Budget 2005-06: Is there any wildcard option?

DSE suggested that NBR should amend current corporate tax structure and accordingly recommended (i) increasing tax disparity between listed and non-listed companies to 15 percent from its current level of 7.5 percent;

(ii) reducing tax on banks and insurance companies to 40 percent from its current level of 45 percent; (iii) introducing differential tax schedule for small companies with market capitalization of 50-100 millions; (iv) providing 10 percent tax rebates to newly listed companies; (v) reducing tax on treasury bonds from its current level of 20 percent. Among other things, DSE also argued that new investment in capital markets should be regarded as "unquestionable" for a minimum of 3 years.

The rational behind DSE's recommendations lies on the fact that a flourishing capital market is one of the important components to evaluate the overall development and growth of an economy. Besides, capital market can broaden tax bases and generate more revenues for the treasury. Total market value of our capital market is approximately 4 percent of GDP; whereas it is more than 25 percent in our neighbouring countries. DSE also argues that our capital market lacks the demand for development-oriented and competitive investment mostly because of current corporate tax structure and schedule. Registered publicly traded companies in Bangladesh pay 30 percent corporate tax on net income less dividends. However, corporate tax rate is reduced to 20 percent if listed companies distribute more than 20 percent of net income as dividends. But if they distribute less than 10 percent of net income as dividends or fail to distribute dividends timely, their corporate tax rates turn out to be similar to non-listed companies (i.e., 37.5 percent). Capital gains from share transfers of listed companies, public limited companies, and government securities are currently tax-exempted. However, capital gains from transfers of stocks and shares of private limited companies are subject to 10 percent taxes (15 percent in previous budget). Individual investors (but not institutional and large investors) receiving dividends up to Tk. 25,000 from listed companies are also tax-exempted.

It is conceivable that a 7.5 percent tax disparity does not provide sufficient incentives to new businesses to be listed with our bourses. A comparatively high tax on banks and insurance companies eventually increase lending rates and decrease deposit rates. Higher taxes on fixed income securities induce (small) investors to invest in fixed bank deposits. In the short-run investors may be benefited from fixed deposits; however, in the long-run stocks and bonds theoretically provide higher returns as opposed to fixed deposits. Unfortunately our fixed income capital markets have not been developed and expanded because of hostile tax rates on bonds and other debt instruments. Credit Rating Information and Services Ltd. (CRISL) was incepted on February 24, 2003 to rate our securities. CRISL so far rated some of the banks and financial institutions. However, ratings for bonds and other debt instruments of listed companies seem to be publicly unavailable. More importantly, the credit rating methodologies of CRISL are flawed and not well-understood. Consequently we failed to develop well-diversified multi-sector open and close-end mutual funds, let alone exchange traded funds and derivative markets. Admittedly, a broader and well-diversified market generates more tax revenues to the treasury.

Government should consider implementing and increasing the security transactions taxes. It not only generates treasury revenues but also reduces speculative trading by informed traders (we have not forgotten 1996 market crash!).

The tax base is narrow in Bangladesh. Besides, most of the government revenues are generated through indirect taxes. NBR is looking for avenues that generate direct tax revenues for the treasury. As a part of this endeavor, NBR recommended imposing taxes on all sorts of deposit rates. Interests earned on bank deposits are subject to taxes in Bangladesh. But financial institutions such as leasing companies etc. that lend money against deposits are not paying taxes for interests that they accumulated over the years. NBR also proposed that government should form a special police force to realize taxes from tax defaulters; initiate a separate bench in the High court to settle tax litigation; appoint magistrates to bring defaulters into justice and realize taxes; impose taxes on private schools, colleges, and universities; withdraw tax-holiday for new business enterprises. In a separate recent investigation, professionals such as doctors, consultant, etc. were also asked to submit their bank statements to NBR.

More than 900 new industries have been established and 100,000 new employments (both white and blue collar) have been generated since the inception of tax-holiday in 2001. Abolishing tax-holiday will reduce the sizes of investment and wipe domestic industries out of competitive world market. Industries, both local and foreign, in our EPZs will be affected if tax-holiday is withdrawn. If NBR removes tax-holiday, a discontinued tax rates may be reinstated to provide at least some incentives for new industries. The service sectors (such as financial intermediation, real estate, renting and business activities, public administration, defense, education, health, social work, community, social, and personal services, transport, construction, wholesale and retail trade, hotels, restaurants, storage, media, communication, utilities, etc.) have already surpassed industrial and agricultural sectors in terms of their contributions to GDP. It is most likely that the service sectors will contribute a significant part of our treasury revenues in future.

Although not clear to all, however, IMF recently asked the government to increase the bank lending rate. The Bangladesh Bank (BB) also favoured IMF's prescriptions probably to control inflation caused by the double-digit growth rate of private sector credit. Accordingly BB asked the commercial banks to increase their lending rate to correct the mismatch between lending and deposit growth rate.

The double-digit lending rates in Bangladesh are much higher than our neighboring countries. However, BB argues that the deposit rates, T-bill rates are also higher in Bangladesh. BB introduced floating exchange rate on May 31, 2003. For a short-holding period, the currency with the higher interest rates appreciates in value as opposed to the theoretical prediction that it should depreciate, as predicted by interest rate parity theory. Have we achieved currency appreciation with high interest rates? Probably the answer is known to even a neophyte!

One does not need to be a student of economics to understand the effect of elevated lending rates. Higher interest rates will simply hamper the growth of investment in all major revenue-generating sectors. IMF's prescription seems to be a big blow for DSE, FBCCI, and other business organizations. DSE (and to some extent NBR) considers IMF's recent position as detrimental to the development of capital markets, industrialization, and major service sectors. The FBCCI and other business communities have argued that inflation, historically in Bangladesh, is not an outcome of erroneous monetary policy. Rather, supply shocks, productivity losses, currency devaluation, worldwide increases in oil prices, budget deficits, bureaucratic expenses, poor law and order situation at every stage of businesses (construction, production, transportation, marketing, retailing etc.) contribute significantly to business loss, price hike, and inflation.

In last year's budget, the finance minister raised the ceiling of tax-exempted income in order to reduce the tax burden so that individuals could combat inflation and the rising cost of living. Would the finance minister increase the interest rates this year to provide his citizens with a better cost of living (or to make IMF happy)? External funds and foreign aid have already changed their flight and Bangladesh should prepare to be self-reliant. The remnants of Indonesia's recovery and success during Asian financial crisis ignoring IMF's suggestion, or Argentina's worst economic failure following the so-called IMF prescriptions can be of an intrepid paradigm for Bangladesh.

We can foresee a major quandary for our honourable finance minister. Simultaneously, we are optimistic that finance minister will exercise his wildcard options (if any) given that the external fund flows will drastically decline in subsequent years and we are too young to be self-reliant.

Dr. M. Imtiaz Mazumder is a Senior Lecturer of Finance at Auckland University of Technology, New Zealand.