Analyzing the taxation system - Part II

The post here may seem more or less directed towards some economics readers, yet I would like to share it as it may help some of the readers of mine. I know some readers might not like it, yet I am sharing it as I feel it is very important for all of us to know and learn something that is related to our country.This post is just a continuation of my previous post :Analyzing the taxation system - Part I.

As far as saving is concerned, taxation has a major role to play. A good taxation system should discourage excessive spending and encourage savings of the people. The saving decisions are said to be made by consumer, firm and government. And saving is expected to transfer income from workers to the capitalists and from the present to future generation (Sandmo, n.d).  Due to political transaction, Bhutan observed increased public expenditure on allocating public goods and services. People earned more by involving in such works but their decision to spend came as result of low tax rate for import of non-essential or luxury goods. The macroeconomic situation of Bhutan is not very impressive since recent years. The inflation rate has been very high and this has impacted the Balance of Payment of the country to a great extent. In the State of the Nation Report, (2013) the trade balance of negative 29 billion and national debt of nu. 96 billion was reported. Through this it is very imperative that saving and spending decisions from government or consumer is ambiguous. In such a situation, the government can make use of the tax to improve the market situation. For instance, to check the rapid surge in import, the government can increase the tax rates on non essential items. This way the tax is good by determining price of goods and services and also determining the saving and expenditure of both citizens and the government.

Tax collected from banks, factories, companies and organizations is major source of income to the government. The net collection during the year 2012-2013 amounts to Nu.15403.118 million, registering a growth of 5.0 percent or Nu.726.189 million over the previous year’s (2011-2012) collection of Nu.14, 676.929 million. The collections from both direct and indirect tax have shown an increase on the whole compared to the previous year. The direct tax recorded a growth of 4.5 percent over the previous year’s collection, while the indirect tax recorded a growth of 5.7 percent. Tax revenue forms 73.0 percent of the total revenue (Ministry of Finance, 2013).

The government uses this tax revenue for the provision of public goods and services. This is indeed a major role of a government in the society. There are certain goods and services which markets cannot provide. Such goods and services include national defense, health, education and other quasi-public goods and services such as roads, bridges, and etc. This should be provided by government because there is neither incentive nor anything for private citizens to voluntarily substitute the role of government. According to Musgrave & Musgrave, (2004) they said that this problem can’t be solved by merely sending a tax collector to consumers to whom the benefits of social goods accrue. On other hand these public goods are services are of no exception. To this end, taxes are of no exception either. Counter argument is if government’s provision of good and service through tax revenue is worth paying taxes. This is because people are usually frustrated at the quality of services provided by government. Wherein, citizens are rather reluctant in paying taxes to the government.

One of the major functions of taxes is distribution and redistribution of wealth and income. The redistribution are aimed at alleviating poverty and this welfare systems are said to be targeted to the most needy, withdrawn and special group of people in the society (FitzRoy & Jin, 2010). Redistribution of wealth and income is aimed at bringing equity in the society. Equity doesn’t mean suppressing rich or boosting the poor but by redistribution wealth and income are shared among the society. The equity function of a tax is said to be imposing tax in accordance with Ability to pay theory (Waidyasekera, n.d). The ability to pay theory as explained by Bhatia, (2006) says that tax liability takes its true form; compulsory payment to the state without quid pro quo. This approach as explained by author says that citizens pay taxes ‘just because he can’ and his share of burden to be determined by his relative paying capacity. Equity is either horizontal or vertical. Horizontal equity is treating equal tax of equal individuals and vertical equity is treating unequal tax for unequal individuals (Bagchi, 2005). According to Adam Smith’s cannon of equality a tax system should be progressive with progressive tax rates. In Bhutan tax paid by citizen is in accordance to Smith’s cannon of equality because rich people pays high tax while poor pays less (progressive nature of tax justified). However, due to no change in tax base for each unit of tax, it is seen more of proportional than progressive. And the taxes paid in this way are used to cater the need of the people who are poor and unemployed. Thus progressive nature of tax is used for redistribution of wealth and income to the disadvantage group.

