The shortfall in revenue collection over the past few years has widened the budget deficit, making it increasingly difficult for the government to meet its necessary expenditures. According to the Financial Comptroller General Office (FCGO), government spending has outpaced revenue collection and other receipts. As of the end of November this year, the government has spent Rs. 510.77 billion, while total receipts amounted to Rs. 360.6 billion, resulting in a deficit of Rs. 150 billion.
Trust deficit
The government’s inability to clear dues owed to contractors and accelerate development works has been exacerbated by revenue shocks. The plummeting revenue has eroded the credibility of the budget and public trust in the government. The Federation of Contractors’ Association Nepal (FCAN) reports that the government still owes contractors nearly Rs. 40 billion.
The government projected to collect Rs. 1,471.62 billion in revenue in the current Fiscal Year 2024/25, but revenue collection up to the end of November stands at a mere Rs. 3,60.6 billion. The escalating budget deficit has caused significant government distress. The government now faces a critical dilemma: whether to implement austerity measures, cut back on piecemeal projects, and shut down unnecessary offices, as recommended by the Public Expenditure Review Commission.
Import based revenue and flaws
Revenue shortfalls have persisted since FY 2018/19. The prolonged economic downturn following the COVID-19 pandemic has led to significant revenue shortfalls each year.
Leveraging the benefits of the import surge in the early 2000s, the government has significantly increased the budget size, as imports tend to generate more revenue. Coupled with the surge in youth migration and remittances, the government has experienced a revenue gain. Remittances have fueled imports and consumption within the country.
Experts have warned that the government’s overreliance on imports for revenue generation is a risky strategy. The government has failed to diversify its revenue sources; customs revenue accounts for 44% of total revenue and 50% of total tax revenue. Customs duty alone contributes 20% of total tax revenue.
Prof. Dr. Achyut Wagle has expressed concern that the government has given up on finding solutions. He believes that the government has adopted a defeatist attitude, suggesting that they have exhausted all possible remedies and that the current state of the economy is the best it can be.
According to Wagle, the government has failed to take any significant steps to further leverage the economy. Policymakers seem overly optimistic about the country’s first-ever sovereign credit rating and strong external sector, among other factors.
Rameshwor Prasad Khanal, Chairperson of the High-Level Economic Reform Commission, has stated that Nepal’s revenue-to-GDP ratio is commendable, although political leadership within the Ministry of Finance has disrupted the system, causing a decline from a peak of 23% to the current 19%. While there has been a slight improvement in revenue in the previous fiscal year, it remains unsatisfactory.
Khanal’s commission has been tasked with recommending new revenue sources and structural economic reforms. However, without creating a conducive environment for investment in the real sector, it will be difficult to expand income tax and establish it as the dominant tax.
Currently, import-based taxes, such as customs duties, value-added tax (VAT), excise duties, and other fees, remain dominant. VAT is the major contributor to revenue, and consumption taxes continue to play a significant role in revenue mobilisation.
The consistent dominance of VAT in revenue mobilisation is largely due to remittance-fuelled imports, which have lubricated the Nepali economy. The increased consumption capacity of the population has led to exponential import growth over the years.
Moreover, while the recent contribution of income tax has grown closer to VAT, this is not due to substantial improvements in income tax collection but rather to a decline in VAT caused by reduced consumption. Despite the growth in remittances from outward youth migration, imports have not increased in recent years due to significant commodity price surges, job cuts, and economic uncertainty, which has compelled people to reduce their spending.
Correlation between trade and revenue
A contraction in international trade has led to a decline in revenue. Nepal’s import-based revenue system has a strong positive correlation with imports. The stereotypical thinking of policymakers regarding imports and revenue has limited their ability to think creatively.
Given the significant informal economy, the government is encouraged to implement a Business Development Programme to help informal businesses enter the tax bracket. According to the 16th Five-Year Plan, nearly 40% of enterprises were unregistered, and 42% did not maintain proper books until FY 2023/24.
Dr. Rup Khadka, a taxation expert, suggests that the government should accurately assess the informal sector’s contribution to the economy and revenue generation. He argues that if the exempted sector is not contributing to revenue, the government should focus on mobilising revenue from this sector. The principle of taxation dictates that taxes should be levied equitably, avoiding undue burden on any specific sector and fostering a conducive economic environment.
Controlling revenue leakages
Due to a lack of effective billing enforcement, VAT leakage is significant. Additionally, despite the surge in imports in 2022/23, there are concerns about widespread revenue leakage. Under-invoicing, fraudulent declarations at customs points, and weak billing enforcement in the market are believed to be contributing factors to revenue leakage, according to revenue administration officials. The country imported goods worth Rs. 1,611.73 billion and collected Rs. 1,010 billion in revenue. In the following year, revenue increased even as foreign trade declined.
The country’s total imports in FY 2023/24 amounted to Rs. 1,592.99 billion, and revenue collection reached Rs. 1,082 billion. Former Finance Secretary and Chairperson of the High-Level Economic Reform Commission, Khanal, noted that the rise in import commodity prices should have led to a corresponding increase in revenue. Citing FY 2023/24 as an example, Khanal suggested that improved control over leakage contributed to the increased revenue collection.
Furthermore, smuggling of goods through the open and porous border with India remains a significant challenge for the country. Strengthening border security and inspections is crucial to address this issue.
Motivating tax payers
The government has been honouring taxpayers on National Tax Day, celebrated annually on Mangsir 1, to recognise their contributions. While honouring taxpayers is one way to acknowledge their contributions, the prudent utilisation of taxpayers’ money is a true testament to their value.
Previously, the government initiated a programme to recognise Commercially Important Persons (CIPs) and grant them various privileges, such as separate CIP lounges at airports, as a token of appreciation for their contributions to revenue, employment, and overall economic progress.
Nepal currently has 6.29 million taxpayers, including 2.027 million enterprises/businesses and 4.267 million individuals with Permanent Account Numbers (PANs). As in previous years, the government honoured taxpayers on National Tax Day, Mangsir 1 (November 16).
Nepal Telecom was honoured for filing the highest income tax, and Shruti Traders was recognised for submitting the highest income tax among sole proprietorships. Bhatbhateni Supermarket and Departmental Store Pvt. Ltd. was felicitated for filing the highest income tax among goods-trading companies based on the income statement of FY 2022/23. Dabur Nepal was honoured for submitting the highest income tax among exporting firms. Raj Bahadur Shah, Managing Director of Jawalakhel Group of Industries, was recognised for paying the highest income tax among individuals.
