Susmi Sapkota
Introduction
Classical liberals believe in minimal taxation and that taxes should only be used to fund essential government functions. At the beginning of this article, let’s talk about Lawrence W. Reed’s fourth principle of the seven principles of sound public policy. Lawrence wrote: If you encourage something, you get more of it; if you discourage something, you get less of it. Explaining this point, Lawrence writes: You and I as human beings are creatures of incentives and disincentives. We respond to incentives and disincentives. Our behaviour is affected by them, sometimes very powerfully. Policymakers who forget this will do dumb things like jack up taxes on some activity and expect that people will do just as much of it as before, as if taxpayers are sheep lining up to be sheared.
Remember when George Bush (the first one) reneged under pressure on his 1988 “No New Taxes!” pledge? We got big tax hikes in the summer of 1990. Among other things, Congress dramatically boosted taxes on boats, aircraft and jewellery in that package. Lawmakers thought that since rich people buy such things, we should “let ‘em have it” with higher taxes. They expected $31 million in new revenue in the first year from the new taxes on those three things. We now know that the higher levies brought in just $16 million. We shelled out $24 million in additional unemployment benefits because of the people thrown out of work in those industries by the higher taxes. Only in Washington, D.C., where too often lawmakers forget the importance of incentives, can you aim for 31, get only 16, spend 24 to get it and think that somehow, you’ve done some good.
History of taxation in Nepal
Every government requires tax revenue to fund its administration and development activities. Though the taxation system has prevailed since the ancient period in Nepal, the modern tax system has gained momentum with the establishment of Democracy. Agricultural land being considered the dominant national resource, land revenue has historically remained the major portion of state income, along with tariffs on foreign trade. However, during the 1960s, additional taxes such as sales tax, import-export tax, and business tax were introduced, thereby expanding the government’s revenue sources.[1]
One of Nepal’s earliest and most well-defined tax regulations is evident on the stone pillar installed by Emperor Ashoka of the Mauryan Empire in Lumbini, marking the birthplace of Siddhartha Gautam (Buddha). We know the exact location of the birth of the Buddha simply because Ashoka provided local people with a tax incentive and wrote it in stone.[2]
Antiquity of Tax
At approximately 450 BC, the Licchavi rulers migrated from the northern part of India and ruled Kathmandu Valley till 750 BC. During the period, taxes were imposed in three forms i.e. Bhaga (tax on agriculture), Bhoga (tax on livestock), and Kara (tax on trade). Collectively, these three taxes were known as “Trikar.” Depending on the soil type and yield of the land, such taxes were levied at the rate of 5% -50% at that time.[3] Nevertheless, livestock was the second largest source of revenue.[4] The government regulated trade and collected taxes to maintain control over economic activities. However, the fundamental principle of taxation during that era aimed to impose taxes without excessively burdening the taxpayers.
Later, in the medieval economy, the primary revenue sources of the government were three types of taxes, imposed on people, i.e. cash, property, and services. Cash taxes were levied on properties like lands, houses, and forts (Kawath). This revenue supported the government in administering security, upholding law and order, and executing public infrastructure projects. Services and land taxes constituted a portion of excise taxes.
The court collected customs duties under the name seva ku, which funded the royal family’s religious ceremonies, periods of fasting, weddings, and the king’s visits. The tax system, in the medieval period, demonstrated the significance given to maintaining and advancing religious institutions. The tax levied for the construction and upkeep of monasteries and temples, Jinsi Kar, ensured the preservation of these revered sites and provided backing for the religious practices conducted therein.[5]
Following the unification of Nepal in the mid-eighteenth century, the Shah regime imposed a variety of new taxes. These extended beyond common economic levies on activities such as land, forestry, mining, and markets, encompassing payments for funding national festivals and royal ceremonies. From 1846 to 1951, Nepal was ruled by the Ranas, who mainly derived government revenue from taxes on land, customs duties, and excise taxes. It has been noted that tax collection during the Shah and Rana administrations was characterized by arbitrariness and discretion, illustrating the predatory nature of the overall system.[6]
However, it is evident that the Rana regime intentionally kept land taxes low in specific regions to encourage settlement in less populated areas of the country. It is noted that due to inefficiencies in the Rana administration, the land tax rates were not regularly adjusted to keep up with inflation. Despite the relatively modest formal burden of land taxes during this period, local populations still faced heavier demands from local landlords (jimidar). These landlords received inadequate state rewards, typically around 4-5% of the revenue collected, which, given the low tax rates, amounted to relatively lower compensation.[7]
Moreover, the government imposed substantial export duties on Nepali traders and minimal import duties on Indian traders on the western frontier of Nepal. This strategy aimed to encourage traders to settle in and stimulate trade in the less developed and thinly populated regions in the West. Additionally, all types of food trade were exempt from taxes in western Nepal.[8]
Income Tax and VAT
