Political Economy of Nepal's Tax Regime: Challenges and Opportunities

1. Political Economy of Nepal’s Tax RegimeMahesh BanskotaInstitute of Integrated Development Studies,Kathmandu Nepal 9 August 2010

2. Structure of Presentation • Political Situation in Nepal • State of Economy • Overview of Budget Conditions • Policy Environment and Policy mapping • Political Economy of Nepal’s tax Regime

3. Political Situation in Nepal • Long years of violence , monarchy abolished, CA elections, Fragile coalitions, Struggle for another Interim Government going on • Some parts of the country still under armed groups , • Development activities slowly restoring infrastructure damaged during conflict • Confidence restoration still a long way

4. State of Economy • Per capita GDP low • Lowest in S Asia and among the lowest in the world • Growth modest - 1.05% ( per capita )1996/97 – 2006/07 period • HDI improved, poverty decreased , but inequality went up • Remittances becoming important almost 20% of GDP ( from India and elsewhere ) but global slowdown reducing growth

6. Contributions to GDP Growth

9. Many Adverse Factors Affecting Economic Activities • Floods in the East, Poor Monsoon, Daily Power cuts ( sometimes for 16 hours /day), deteriorating labor relations, unrest in the Terai, • Investors worried about extortion, death threats, kidnappings • Private investments declined to lowest levels in recent past

10. Overview of Budget Conditions

12. Tax revenue • Increased post-1990 • Stagnated around 9% between 1994/95 and 2005/06: MAOIST CONFLICT • Started growing post-Maoist conflict • Non-tax revenue • No improvement since 1990 • Stagnating around 2% to 3%

15. CURRENT FISCAL SITUATION Source: Economic Survey 2008/09 MOF • 1988/89: 10%, nation on the cusp of democracy • 1990/91: Democracy in 1990 • Subsequent Economic Liberalization • Deficit start lowering

19. POLICY ENVIRONMENT AND POLICY MAPPING

20. Better understandings of policy making- at its different stages of its formulation, decision making and implementation- could help improve policy making and contribute to its effectiveness • Is it society centered with greater role of classes, interest groups, parties and voters or is it State-centered with greater role of technocrats, bureaucrats and other state interest groups or is it more pluralist and open for any organization to participate?

21. Different Actors • State and non state, • formal and informal, - • legislators, political parties, • executive, • judiciary, • business, unions, • media and civil society

22. The nature of the political, economic and social environment? The political context - participation, the playing field for different actors, the policy space, the constraints, compromises , political leaders The economic environment - liberal economic policies , difficult economic decisions , conditions of donors The social environment - social interactions , who is benefiting and who is suffering? Policy responses - Reaction of the bureaucracy, the public can be muted or ,vociferous and violent ,crises situations

23. Political Economy of Nepal’s Tax Regime • A limited fiscal landscape – large poor rural population, small formal sector, widespread illiteracy, open border with India and unregulated and undocumented border trade and movement, • Weak government – unstable government, no political commitment for development, politicized bureaucracy, and limited capacity to evaluate, monitor and enforce

24. Political Parties • multi party politics, unstable governments, 2010 budget approval has suffered, little focus on substantive issues • Maoist came to power in 2008, their budget also towed a similar line although the FM Speech was described as the “most analytical “ • Motivated by “individual projects” in constituencies • Technical support for Budget discussion in parliament non existent • Most active role played by few economists from the respective parties

25. Performance of Past Policies fate of most policies in Nepal ? It is not enough just to get the technical aspects of the plan correct – increasingly look at political issues especially after MultiParty different organizations were in the driving seat assumptions about the resources were misplaced multiple stakeholders who had different roles in formulation and implementation

26. Executive • Objective is to see that state apparatus continues to function • Demand for resources collected by line agencies • Links between planning and budget • Incremental approach, less contentious • Capacity limitations in budget formulation and implementation