Tax is used to intervene in market failure situation. Market fails because of externalities caused by market force while attempting to make profit. For example an industry pollutes environment while manufacturing certain goods. Industries don’t take into consideration the effects of pollution on third party. This adverse effect on the people who are not responsible for it is called externalities or spillover effect. Government should do something to reduce production externalities. Imposing high tax on industries can de-incentivize production of goods by particular industry thereby reducing externality. The price of the product will increase as a result of tax and in long run the demand for the product will be affected. To support it Zilberman, (1999) explained that Pareto optimum for competitive economy will not be achieved in presence of externalities, as individuals acting in their own self interest have no correct incentives to maximize total surplus. To tackle this problem or to internalize the externalities, governments impose tax as the policy action.

Tax and taxation policy is used as mechanism to counteract the cyclical fluctuation of the market economy. This policy is said to have its least effect during ‘Great Moderation’ period; a years between 1983 and 2007. And such situation is said to have replicated during 2007 to 2009 economic crisis during Obama administration (Listokin, 2009). The housing bubble of 2008 is a typical example: Up until the year 2008, the financial institutions and banks in the United States gave loans to investors at lower interest rates, and as a corollary of this, it experienced a housing boom. But in 2008, the housing boom culminated in a bust when house owners were no longer to repay loans as demand for housing decreased, resulting in lowered housing prices. Similarly, in recent years, Bhutan has been experiencing a housing boom as a result of low-interest loans given by financial institutions and banks to housing owners. So, there is fear among economic experts and policy makers that a housing burst is more than imminent; already, signs of a burst have displayed in recent times. Going by some of the media reports, there are complaints from house owners that they are not able to pay off those loans which were used for building houses, as housing prices have started to decline. Thus, in times of busts taxes can be used as a tool for economic stabilization.

 

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Analyzing the taxation system - Part I

The system of taxation in every country receives a good number of appreciations and criticisms from everyone and the Bhutanese taxation system has no exception. In accordance to my course requirement it is mandatory for me to learn and understand the macroeconomic functions of the nation. In this light we were made to analyze the Bhutanese economy, the taxation system, the faults in the Bhutanese public administration, bureaucracy in Bhutan, etc.... Here, I would like to talk something about the pros and cons of the Bhutanese taxation. I will be discussing the definition of tax in the Bhutanese context, whether it is good or bad and later with some analysis of it. I am sharing this as I have done it in my Public Financial Management unit as an assignment and I would love to share it to my readers...

Courtesy: Google

Introduction of tax and its definition in the Bhutanese context

According to Bhatia, (2006) tax is defined to be as a compulsory levy which should be paid by economic unit to the government without any corresponding entitlement to receive a definite and direct quid pro quo from the government. Rationally, people always expect something for something they have given to someone. Tax is something people give to the government and in return people may expect something. However, people are limited to indirect benefits rather than direct and definite entitlements. Gans et al, (2012) quotes American Statesman Benjamin Franklin to have said that ‘in this world nothing is certain but death and taxes.’ Certainty of death inflicts fear to the people, so does the certainty of taxes. People of less or no income, when they are imposed tax it appears to be like death penalty. In this light, can we generalize that taxes are bad? The answer is obviously no because a tax besides its negative impact has its own silver lining. Mere perception will not adequately justify whether it is good or bad but with analysis of affects of tax to the tax payers, role of tax in generation of state revenue, its cyclical mechanism, and redistribution functions may help us decide the fate of taxation in Bhutanese economy.

History of taxation in Bhutan can be traced back to 17^th century. During those time taxes were paid in kind to the number of petty rulers. There was no proper system of taxation. People were persuaded very much to get as much as possible. The second king realizing the irregularities in the tax system centralized the tax collection authority and ensured that the revenue was used for enhancing the living conditions of the people (Bhutan 2008, 2008). In a way, the tax was not fairly exercised to the people. The need for the formal taxation system was felt in 1960s when Bhutan steered towards first ever five year development plan. They felt the need of budget in order to bring about socioeconomic development in the country. People were levied taxes in the form of compulsory labor contribution in building public structures and in equivalent kind. Later in 1970s when Bhutan started printing her currency (ngultrum) the taxes were to be paid in money. By weighing the level of compulsion; failure to pay tax were said to be punishable by law and by the amount of administrative burden in collecting the tax, tax was questionable if it really served its purpose. People were compelled from no or very less means and collectors had to go the remotest of villages to collect tax.

