William Spencer Vickrey (June 21, 1914-October 11, 1996) wrote a week before his death and three days before he received the Nobel Memorial Prize in Economics the famous 'Fifteen Fatal Fallacies of Financial Fundamentalism: A Disquisition on Demand Side Economics'. Since its publication in 1996, most economists -- classical and neoclassical, Keynesian and mainstream -- have mused over the reality that emerged in fiscal management from Vickrey's analysis.
After almost two decades, if we revisit Fallacy Eleven, in particular where Vickrey stated that "It is claimed that exemption of capital gains from income tax will promote investment and growth" , we may argue that a paradigm shift is needed in the tax and duty Exemption scenario in Bangladesh.
Based on real situations, Vickrey observed that any attempt to define a special category of income entitled to differential treatment is an invitation to the sorcerer's apprentices in the US Congress and in the offices of the IRS (Internal Revenue Service) to start casting spells that are bound to produce surprising consequences. If we place the theorem in a context which exists in developing economies like Bangladesh, we find that attempting to draw administrable rules defining economically meaningful lines between interest credited to accounts but not drawn on zero coupon bonds, stock appreciation from undistributed profits, inflationary gains, profits from insider trading, gains from speculation in land, gambles on derivatives, profits or losses on speculative ventures and so on is a Sisyphean task.
Through empirical study, it has been presumed that concessions to gains must entail corresponding limitations on the deductibility of losses, lest there be intolerably large opportunities for arbitrage against the revenue. In an attempt to counter the skills of the taxpayers' techies, the rules are likely to be more severe on the deductibility of losses than liberal with respect to gains, so as to produce a number of situations where the revenue authorities are playing "heads I win, tails you lose" with the taxpayer. Even with effectively parallel rules, reduced effective deductibility of losses may well be more of a disincentive to speculative investment than the attractiveness of low taxes on gains in the event of success.
Most economically desirable investments take considerable time for the anticipated results to be reflected in the capital markets or in the economy. In the disclosure of undisclosed income for and the promise of a tax concession to be effective in a remote future and subject to possible alteration by future legislatures is likely to be of little weight in the calculation of the investor. In any case, the personal income tax on gains is levied after or below the market and has its primary effect on the disposable income of the investor, and relatively little effect on the capital market from which the funds for capital formation are derived.
Taxpayer compliance has to be simplified. The actual computation of the cumulative tax and tax payable requires only six additional entries on the return, three of which are items simply copied from a preceding return. As an introductory measure, cumulative assessment could be limited to those subject to rates above the initial bracket.
The tax gap refers to the difference between taxes receivable and taxes collected, as is in the calculation of tax-GDP ratio. Generally speaking, the tax gap is the gap between the amount that should be levied and the amount actually levied. The account of tax gap seems to be the same as the amount of tax evasion, but there is a difference, the two cannot be replaced with each other. The actual tax revenue includes the tax overdue payment and fine, so the calculated tax gap is smaller than the required gap. If the taxation authority does not levy taxes, the fault of the reduction in tax revenues should be borne by the taxation authorities, which means that the taxpayer has not violated the law.
From the above analysis we can understand that tax gap cannot explain tax evasion and tax non-compliance. An important way to study tax gap is to examine the size of the tax gap in a country by analysing the size of the underground economy and its influencing factors. The size of the underground economy is directly related to the institutional infrastructure. The institutional infrastructure of a country mainly includes the intensity of government regulation, the establishment and implementation of laws, the degree of judicial independence, the size of effective tax rates, the effective provision of public goods or services, and the effective protection of property rights. It is generally believed that the higher the level of government regulation, the greater the size of its underground economy and the greater the tax gap. And vice versa, when government over-regulation occurs, an alternative relationship exists between the size of the underground economy and the size of the official economy.
Tax custom is different from tax avoidance or tax evasion. It does not measure the taxation behaviour of individual or individuals, but the tax attitude of individual or individuals. The tax custom can also be considered as the moral responsibility of the individual. Making a specific contribution to society by paying taxes on the government must fulfil this responsibility. It embodies the ethical code of conduct for individual or individuals in taxation, although it does not require the form of law. The decline or deterioration of taxation practices will reduce the moral costs of taxpayers engaging in illegal operations or underground economic activities.
A sound tax system must have the following five important characteristics:
- POLITICAL PARTICIPATION: The wide participation of taxpayers in the political decision-making process is an important guarantee for establishing social taxation and good customs. When taxpayers lack effective access to decision-making, they will be concerned about tax revenue collection and the lack of efficiency in the provision of public goods or services, leading to reduction in tax compliance. As a result, the scale of tax evasion expands and tax gap increases. This situation further weakens the ability of the government to provide public goods or services, and thus trap the construction process in a vicious cycle.
- RESPONSIBILITY AND TRANSPARENCY: Government should legitimately use tax revenues, and procedures for providing public goods or services should be transparent to taxpayers.
- PERCEIVABLE FAIRNESS: In a reasonable and effective tax system, taxpayers can perceive themselves as being treated equally and justly. With regard to tax incentives or tax exemptions, if taxpayers perceive that they are being treated unfairly, their tax willingness will inevitably decline.
- EFFECTIVENESS: Government should have the ability to transform gradually increasing tax revenues into higher levels of public goods or services and enhance political stability.
- SHARING A PROSPEROUS POLITICAL COMMITMENT: The national taxation system should be closely linked with the national goal of promoting economic growth. Promoting economic growth is one of the strategic goals that government promises to taxpayers.
Under the premise of economic development level, the ability of raising tax revenue is mainly determined by the tax system design and the efficiency of its collection and management. From the perspective of taxation practices, the design of taxation system is affected and restricted by the efficiency of tax collection and management. Therefore, it is true that the relative size of tax revenue collection and tax gap is closely related to the tax collection and management efficiency of the tax administration agencies.
A reasonable explanation for the introduction of value-added tax is to increase taxpayer's compliance with tax payment through mutual supervision mechanism between taxpayers without increasing the cost imposed by the tax administration authorities. This consideration for the factors of taxation determines that only adoption of such tax system is mainly based on turnover tax. From the perspective of taxation, due to restrictions on the level of taxation, tax revenues can only be raised through indirect taxes that focus on taxes such as value-added tax and consumption tax, while direct taxes represented by income taxes and property taxes are included in total tax revenue. The proportion is relatively low. Contrary to the practice of taxation in developed countries, personal income tax still plays a very limited role in developing countries today, both in terms of income mobilisation and adjustment of income disparities. In 2000, the income tax of developed countries was 53.8 per cent of total income, compared with 28.3 per cent in developing countries. The same is true about the property tax situation. Due to the lack of necessary information and assessment mechanisms for the assessment of property values, property taxes cannot be successfully implemented in many developing countries; even if developing countries with property taxes exist, their income collection is still insufficient. From the above, we can see that compared with indirect taxes, developing countries like Bangladesh still have a large tax gap in terms of direct taxes.
Dr Muhammad Abdul Mazid is former Chairman, NBR. [email protected]