27. Policy Change: Imposition of Tax on cooperatives In 1995, (?), government imposed a tax of 30% on cooperative incomes without differentiating the types of cooperatives. Taxing cooperatives only in urban locations Taxing cooperatives onli in five larger urban areas Reduction in the tax rate from 30% to 20% Making the tax applicable to only those cooperatives that paid dividend above a certain level Currently cooperatives in only five biggest urban centers are supposed to be paying taxes. According to the Associations of Cooperatives, all the cooperatives have been suggested not to pay any tax. The resistance against the tax is still going on

28. Non State Actors • Business groups – no direct or organized pre budget discussions, individual inputs solicited, focus on specific problems, taxes • Professional Associations – no direct or organized role, some eminent economist involved in pre budget discussions • Unions work through their parties mostly on post budget issues – taxes • The Media – role in post budget discussions has increased considerably

29. External Actors • Major role in budget process especially the development budget • Policy Influence through supply of resources but also conditions for aid • Diverse group, coordination • History may show major role in improvement of fiscal capacity, discipline, planning and management

30. Extent and nature of Influence • State Actors – Recurrent expenditure -once provided difficult to cut back , Some role in Revenue Mobilization ( commitment ) • Development Expenditure –Significant role of External Actors ( Donors ) in making resources available, while state actors can influence where and how it is used • Non State Actors – roles limited except when taxes seriously affects them

31. Political Factor, Earmarked Revenue and Budgetary Support • Revenue –Monsoon and Donors • Expenditure -Large deviations between budget estimates and actual spending • Strong systematic biases – overspending on salaries and under spending on everything else • Leakages and delays in allocated funds release and arrival at destination 9very important to find out ? )

32. Fiscal federalism and decentralization – key political factor • Major discussion ongoing in federalism- ethnic rather than administrative federalism • Historically decentralization efforts have faced uphill battle with the centre – bureaucracy with support from politicians

33. Fiscal Politics in Action • Tax on Cooperatives • Moaist Finance Minister cuts festival grant • Public outcry on Minister Cash Grant to Persons Marrying WIDOWS

34. TAX ON COOPERATIVES 1.District Level Cooperative Unions 134 2. Tertiary Level Cooperative Unions 5 3. National Cooperative Bank 1 4. National Cooperative Federation 1

35. two stakeholders(government) are eager to impose the tax, two (Federations) are just as eager to oppose it and the remaining three ( all government) are almost neutral or prefer to say that their overall influence with either those imposing the policy or convincing those who are opposing the policy is low.

36. Chart 3.5 Force Field Review for Tax on Cooperatives Forces in favor of PAY Forces in favor of NOT PAY T T A X O N C O O P E R A T I V E • .National cooperative federation (***) • .National Saving and Loan Cooperative Union (***) • .Political parties ( may do so through sister organization) (*) • .District association of cooperatives (***) • .Central cooperative Bank(*) • MoF commitment for Tax (***) • Commercial Banks paying taxes (***) • Public pressure from those who lost their savings to cooperatives (*) • MoAC position on Tax (*) • Financial Intermediaries • ( Business entity) independent of coops(**)

37. Chart 3.4Importance/Influence Mix – Tax on Cooperative

38. “Fiscal policy has remained prudent. • welcomes the government’s plan to reduce the domestically financed fiscal deficit for 2009/10 to 26 billion Nepalese rupees according to the authorities’ definition (equivalent to a net domestic financing of 1.6 percent of GDP). • Revenue collection has been impressive in the past few years, but expenditure should be oriented more toward investment, which requires enhancing implementation capacity. • Statement of the IMF Staff at the Conclusion of the 2010 Article IV Discussions with Nepal Press Release No. 10/74March 8, 2010

39. Summary • Incremental • Weak Internal Demand • Large deviations between budget and actual • Under estimating salaries and overestimating everything else • Large leakages • Tax Increases focus on limited urban consumers

45. Institutional Reform