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An increase in VAT dependency in the proposed budget is feared to fuel price hikes eroding further the consumption capacity of a large bracket of people in times of high inflation.

In the proposed budget, the government seeks to collect one third of its total annual revenue from VAT, raising the target to 33.8% from 32.8% from the outgoing financial year.

In so doing, the finance minister has axed most tax exemptions, expanded and restructured the VAT net to rake in more money to reduce budget deficit and fight inflation.

Income tax, the other major source of revenue, has been given a 32.5% target, from 30.7% in the outgoing year.

Experts have long been urging the revenue administration to focus on direct tax reducing dependency on indirect tax such as VAT.  

"Direct tax should receive more focus. Direct tax even helps reduce discrepancy between different social classes," said Dr Muhammad Abdul Mazid, former chairman of NBR, on the proposed tax measures.

"But we have not seen many initiatives to increase direct tax. The new initiatives that have been proposed such as bank surcharge, higher call rates etc. are all indirect taxes. VAT is an indirect tax. It has a negative impact on inflation. VAT will impact things such as raw materials, in turn increasing cost of business," he said.

Dependency on VAT is not new, however, as it is an economically efficient way of raising tax revenue.

VAT has always been retaining its position as the top revenue source for the government. The gap between the collection of VAT and income tax is always worth pointing out. It reached 9%, highest ever in the last one and a half decades.

Data of the last 14 years show collection of VAT exceeded the targets in 10 years and hovered over 30% of the total revenue. It reached the highest 35% in FY22.

The collection of income tax does not look promising. The collection surpassed the target only for six years, but only slightly. It failed to reach the target for eight years. Annual actual collection has never crossed 30%. The highest was 29.2% in FY23.   

Past growth data indicate that collection of VAT has always been easier with less fluctuations than that of income tax.

VAT, added to production in the supply chain, is globally known as regressive tax as it helps raise government revenues without taxing the wealthy and burdens lower-income people. This amounts to a tax injustice to the poor.

VAT in EU

As Bangladesh aspires to become a developed country by 2041, we analyse the VAT and social safety net of some developed economies in the European Union here that will make it clear whether we are on the right track or not.  

Though VAT is considered a regressive tax, according to Tax Foundation Europe, more than 170 countries worldwide – including all major European countries – levy a VAT on goods and services.

Some European Union countries have a higher amount of VAT than the ones in Bangladesh. VAT rates are generally between 15 and 27%, whereas, the highest is 15% in Bangladesh.

Hungary has the highest 27% VAT, Luxembourg levies the lowest at 17%, while the EU's average standard rate is 21.6%.

In 2022, VAT accounted for 55% of EU's total taxes on production and imports.

The tax-to-GDP ratio varied significantly between EU countries. In 2022, the highest shares of taxes and social contributions as a percentage of GDP were recorded in France (48.0%), Belgium (45.6%) and Austria (43.6%).

To minimise economic distortions, EU countries levy reduced rates and exempt certain goods and services from the VAT to promote equity as lower-income households tend to spend a larger share of their incomes on food and public transportation. Other reasons for reduced VAT rates include encouraging the consumption of "merit goods" such as books, promoting local tourism and clean power.

Social safety net in EU

Taking more VAT looks justified when the EU invests more to ensure a strong social safety net. Their allocations for health remain as a notable example.

An OECD document says in 2020, an unprecedented 10.9% of the GDP of the European Union was devoted to health care, with Germany and France dedicating the highest 12% of GDP in health and Luxembourg with the lowest 5.8%.

Large expenditure ensures their citizens good healthcare helping them to live healthy lives which contribute to increasing their productivity too.

Moreover, those countries offer billions of dollars in cash assistance to people when they face any disaster caused by either economic crisis or disease.    

In 2022 at the EU level, 88% of expenditure on social protection was in the form of cash benefits and social transfers in purchased market production. Payments of retirement or survivors' pensions, unemployment allowance, benefits connected with absence from work as a result of ill health, accident, maternity, payment of family, education or other allowances in respect of dependents are included in this category.