Are Taxes good or bad to the economy?

When government of any country imposes tax and when taxes are collected, it involves good number of responses from the tax-payers and the economy. Such responses can be of great variety and they can profoundly influence the working of the economy in terms of production, growth, saving, investment, choice of techniques of production, regional imbalances, inequalities of income and wealth, etc (Bhatia, 2006). Besides having very good taxation system of a country, the taxation has got both beneficial and harmful effects.

When a taxation system exhibits a harmful effect to the society and the economy, it can be termed as the burden of that tax. The reduction in the disposable income of the tax payer may be referred as the money burden (Bhatia, 2006). Looking at the tax slab of Personal Income Tax (PIT), Business Income Tax (BIT) and Corporate Income Tax (CIT), it is evident that there are some drawbacks though they have not been revised for a long time. Despite the general increase in the personal disposable income as well as the cost of living in Bhutan over the last couple of years, the rates remained unchanged for a long time. For instance, when PIT was first introduced in Bhutan in 2001, taxes were exempted for those earning salary less than Nu.100, 000 in a year. India then provided tax exemption to those earning below Nu. 70,000. Today, while Bhutan’s PIT rate remains as it is, India has increased the minimum income qualified for tax exemption to Nu.150, 000. Dividing the exemption rate of 100,000 by 12 months, people with just more than Nu.8000 per month are liable for personal income tax imposing money burden. This de-incentivizes civil servants to work hard or work at all. In this light, government should increase the exemption rate to reasonable amount so that tax will become progressive and citizens will pay without a word.

Note: To be continued in later parts.......

 

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Analyzing the Bhutanese Economy

It has been almost two months here in Royal Institute of management pursuing my Post Graduate Diploma in Public Administration. Therefore, I am very sorry to all my readers for not being able to update my blog contents. I have been extremely busy with my course as I was trying my best to get cope up with the course. Although the course is very difficult comparing to my degree course - Bachelors in Computer Applications, Some of my modules in my degree courses help me a little in my post graduate course. It is very difficult a times while dealing most of the time with economics' terms at the macro level. Most of the sessions are engaged discussing about the economy, administration and management at the national level.

Source: Google

I have been engaged vigorously for more than two weeks now to understand and deal with the Bhutanese economy in order to tackle my assignment on Introduction to Public Administration unit. The Bhutanese economy has opened up since 1961 with the launching of First Five Year plan. Bhutan got assistance for other donor countries after 1971 after joining the United Nations Organization. After that Bhutan has been recognized as the sovereign country and the country got several assistance from regional and international organizations/ countries. I have analyzed the Bhutanese economy in terms of the Bhutanese economy being opened to the other world. I have analyzed it with regard to economic factor, social factor, geographical factor, political factor and technological factor. 

To analyze more about the Bhutanese economy, I have also done SWOT (Strength, Weakness, Opportunities, Threats) analysis of the Bhutanese economy. I have found that Bhutan has got strengths in terms of getting electricity, political stability, atmosphere, etc.. which in terms directly or indirectly helps to boom our economy. About weaknesses, Bhutan lacks in terms of resolving insolvency to start business, improper procedural while starting business, etc.. Bhutan has got very good opportunities in hydro-power sector as the neighboring country increases demand for the electricity. The country has also got good opportunity in Tourism sector and FDIs as it really helps in generating the national revenue. However, Bhutan has threat for her economy because of global warming and also because of joining World Trade Organization is not analyzed and studied most profoundly. 

It was a good opportunity for me to learn and study about the indicators being set by the World Bank to analyze the ease of doing business. Our country is being ranked 141 out of 189 countries in terms of ease in doing business in the world. Its previous ranking was 146 and it shows a good indicator for the Bhutanese economy as its ranking has been increased by 5. In the SAARC region our country is being ranked 7th in terms of ease in doing business. However, our country is being ranked first in getting electricity in SAARC region.

It was very difficult for me to formulate strategies to help our country's economy grow. I had to write in terms of turning the threats of the Bhutanese economy into opportunities of the Bhutanese economy. I feel it is very important for all the Bhutanese to understand the economic situation of the country. It is must for all of us to know the current situation and work according to it.

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