Nepal as a low-income country is characterized by typical features like dependency on agriculture, income from remittances and fragility. As remittance from workers abroad and a good harvest contributes a major portion of the GDP, there are significant weaknesses in government policy. The institutional development is poor in low income countries. In such countries, institutions have either excess liquidity or are struggling to lower non-performing assets. Low-income countries are heavily reliant on foreign aid. Low-income countries including Nepal are facing some similar risks such as political tensions, energy crisis, weak banking sectors and weak investment environment. As far as tax revenue is concerned, these countries require proper revenue mobilization through tax policy reforms.

 

Revenue mobilization in Nepal is weak. The reason is weakness in the tax administration. Tax to GDP ratio is low, around 15% (though there has been a significant rise compared to previous years). This indicates a narrow tax base. The low level of tax collection implies less spending for infrastructure and social sectors. Tax collection from direct taxes and consumption-based taxes is low. There has been rise in tax collection from consumption-based tax i.e. VAT in recent years but rise in tax collection from direct tax i.e. income tax has remained sluggish. The ratio of indirect taxes to GDP is around seven percent. However, the ratio of direct taxes to GDP is nearly four percent. The average VAT revenue percentage to GDP in lower income countries is five percent and that of income tax is 3.55 to five percent. In the developed countries, total contribution of tax to the GDP is over 30 per cent - the highest being 48 per cent in Denmark.

 

The underperformance of tax revenue mobilization in Nepal is due to administrative and structural factors rather than paucity in the policy itself. The peculiar view is “policy is administration”, however these two factors should be construed separately in order to see through the real problems. The indirect tax is consumption-based tax. These are the best tax practices in case of indirect tax worldwide. Many countries including India have been trying to move towards more simplified form of indirect tax by levying tax on goods and services (GST) at blanket rate. With some drawbacks of this form of consumption tax for low-income countries like Nepal where consumers have uneven income, it should be noted that it is simple to administer and there is less space for tax evasion and disputes regarding interpretations. However, limited rationalization in direct taxes i.e. personal tax and corporate tax is seen.

 

The tax base is narrow. The percentage of people paying tax in Nepal is below one percent. Bhutan has the highest percentage of people paying tax in South Asia - around seven percent. As said earlier, as the Nepali economy is substantially dependent on agriculture and remittance, which enjoy tax exemption, a tremendous growth cannot be expected. Moreover, there are several other exemptions which are granted on income taxes. These exemptions are of course need-based and required to boost up certain sectors. 

 

Inefficient tax administration is another major challenge. There are cumbersome compliance procedures. It has been estimated that more than 300 hours are spent on preparing and paying taxes in low-income countries including Nepal. Tax awareness among people seems to be insufficient. Moreover, there are structural challenges. With limited number of tax offices, the process has become more cumbersome. Though electronic tax system is in progress, the tax payers are still unaware on its use. Many of them, especially those from remote areas, opt to travel long distances for preparing, paying taxes and for other compliances. For example, a businessman in Bajura opts to travel to Dhangadhi for the process and one from Salleri has to travel to Lahan. A large number of cash payments occurs outside the financial institutions, thereby resulting in evasion practices. 

 

Informality exists. As administrative capacity is weak, there exist a large number of hard-to-tax groups like small businesses, small farms and professionals. There exists a large tax gap. Tendency of deliberately remaining outside the tax net is seen. However, micro traders genuinely tend to have income or sales well below the threshold. Weak tax collection is also associated with low tax payer morale, corruption and weak governance.

 

Changes are required in the tax policy as well as the tax administration. Broadening the tax base requires policy to address informalities and personal income tax. A right balance should be sought for taxation of domestic and foreign investment. This is necessary not only to boost up revenue and foreign investment but also to curb tendencies of base erosion and profit shifting. Simplifying the policies, effective tax administration and compliance are required. Educating and raising awareness among people about tax practices should be made more resilient. Promoting trust among the tax payers and tax administration can ensure more effective administration and governance. There should always be political will and leadership for driving the reform. It is a positive vibe that reform is being carried out in the tax policy and administration in recent days.