Taxes are sums of money imposed by the government in the form of charges or fees that are mandatorily paid by individuals or businesses, which help fund public expenditure and services. Among many sources of revenue that the government generates as an income to run the day-to-day economy, one of the major sources is taxes. 

Nepal’s annual budget of FY 2081/82 B.S. plans to generate more than two-thirds of the total estimated budget (67.7%) equivalent to NPR 12 Kharba 60 Arba 30 Crores through taxes only. Thus, taxes play a vital role as the main income stream for Nepal's government.

Tax-to-GDP Ratio 

The tax-to-GDP ratio represents a nation's tax revenue relative to the size of its economy. As per ADB, “Tax-to-GDP ratio is total tax revenue as a percentage of GDP, which indicates the share of a country's output collected by the government through taxes.” As taxes constitute a major proportion of public spending for countries, this ratio reflects the government's capacity to fund public services, and infrastructure, and fulfil its obligations. 

Generally, a higher tax revenue (% of GDP) indicates a country’s watertight taxation policies, with prioritization on the improvement of educational, health, and infrastructure sectors that are essential for prosperity. Conversely, lower tax revenues (% of GDP) can mean that the country doesn’t have proper taxation laws and needs efficient policies for increased tax revenue.

In addition, a higher tax revenue (% of GDP) generally suggests a heavier tax burden on individuals and businesses but also indicates that a country has sufficient revenue to fund building and improving public infrastructures. On the contrary, lower tax revenue indicates that the country has fewer funds for infrastructure and development and the ability to spend on improving education, health, and other essential sectors. 

For instance, Scandinavian countries like Denmark had the highest Tax-to-GDP ratio in 2021 with 47.18%, alongside Sweden at 33.50%. Whereas Afghanistan had a tax-to-GDP ratio of a mere 9.9% in 2017 and Sudan had an even lower at 7.4% in 2016.

Tax-to-GDP ratio of Nepal

As per the World Bank, Nepal's tax-to-GDP ratio peaked at 23.01% in 2021, the highest in South Asia. Despite maintaining the highest tax-GDP ratio in the region, it fell from 23.01% in 2021 to 20.65% in 2022 as illustrated in Figure 1.1.

Figure 1.1. Tax in Percent of GDP from 2000- 2022 in South Asia

Source: The World Bank

As illustrated in Figure 1.1, in the same year (2021), India’s tax revenue (% of GDP) stood at 18.10%, Bangladesh at 7.64%, Sri Lanka at 7.34%, Pakistan at 10.34%, the Maldives at 18.92%, and Bhutan at 10.7%. It is worth mentioning that, in 2021, when South Asia’s average tax revenue (% of GDP) was at 15.86%, Nepal’s tax revenue (% of GDP) was at 23.01%. Subsequently, Nepal’s tax-to-GDP ratio in 2022 decreased to 20.65%. 

Likewise, the average tax-to-GDP ratio for the 38 Organization for Economic Cooperation and Development (OECD) countries, which are among the largest economies in the world, was 34.1% as of 2023. 

As of present, based on governmental data, pursuant to Figure 1.2 (which shows a greater discrepancy compared to the data from the World Bank) Nepal’s recent decline in total tax (% of GDP) from a record 19.99% in FY 2020/2021 to a landslide decrease in FY 2022/2023 to 16.09%, raises some serious concerns and vividly shows that there are areas for improvement. Given that taxes are a major source of income for Nepal, this decline calls for stronger measures to prevent revenue leakages.

Figure 1.2: Total Tax as Percentage of the GDP from Fiscal Year 2012/13 to 2022/23

Source: Ministry of Finance (MoF)

The above chart in Figure 1.2 shows the total tax revenue as a percentage of GDP over the fiscal years from 2012/13 to 2022/23. The chart indicates an overall upward trend until 2019/20, with a noticeable peak around 2020/21. However, there is a significant drop in the percentage in 2022/23, reflecting potential economic challenges or changes in tax policies affecting revenue collection. This visualization helps to understand the fiscal dynamics and the effectiveness of tax revenue policies over the years.

Conclusion

The decrease in tax-to-GDP in Nepal comes with daunting questions on whether the economic policies, laws, and regulations losing their effectiveness in managing the taxation system, or if this decrease is a lingering effect of the 2019/20 pandemic. While there are no concrete answers for the decline, it can be concluded, without a shadow of a doubt that this decrement indicates areas needing improvement. 

Additionally, one pertinent concern that will always remain regardless of the increase or decrease in tax revenues is whether the collected taxes and revenue generated thereafter are even utilized based on the country’s economic needs or not. 

Therefore, while primarily focusing on eradicating revenue leakages and ensuring fiscal good governance, the government should equally put their resources into ensuring that the people’s taxes are utilized in a way that creates maximum happiness for the maximum number of people.