Social safety net in Bangladesh

How much does Bangladesh spend for health care? This is shocking. Less than one percent of its GDP, resulting in a weak public health care system for people who are forced to bear the burden of the unseen cost for seeking treatment.  

Bangladeshis have been paying over two-thirds of their treatment cost out of their own pockets, according to the sixth Bangladesh National Health Accounts published in January last year.

The share of out-of-pocket health expenditure in the country was 56% in 1997, the year the report was first published, which jumped to around 69% in 2020, according to a report prepared by the Health Economics Unit of the health ministry.

Under the Sustainable Development Goals (SDG) monitoring framework, out-of-pocket payments as a share of total household consumption exceeding 10% (lower threshold) or 25% (upper threshold) is considered catastrophic.

On average across the EU, around 15% of all spending on health care comes directly from patients through out-of-pocket (OOP) payments.

While releasing the report last year Maya Vandenent, chief of health of Unicef Bangladesh, said, "Due to increasing out-of-pocket health expenditure, people are facing catastrophic situations while seeking treatment. This should be given importance."

Out-of-pocket expenditure is the money paid directly by households, at the point of receiving health care. This occurs when services are neither provided free of cost through a government health facility, nor is the individual covered under any public or private insurance or social protection scheme.

In the proposed budget, the government has increased healthcare expenditure by 39% compared to the last revised budget for the fiscal year 2024. In the latest proposed budget for the fiscal year, Tk41,408 crore has been earmarked for health, which is 5.2% of the total budget. But it represents 0.7% of the GDP. In the last revised budget, Tk29,782 crore was allocated, which was 0.8% of the GDP, which is much lower than the minimum 5% threshold set up by WHO.

In his speech, the finance minister said ensuring universal health and nutrition is one of the basic principles of our government, adding, "We are working to implement this principle. Specially, we are working diligently to build a healthy, strong and lively population by providing affordable quality Health, Nutrition and Family Welfare (HNP) services to the public."

But poor allocation will make the finance minister's goal difficult to achieve.

From the next fiscal year, referral hospitals, where many people from various socio-economic backgrounds seek medical care, will face a significant increase in equipment import duty from 1% to 10%. 

This change may lead to higher medical expenses for the poor, lower class, lower-middle class, and middle class, experts said.

Experts say where health systems fail to provide adequate financial protection, people may suffer financial hardship from paying for health care, or they simply forgo health care altogether. As a result, lack of financial protection can reduce access to health care, undermine health status, deepen poverty and exacerbate health and socio‑economic inequalities, they say.  

Cash transfer capacity of the state to needy people is also weak. The proposed budget announced to add around 10 lakh new beneficiaries under the social safety net. This includes 3.34 lakh people with disability, two lakh elderly, and two lakh widows.

But there will be no increase in the allowance for any other beneficiary under the social security net. The government last increased allowances for the elderly and widows by Tk50-Tk100 before the FY24 national election. They currently receive Tk600 and Tk550 per month, respectively.

Since then, the prices of daily commodities have risen by around 10%, and the finance ministry projects 6.5% inflation for the upcoming financial year, but their allowances remain unchanged.

Food-aided schemes such as family cards and sales from trucks of essential food commodities at discounted rates cannot relieve the low-income people much, as their real inflationary pressure would amount to 20%, according to economist Prof Mustafizur Rahman.

Monthly average living cost of an individual is around Tk7,400. So, the financial assistance they get from the government is not enough for their survival.   

The EU examples show collection of good revenue from VAT strengthens the government's financial capacity to stand by the people. And the other way around, a huge expenditure for healthcare and building a strong social safety net contribute to healthy lives of people and increase their productivity and purchasing capacity which helps the government in collection of VAT.

Which one should come first? Should the government invest in human capital first to increase people's productivity and purchasing capacity or impose more VAT to collect more money to invest in human capital?

It is a chicken or the egg causality dilemma – "Which came first: The chicken or the egg?"