The history of taxation in Nepal dates back to antiquity. Nevertheless, the modern tax system gained its momentum with the establishment of democracy, and implementation of the first consolidated budget took place in 1951.

Until the late 1950s, the two major sources of revenues were land tax and tariff on foreign trade. After 1959, however, sales, and property taxes, as well as several other minor taxes, were introduced. An import-export tax and various business taxes, such as a sales tax, were the principal sources of revenue. The land tax, which accounted for a considerable portion of revenue prior to 1960, no longer provided an important source of revenue. Income tax on individual incomes accounted for less than 7 percent of revenues. Most of the other taxes were progressive in nature.

The total revenue/GDP ratio (R/Y) or tax effort ratio in Nepal is currently estimated to be 14.8 percent of GDP, which is perhaps the lowest in the world. The tax effort ratio went up marginally from 11 percent to 14.8 percent of GDP over a period of years between 2001/02 and 2008/09. During the period 2001/02 to 2008/09, the tax revenue to GDP ratio increased steadily from 8.6 percent to 12.0 percent, while the share of non-tax revenue in GDP has risen marginally from 2.4 percent to 2.8 percent of GDP. (calculations based on data from Economic Survey 2008/09)

Nepal’s tax structure is composed of three categories of revenues. These are (a) Direct taxes (b) Indirect taxes and (c) Non-taxes. The tax structure is heavily dominated by indirect taxes that still contribute more than sixty percent of the total revenue and the remaining is covered by direct and non-taxes. The major components of direct taxes comprised of income tax and house and land registration fees. The premium indirect taxes constitute custom duties, value added tax and excise duties.

The total revenue elasticity is found to be 0.64 (Rana, 2009) which is less than one for the period 1963/64-2001/02 indicating poor responsiveness with respect to GDP. The low tax elasticity for total revenue signifies that the government has concentrated more in introducing discretionary measures rather than broadening the tax base which is not conducive to supplement growing development activities. This also suggests that the Nepalese tax system is regressive in nature, which does not lead the overall economy towards short run stability as well as in the long run development. This can be mainly attributed to the reasons, given the existing tax structure, automatic growth in total revenue is insignificant and heavy reliance on indirect taxes like customs, sales and excises which have low elasticity will lead to revenue reduction. An efficient tax system is the promotion of strong and self sustaining tax structure that is obtained in the elastic tax system. Elasticity in tax system is that it is a crucial determinant to siphon-off automatically an increasing portion of national income to the public exchequer without additional effort.

The governments in the past and present mobilized revenues through a series of tax reforms during the Tenth plan and 3 Year Interim Development Plan. These reform comprised of: (a) Streamlining and rationalization of tax rates in conformity with provisions envisaged by WTO, SAFTA and BIMSTEC; (b) expanding the base through minimizing a number of tax shelters and introducing new tax imposts; (c) reforming tax laws and regulations; (d) and improving efficiency of tax administrations.

The tax system in Nepal is circumscribed by serious structural constraints

with tremendous administrative and procedural complexities envisaged in the existing Income Tax Act that it lacks simplicity and transparency. Tax payers are often unaware about the specific size of tax they are to comply with, because tax is determined arbitrarily between tax payers and the tax officials resulting in enormous corruption.

The major issues and problems of taxation in Nepal include: (a) marginally high tax rate (b) limited tax base (base eroded due to prevalence of a number of tax shelters e.g. no tax on income from agriculture, because this is a subsistence sector, relatively blanket exemptions concessions and deductions provided to industrial sector.) (c) leakages in tax collection (d) rigid and complex Income Tax Act 2000 (e) inefficient, indifferent and corrupt

tax administration and (f) no consolidated record of property of land and building with the Internal Revenue Department (g) adhocism and arbitration in tax settlement (h) low elasticity of taxation (i) limited potentialities of direct taxes (j) negative responsiveness of land tax with higher administrative costs.

As a result, it is imperative to vehemently concentrate on these issues as soon as possible to rectify the modality of tax structure and mobilize additional

resources on a greater quantum by establishing an effective, dynamic and highly power driven Autonomous Revenue Board under the chairmanship of Finance Minister.

Dr. Rana was formerly Senior Economist of Agricultural Projects Services Centre (APROSC)