Published in The Financial Express on Friday, 8 August 2014.
CPD explains its position
Corporate tax structure and investment
Khondaker Golam Moazzem
Corporate tax came into particular focus this year in the course of discussions on the national budget for FY2014-15. A major conclusion of these discussions was that corporate taxes in Bangladesh were very high, misaligned with other taxes and the rates ought to be reduced. These discussions generated some heat when the Centre for Policy Dialogue (CPD) in its proposals for the national budget of FY2015 came up with a ‘different’ view in this context. A number of economic analysts and stakeholders responded by contesting the CPD, both privately and by using public platforms and media including the Financial Express. Some had argued that the CPD’s analysis as regards comparing corporate taxes of Bangladesh with other countries was ‘faulty’ as it was like comparing ‘apples’ and ‘oranges’; some felt that the CPD’s analysis was ‘wrong’ and this could lead to ‘wrong’ policy conclusions. While appreciating comments, concerns and suggestions made by experts, we would like to put on record the following:
It is apprehended that many among those with critical views have not gone through the full text of the relevant section of the CPD’s budget proposals available in the website (CPD 2014: A Set of Proposals for the National Budget FY2015; P.14). Indeed, a quick response from the CPD’s side on the concerned issues would have been helpful in clarifying a number of attendant concerns. At the same time, the issue is still relevant given its importance from the perspective of medium to long-term fiscal policy of the country.
This write-up highlights three key issues: a) whether the CPD’s analysis on corporate tax and conclusion drawn therein are ‘wrong’ which some analysts had argued, b) whether the CPD’s argument that ‘lowering of corporate tax rate had only a limited positive impact on investment’ was logically justified and c) what should be the desirable corporate tax structure in Bangladesh that could adequately address the concerns of generating higher revenue for public investment and promoting and stimulating private investment in the country?
CPD’S ANALYSIS: It will be pertinent to carefully recall the CPD’s remarks on the level of corporate tax in Bangladesh as against other countries. It was mentioned in the aforesaid CPD report that “the logic of lowering the corporate tax rate on the ground that it is very ‘high’ compared to other competing countries of Asia is not ‘correct’. The average corporate tax rate of Bangladesh is one of the lowest in South Asia which is close to the average corporate tax rate of South East Asian countries” (p.14). The CPD’s views were based on the analysis of publicly available global database prepared by the KPMG,a globally renowned professional service company.
According to the KPMG database (accessed on April, 2014) corporate tax in Bangladesh in 2014 was found to be 27.5 per cent; corporate tax rates of most of other South Asian countries were found to be higher than that of Bangladesh. The CPD had used the information as the basis for its analysis. As a matter of fact, the tax rate used by the KPMG as corporate tax rate for Bangladesh is applicable for listed companies. The KPMG did that with full information of different other corporate taxes of Bangladesh including tax rates for non-listed companies and other sectors which were higher than those of the listed companies. This was mentioned in the detailed footnote in KPMG database. Because of the nature of the CPD’s budget proposals (since it’s not a detailed analytical report) the long footnote was not quoted.
Commentators would know that globally representative and reputed databases follow appropriate methodologies for defining variables and measurement procedures. The KPMG’s work would have been easy had there been one ‘definitive’ corporate tax in Bangladesh.
According to the National Board of Revenue (NBR), income tax is of two types – tax rate for companies and tax rate for ‘other than companies’. The tax rate for non-listed companies (i.e. 37.5 per cent which has been reduced to 35.5 per cent in the budget for FY2015) has been ‘mistakenly’ considered by many as the benchmark ‘corporate tax’ for Bangladesh. In the absence of no announced ‘corporate tax’ rate (in some countries there is the tradition of an announced corporate tax), the KPMG perhaps relies on the tax rate for companies listed in the stock exchange as the benchmark corporate tax rate. This was perhaps because auditing and financial reporting of the listed companies were considered to represent corporate practice and governance.
A detailed analysis of taxes imposed on different types of companies would have given a ‘weighted’ average that would not be very high in case of Bangladesh. At present, a total of 181,642 companies are registered with the joint stock companies of which 71 per cent are private and public companies and 22 per cent are partnership firms. Besides, a large number of industrial establishments operate under individual proprietorship (73 per cent of total industrial establishments in FY2006). A large part of those companies could have been ‘incorporated’. But because these are not, as many avoid being incorporated which has been noted by some analysts), these companies tend to hide under personal income tax category (highest rate is 25 per cent; a new category has been introduced in FY2015 at 30 per cent) which is lower than taxes applicable for listed and non-listed companies. Among the non-listed companies, tax rates vary from zero per cent (those which enjoy tax holiday facility for a long period) to very low rates (for cottage and small industries with sales less than certain level) to tax on gross sales as final settlement (0.3 per cent for RMG sector which is way lower than other applicable tax rates) to as high as over 40 per cent for cigarettes, mobile telephone operators and banks and financial companies. Besides, a number of relaxations have been made both for listed and non-listed companies to encourage those to declare higher dividends and profits. Thus, a more thorough and detailed analysis was needed to arrive at the average picture as regards corporate taxation in Bangladesh. A general observation that can be made is that the average would not be so high, as the case is usually made out to be by taking corporate tax rates of few high tax-paying companies as the base. Indeed, the problem of comparing ‘apples’ and ‘oranges’ would be minimised if analysts follow globally accepted databases such as those prepared by the KPMG, the World Bank and the OECD.
