Forget about taxing corporate profits!
In Bangladesh, most people are subsistence farmers with no taxable income. Large private companies are the largest potential sources of tax revenue. However, Bangladesh does not do a good job of collecting income taxes from companies. Our tax rules (modeled on Western rules) require profitable companies to pay a certain percentage of their annual profits to the Treasury as tax. This system works in countries where government officials are less corrupt. In Bangladesh this system has failed because companies here (in complicity with corrupt government officials) can falsely declare a very low level of profits in order to pay a very low level of tax. It is time to admit that the Western model of corporate taxation is not working in Bangladesh, and to replace it with a system which works.
The problem with the current system is that companies can easily manipulate their accounts to declare whatever profit or loss they desire. The solution is obvious: tax companies on the basis of their sales receipts, not on the basis of their declared profits. Though it is easy to conceal profits, it is nearly impossible to conceal sales receipts. We should abolish taxes on corporate profits, and replace them with taxes on corporate sales receipts.
For all latest news, follow The Daily Star's Google News channel. Small businesses, such as small retail shops, usually receive their sales receipts in cash, and hold onto the cash until they need to spend or invest it. However, a large company may receive millions of Taka every day as sales receipts. The only realistic way to protect such large amounts of cash from theft is to deposit the money into company bank accounts as promptly as possible. Less cash lying around the office means that less cash can be stolen.
As all companies deposit sales receipts into their bank accounts, collecting sales taxes would be extremely easy. The government need only make rules requiring banks to deduct a fixed percentage of all sales receipts deposited by each corporate client. At the end of each month, the banks could deposit the collected funds to the Treasury on each company's behalf. In other words, banks could be made to collect sales taxes from their corporate clients. Corporate tax collection would then be accomplished without any direct interaction between government officials and the companies being taxed. Corrupt officials could no longer help companies evade taxes.
A numerical example may clarify this. Suppose that Company X has sales receipts of 1 billion Taka (about 14 million US$) every year, and that their profit is 100 million Taka (10% of sales). If they declared profit of 100 million Taka they would be liable to pay 40 million Taka as tax. However, they are only declaring 10 million Taka profit and paying 4 million Taka as tax. If the 40 percent tax on profits were replaced by a 4 percent sales tax collected by Company X's bankers, Company X would have 40 million Taka deducted from its deposited sales receipts.
Many would argue that sales taxes are unfair, as they are actually paid by consumers. There is some truth to this: if the 40 percent tax on profit is replaced with a 4 percent sales tax, many companies will increase their sales prices by 4 percent. However, companies which are already paying taxes on their true profits will not raise prices: the sales tax will replace the income tax which they are already paying. On the other hand, companies which are currently evading taxes on their profits will probably raise their prices to cover the sales tax.
It is important to realize that companies see all taxes (whether import duties, income tax, or sales tax) as costs of doing business. So in the end, all taxes paid by companies are passed on to consumers in the form of higher prices. This does not mean that companies should not be taxed.
The government's objective should be to tax companies in a fair manner. Large companies are big users of government services. They are the largest consumers of power, the biggest beneficiaries of roads, highways and bridges. And if necessary government services to the public could be fully funded, big companies would benefit greatly from the higher productivity of a healthier and better educated work force. From this perspective, sales taxes make perfect sense, as larger companies will have to pay more in sales taxes.
In the highly corrupt context of Bangladesh, the fairer tax is the one which is harder to evade. At present, tax evading companies have a big advantage over law-abiding competitors. Tax evaders retain more profit in good years, making them more likely to survive the bad years. If we continue the failed system of taxing profits, all the corporate taxpayers in Bangladesh may eventually be driven out of business by their tax-evading rivals.
Tax revenue in Bangladesh's tax revenue is mainly raised through tariffs and VAT levied on imports. In the 2005 fiscal year (July 04 to June 05), total receipts from taxes on imports were 151 billion Taka (about 50% of the total tax revenue). The total income tax collected during the same period was only 56 billion Taka. Why are import duties so much easier to collect than other taxes? The answer is surprisingly simple.
Imports are normally paid for via letters of credit ( "L/C" arrangements between the importer's bank in Bangladesh and the exporter's bank overseas). Import tariffs are difficult to evade because the importers' banks in Bangladesh have transparent records of each import transaction. The banks' L/C records show the exact value of each imported consignment, making it easy to assess the import duties.
As import tariffs are successfully assessed on the basis of banking records, we can confidently predict that taxes on sales receipts will also be successfully assessed on the basis of banking records. Banks have no incentive to help their clients evade taxes. Interest rates in Bangladesh are high, and banking is a profitable business; banks are motivated by profit and will not knowingly take the huge risk involved in helping their clients evade taxes.
The government has made a commitment to gradual reduction in tariffs on imports. Though this commitment was originally made in response to pressure from the World Bank (which has always argued in favor of trade liberalization), politicians have now realized that lowering import duties on commodities is the easiest way to control consumer price inflation, which has become a major political issue over the last year. As import tariffs are set to fall, it is imperative to find an alternative source of tax revenue which is just as easy to assess. Sales taxes are the only realistic option.