Even though different forms of tax system have prevailed in Nepal since the pre-historic era, the concept of introducing income tax emerged with the establishment of a multi-party democratic system in the early 1950s.[9] And yet, it could not be implemented till 1958 due to political instability. This tax, however, was imposed by the first elected government in 1959 to increase the revenue that would finance development activities and help achieve social justice. It was levied on business income and salaries, as an experimental basis, which later extended to all other income sources under Income Tax Act 1962.[10] When the Income Tax Act 1974 was passed into law, sources of income were classified into five categories: a) agriculture, b) industry trade, profession or occupation, c) remuneration, d) house and compound rent, and e) other sources. However, agricultural income remained exempt from income tax for the most part, with occasional exceptions in certain years through the enactment of finance acts.[11]
To improve revenue mobilization for national economic development and to update and unify laws concerning income tax, the Parliament of Nepal passed the Income Tax Act of 2002. This legislation replaced the Income Tax Act of 1974, which had undergone eight amendments and had been effective for 28 years. The concept of value-added tax (VAT) was introduced in Nepal in the early 1990s. The Government of Nepal expressed its intent to introduce VAT during the Eighth Plan, following which the finance minister announced plans to implement a two-tier sales tax system to lay the groundwork for VAT implementation starting from the fiscal year 1992/93.[12]
In 1995, the Parliament of Nepal passed the “Value Added Tax Act – 1995 (2052)”. The VAT regulations were subsequently drafted in 1996, and the Act was officially enacted in 1997. However, its implementation faced delays due to political instability and strong opposition from the business community. Eventually, a single VAT rate of 10 percent was fully implemented from 16th November 1997, replacing existing taxes like sales tax, hotel tax, contract tax, and entertainment tax. The government of Nepal later raised the VAT rate from 10 to 13 percent, effective from 15th February 2004.[13]
A New Proposal
The tax system in Nepal relies heavily on indirect taxes, which account for more than sixty percent of total revenue. Direct taxes, including income tax and fees from house and land registration, make up the rest. Indirect taxes primarily consist of customs duties, VAT, and excise duties. Similarly, the Nepali taxation system is considered regressive because of its heavy dependence on indirect taxes, which are less responsive to changes in the economy. This reliance on indirect taxes poses challenges to both short-term economic stability and long-term development due to their low elasticity, potentially leading to reduced revenue over time.[14]
The lack of a progressive tax system contributes to income and wealth inequality. Therefore, progressive direct taxes such as income tax and property tax are essential measures to address this disparity in income and wealth distribution. Implementing a thoughtful wealth tax specifically targeting unproductive accumulation of wealth, while exempting productive investments from taxation, would also be beneficial in reducing inequality.[15]
The total revenue/GDP ratio (R/Y) or tax effort ratio in Nepal is currently estimated to be 14.8 percent of GDP, which is perhaps the lowest in the world. The tax effort ratio went up marginally from 11 percent to 14.8 percent of GDP over a period of years between 2001/02 and 2008/09. During the period 2001/02 to 2008/09, the tax revenue to GDP ratio increased steadily from 8.6 percent to 12.0 percent, while the share of non-tax revenue in GDP rose marginally from 2.4 percent to 2.8 percent of GDP (calculations based on data from Economic Survey 2008/09).
The total revenue elasticity is found to be 0.64 which is less than one for the period 1963/64-2001/02 indicating poor responsiveness concerning GDP. The government’s emphasis on discretionary measures rather than expanding the tax base has resulted in low tax elasticity for total revenue, hindering efforts to support growing development activities effectively.[16]
Conclusion
Citizens are obligated to pay taxes regularly, and the Government must utilize these funds effectively and efficiently. Given that government expenditure exceeds government revenue, achieving the required revenue amount may involve higher tax rates. Nonetheless, a narrow tax base increases the risk of tax evasion. Thus, broadening the tax base with lower rates is seen as more effective. Though, enhancing revenue is crucial for strengthening overall domestic resource mobilization, merely adjusting rates upwards or introducing new taxes may not always yield the desired revenue increase.[17] While tax exemptions may reduce overall tax collection, they play a vital role in incentivizing private investments and encouraging workers to achieve higher performance levels.[18]
[1] https://www.nrsnepal.com/taxation-system-nepal
[2] https://ecs.com.np/heritage-tale/taxation
[3] https://nepjol.info/index.php/pragyaratna/article/view/64535/48925
[4] https://ecs.com.np/heritage-tale/taxation
[5] https://itihasaa.com/nepali-civilization/medieval-malla-economy/
[6] http://securelivelihoods.org/wp-content/uploads/Taxation-livelihoods-governance-evidence-from-Nepal.pdf
[7] http://securelivelihoods.org/wp-content/uploads/Taxation-livelihoods-governance-evidence-from-Nepal.pdf
[8] https://ecs.com.np/heritage-tale/taxation
[9] https://nepjol.info/index.php/pragyaratna/article/view/64535/48925
[10] https://www.nrb.org.np/contents/uploads/2021/09/vol8_art2.pdf
[11] https://nepjol.info/index.php/pragyaratna/article/view/64535/48925
[12] https://www.researchgate.net/publication/348600646_Nepalese_Tax_Structure_An_Analytical_Perspective
[13] https://www.researchgate.net/publication/348600646_Nepalese_Tax_Structure_An_Analytical_Perspective
[14] https://thehimalayantimes.com/opinion/tax-system-in-nepal-valid-reforms-essential
[15] https://necs.org.np/wp-content/uploads/2021/04/6.pdf
[16] https://thehimalayantimes.com/opinion/tax-system-in-nepal-valid-reforms-essential
[17] https://necs.org.np/wp-content/uploads/2021/04/6.pdf