tax system.

Policy brief 31001 | November 2011 International Growth Centre 2

“Broadening the base Bangladesh’s Tax Efficiency, Given the Tax Rate Structures, is the Lowest
of the income tax by Among Regional Comparators
eliminating special
treatments would im- Countries Total Tax Income Tax Value Added Tax
Bangladesh 0.508 0.357 0.482
prove the horizontal
India 0.775 0.975 0.774
equity of the tax”
Pakistan 0.942 0.952 0.969
Sri Lanka 1.182 0.677 1.812
Indonesia 1.014 1.283 0.821
Philippines 1.02 1.19 0.743
Singapore 1.009 0.967 0.989
South Korea 1.206 1.372 1.572
Thailand 0.936 0.705 0.687
Source: Author’s Estimates

Bangladesh has the Lowest Tax-to-GDP Ratio Among Regional

Competitors

Bangladesh 9.2

Sri Lanka 12.9

Pakistan 10.0

Nepal 12.3

India 16.7

Bhutan 14.7

“Lower tax efforts in

VAT collection reflect
mainly weaknesses
in tax administration Implications
coupled with identi-
fied deficiencies in tax Improving tax efficiency will require major reforms in both tax policy and tax
policy/system” administration areas. Policy reforms must go hand-in-hand with the modernization
of tax administration.

A large part of the tax efficiency loss is attributable to weaknesses and outdated
(manual operations based) tax administration in Bangladesh.

Without a major reform initiative on the tax front, Bangladesh will never attain the
tax to GDP ratio of 12.4 percent by FY15, from the current level of 10 percent in
FY11, targeted under its newly announced Sixth Five Year Plan. The revenue gains
made in recent years will not be sustainable without fundamental reforms. A failure
on the revenue mobilization front will seriously undermine the government’s efforts
on expanding public services and meeting the growing infrastructure needs of the

Policy brief 31001 | November 2011 International Growth Centre 3

“Like most other economy. Without major reform, Bangladesh’s goal of reaching the middle-income
countries, a funda- status by 2021 will be unlikely.
mental reform of the
tax system...will be a
challenging task both Implementation
politically and ad-
ministratively” The present study is first of its kind. Further in-depth research will be needed on
each of the major components of the tax system. Moreover, estimating the tax gap
in Bangladesh, by types of tax gap and by taxes would enable the NBR to make
better tax policy decisions regarding the tax system, including efforts to combat tax
evasion where it is most prominent.

Like most other countries, a fundamental reform of the tax system encompassing
all major types of taxes (VAT, Customs duty and direct taxes) will be a challenging
task both politically and administratively. The NBR is currently working on a
five-year plan for modernization of tax administration, tax policy reform, and
capacity buliding for policy analysis by strengthening the Research and Statistical
Division of the NBR. This is a major and a comprehensive undertaking. While the
government is politically committed to the NBR modernization plan, its effective
implementation will require support from development partners in terms of
resources and technical assistance.

Despite political commitments for fundamental reforms at this early stage, there
are vested groups in the business community and tax administration who would
like to maintain the status quo and resist major changes. In addition to extensive
consultations with the stakeholders, massive publicity campaigns will need to
be undertaken to create awareness among the taxpayers about the reforms. They
should inform the tax payer why such reforms would be needed, and of their
enhanced rights and obligations. Taxpayers’ education campaigns will also be
beneficial.

“Without major Further Reading

reform, Bangladesh’s
goal of reaching the David A. Grigorian (2004). Tax Potential vs. Tax Effort: A Cross-Country Analysis
middle-income status of Armenia’s Stubbornly Low Tax Collection, IMF Staff paper
by 2021 will be un-
likely” Joweria M. Teera and Professor John Hudson, 2004. “Tax Performance: A
comparative study. Journal of International Development, Volume 16, Issue 6, pages
785–802.

Teera, J. (2002). “Tax Performance: A Comparative Study,” Working Paper 01-02,

Centre for Public Economics, University of Bath.

Policy brief 31001 | November 2011 International Growth Centre 4

 About the authors
Ahsan H. Mansur is Executive Director of the Policy
Research Institute of Bangladesh. Dr. Mansur started his
career as a Lecturer, Department of Economics, Dhaka
University in 1976. He left for Canada for higher studies
in economics in the same year. As a graduate student and
research assistant, he was also offering regular economics
courses at the undergraduate level at the University of
Western Ontario, Canada (1978-81). Dr. Mansur joined the
IMF under its Economist Program in 1981, and completed
his PhD in Economics (on general equilibrium analysis)
from the University of Western Ontario in 1982.

Dr. Mohammad Yunus obtained his M.S.S. in Economics

from University of Chittagong, Bangladesh in 1990, M.Sc.
at the University of Strathclyde in 1997 and M.Phil. from
the same University in 1998. He was awarded Ph.D. in
2006 by the Georgia State University, Atlanta, USA, for his
thesis on Essays on Optimal Mix of Taxes, Persistence and
Spatiality under Tax Evasion. He joined the BIDS in 1992 as
a Research Associate and was promoted to Research Fellow
in 2000. His current research interests include taxation, state
and local government fiscal policies, fiscal decentralisation,
food security and poverty alleviation, exchange rate issues,
tobacco consumption and knowledge about its health
hazards, applied econometrics (time-series and panel
data). He has published extensively in both nationally
and internationally accredited journals. He has also to his
credit numerous other publications in the form of research
reports, and contribution to various other edited volumes.

Biplob Kumar Nandi is a Senior Research Associate at the

Policy Research Institute of Bangladesh.

November 2011 International Growth Centre 6

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