Those who are uncomfortable with the analysis carried out on the basis of the KPMG database may like to follow other global databases such as those prepared by the World Bank and other international organisations. In fact, analysts will find that a similar conclusion can be drawn from the World Development Indicator (WDI) database. According to the WDI, corporate tax is defined as ‘total tax rate as percentage of total commercial profit’. A total of 187 countries were compared in this database in 2013 which included Bangladesh as well. Bangladesh’s corporate tax rate in 2013 was mentioned to be 35 per cent – which is applicable for non-listed companies. In terms of rate of tax, Bangladesh is ranked 126th among 187 countries (see the figure below). More importantly, its position is well below the average for the low income countries (62.5 per cent), low and middle income countries (42.5 per cent), middle income countries (40.3 per cent) and even those of high income countries (37 per cent). Bangladesh’s corporate tax rate was found to be one of the lowest in South Asia where India’s was the highest. Thus the CPD’s analysis using the database of the KPMG and the conclusion was in no way ‘incorrect’ or ‘mistaken’; indeed the analysis was logically consistent with other global data bases.
IMPACT OF REDUCTION OF CORPORATE TAX RATE ON PRIVATE INVESTMENT: The CPD in its budget proposal for FY2015 also made following comments concerning the corporate tax issue: “a) the argument that a lowering of the corporate tax rate will have positive impact on private investment is not ‘robust’. In the backdrop of overt dependence on debt-based financing for investment by the corporate sector, a reduction of corporate tax rate may not have adequate positive impact on investment; and b) if supportive measures such as a conducive business environment and supportive infrastructure are not put in place, an increasing investible surplus through lowering of corporate tax rate will likely have only a limited impact on investment” (p.14). As would be noted, the CPD’s comments were made in the particular context of Bangladesh where these factors were emerging as binding constraints to investment.
Empirically, the relationship between corporate tax rate and private investment is found to be mixed in the context of developing countries. Relevant analysis shows that nature and extent of impact of changes in the corporate tax rate on investment are different for developing countries (Mooij and Ederveen, 2003 and 2008). In fact, empirical works on developed countries had found a reverse relationship between corporate tax and private investment (Chen and Mintz, 2010). On the other hand, impact of reduction of marginal effective tax rate on ‘domestic’ private investment in developing countries was at best found to be ‘neutral’; impact of average effective tax rate on private investment was found to be negative (IMF, 2012). It is also important to note that given the limited openness of the capital account, the possibility of investing outside the country in response to high corporate tax was low in Bangladesh context.
In the absence of detailed analysis on impact of changes in corporate tax on private investment, the CPD argument is based on the current situation of domestic business environment from the perspective of demand and supply side (CPD, 2014). A number of perception surveys have highlighted the complexity of tax structure in Bangladesh. Some research have also shown that higher corporate taxes discourage and deter doing business in developing country (Bruhn, 2011).
The argument that the CPD has given as regards limited positive impact of reduction of corporate tax rate on domestic investment, in the backdrop of weak business environment, was logically consistent with findings of other researches (Fiestas and Sinha, 2011).
DESIRED STRUCTURE OF CORPORATE TAX: Tax policy is the major fiscal instrument of the government for facilitating various activities undertaken by public and private sectors. Revenue mobilised through imposition of taxes on producers, consumers and importers is used for meeting public expenditure including public investment and for providing incentives and support for private investment. Similarly, revenue forgone because of reduction of taxes and duties is justified on ground of achieving similar objectives. Corporate tax is one of the major domestic sources of revenue in Bangladesh. During FY2012, income tax collected through corporate taxes was over Tk.161.88 billion which was 56.5 per cent of total income tax. If the income tax on proprietorship was included in it, tax collection from companies would indeed be much higher. Thus a reduction of corporate tax needs to be justified following the ‘Laffer Curve’ argument according to which ‘economic effect’ of reduction of corporate taxes should outweigh ‘arithmetic effect’ which would ultimately ensure higher welfare. A recent article by Zahid Hussain (2014) has mentioned that reduction of corporate taxes for listed companies would further reduce government revenue which would imply that this measure will have only limited implications for investment (strong arithmetic effect). Such measures also have no clear-cut positive effect on non-listed companies. However, companies in high tax brackets would experience positive impact by way of higher investment and higher revenue (strong economic effect). To address multi-pronged challenges, the government needs to carefully craft its tax policy including those related to corporate taxes. Misalignments in the corporate taxes need to be properly addressed as suggested by a number of analysts. A major challenge for Bangladesh is that policies have been drawn from pre-conceived ideas without detailed analysis of the underlying factors. A revision of the corporate tax structure should be undertaken only based on a detailed analysis of the relevant issues and contexts.
Given the formidable challenges faced by the domestic business sector in view of the prevailing environment as well as fiscal compulsions faced by the government, one could argue that the position taken by the CPD on the issue of corporate tax was a justified one.
Dr Khondaker Golam Moazzem is Additional Research Director, Centre for Policy Dialogue (CPD).
moazzemcpd@gmail.com