Dec 5, 2011

Flat Tax System for Nepal?

-Surath Giri

About a month ago, Ministry of Finance under the landmark direction by the National Information Commission (NIC) exposed the massive VAT evade scams by the private sector of Nepal. The incident sent out ripples all over the private business community. As in the past, the incident was treated as a vindication that private sector is overwhelmingly fraud and cannot be trusted. Many accusations were hurled at the private sector which compelled major  business houses involved in the scam to rush in to save their ass*s. Amid all the hue and cry, a small fact was overlooked. Almost every business house in Nepal is evading taxes. Casinos, Super Markets, Large Scale Industries, Retailers and almost every significant business that comes within the realm of formal economy of Nepal have been found time and again to evade taxes. So, an interesting question to ask would be "Why does everyone try to evade taxes in Nepal?" 

The most obvious answer you would get if you ask a citizen in Nepal is : "The private sector is corrupt, unpatriotic and too profit-focused." Well, let's put on our thinking cap and venture beyond the usual leftist rhetoric. If they had a choice, I am sure very few Nepalese citizens would willingly pay taxes to fill in the treasury of our corrupt politicians and encourage them to ruin the country even more. Could our overly bureaucratic and unfair progressive taxation system have anything to do with the tax evasion trends?

Doing Business Report states "On average, firms make 34 tax payments a year, spend 326 hours a year filing, preparing and paying taxes and pay total taxes amounting to 17.2% of profit in Nepal" which when compared to other South Asian Countries is a much better situation. But again, with all the numerous reasons for an individual or business not to pay taxes, simplifying the taxation system could surely improve the scenario.  Besides simplifying the procedures, adopting a more fair taxation system (one that doesn't penalize business or individuals for being more productive or working harder) could be beneficial to us.

Many people around the world believe adopting a flat tax system would help mitigate such problems because flat tax system while simplifying the procedures and making it easy for people to understand and pay taxes also makes taxation fair and equal for everyone.  So what is flat tax system?

A flat tax is a fiscal system with only one tax rate for all levels of income (whatever your level of income you just pay a certain percentage of your income as tax and that's all), in which all income is taxed once and only once. Countries around the world, such as Hong Kong, the Channel Islands, Estonia, Lithuania, Latvia, Russia, Serbia, Ukraine and Slovakia have seen remarkable results after adopting flat tax system. Tax evasion has decreased whereas the collection of tax revenues has increased over the longer period of time. Similarly, the total number of hours spent on administering the taxes (which is a very non-productive usage of time) has decreased significantly. Additionally, the low rate of taxes and the equal taxation for everyone has prompted many multinationals to seek solace in countries with flat tax system.





And contrary to what critics of flat tax predicted, countries adopting flat taxes have seen increase in the share of taxes paid by the rich. How? First, taxpayers in the highest brackets shifted money from consumption or tax-sheltered investments into more productive, taxable investments. Second, taxpayers became more honest as evasion became less rewarding. Third, some taxpayers, rewarded by higher after-tax returns, worked harder. (Source: http://bit.ly/vq5aCl )

Hong Kong is one of the famous success stories of flat tax system. It maintains a dual taxation system where taxpayers can choose between a progressive taxation system that ranges fro 2 percent to 20 percent or a flat tax of 16 percent. However, flat taxation has been the most popular choice among the tax payers so far. Notably, the flat tax has generated a high enough level of government revenue such that, between 1950 and 1981, fiscal surpluses have been recorded in no less than 27 years. (Source: http://bit.ly/vq5aCl )

Similarly, Estonia, an ex-communist country has also been successfully implementing the flat tax system with remarkable results which has inspired Russia not only to adopt a similar system but also to compete with the flat taxers with the lowest rates of taxes in Eastern Europe.

Nepal has a flat tax rate of 25 percent for corporations whereas individuals are subject to a progressive taxation system. Despite this, one of the principle of flat taxation: "tax an income only once" is yet to followed in Nepalese scenario.

Note: A paper on flat tax entitled "Flat Tax-The British Case" by Romanian Economist Andrei Grecu can be found at: http://bit.ly/vq5aCl . The paper explains the concept in more details.

Do you think a complete flat tax system would help Nepal minimize its tax evasion woes? Would such system be suitable for Nepal? Why ? Why not? Is the current rate of taxation of 25% too high or just enough? 
Please share your views!