Former finance secretary and economist Rameshore Khanal argues that federalism is not the cause of current anomalies in local taxation and that federalism has not raised government expenditure. In the interview with Republica’s Mahabir Paudyal and Rudra Pangeni, he dwells on various aspects of taxation, fiscal federalism and fiscal governance. Excerpts:
With the recent anomalies of taxation in local governments, question has been raised about fiscal viability of federalism itself. What has local taxation to do with federal governance?
First, we need to be clear that local taxes are not the consequence of federalism. Adopting federal structure was a political decision and federalism is about political rights, autonomy of local governments and sub-national governments. Any government raises tax to finance its activities. The activities the government performs do not increase just because the system of governance is federal or unitary. The activities of the local governments are based essentially on guidelines outlined in the constitution. They have been granted powers related to education, health, sewerage system, local facilities and basic utilities for people. These are the basic activities the local governments carry out throughout the world. These activities would be carried out even if the country was in unitary structure. These functions of local governments have not changed just because the country has implemented federal system. Therefore the local taxation and federalism should not be connected and explained that way. Even if the country had not gone federal we would be raising these taxes anyway.
How so? Will you elaborate more on this?
Look even when the elected governments were not in place in local levels, people were paying land tax, tax on business operation and different kinds of registration and service fees. The taxes and service fees people are speaking against are not totally new. No local government has invented new taxes and new fees. If you look at the history of local level taxation in Nepal, there was a time when people had to pay tax for the ownership of radio set, bicycle and guns. There were different kinds of property taxes. In the past, people paid fees for crossing the bridges. During our times we used to pay small amount of fee for crossing the rivers through bridges or through ferries. The local governments today have rediscovered the same old taxes. What they have done differently is they have increased the amount of service fees, exorbitantly highly in some cases. This is why it became the subject of criticism but local taxation, like I said, is not new.
Having said this, whatever the local governments have done now is not entirely correct. Local governments should have worked with provincial and federal governments. Three tiers of governments should have collectively worked to develop the principles of taxation and different service fees and charges. They did not do so. This is where they made a mistake. Had those principles been properly developed, taxation and fee system would have been much more scientific. Federal government fell short in creating the constitutional bodies which would have sorted out these issues amicably. National Natural Resources and Fiscal Commission is yet to come into full shape. And we are yet to create Inter-governmental Council which would have looked into the disputes on common interests. These two bodies have not been put in place. And since there is absence of laws and guidelines, local governments in different places started to work in their own way. This is the reason for disputes and anomalies in taxation. I hope by next year they will have learned lesson and they won’t repeat the mistakes they are making now. I say this because many local governments have promised to correct these anomalies. Local governments of Birgunj and Biratnagar have come forward and assured the people that they will correct the anomalies. Because of all this uproar the federal government will also be compelled to constitute the required constitutional bodies to look into these matters.
You said developing principles of taxation would have made taxation issue simpler. How does it actually help?
Had the principles of local level public finance been developed, allocation of money raised would have been much efficient. Such principles were not developed. So there is no proper rule on what percentage of total revenue should be used to finance the recurrent expenditure, what percentage of revenue should finance capital expenditure and what sort of planning should be worked out. There are certain activities which local governments must finance through taxation and revenues. There are other activities where community participation could be more appropriate. A community would be asked to contribute certain percent, say 30 or 40, and the rest would be shared by the government, in other words, executing public private partnership model. After all, we have had this practice in Nepal for several years. Another modality would have been financing development activities and projects by loan. If the local government invested in busparks, amusement parks, market place and so on it would also raise revenues from these projects. The income you earn from these projects could be used to pay back the loan. So there should have been proper planning on what are the activities to be solely financed by the revenue, the activities to be implemented by public private partnership model or community participation and those to be financed by loan.
This time around they could not do it because rural municipalities and municipalities had to act on their own and they were not supported by the central government. They had to act in haste as well. Next year, they should review all these aspects. Local governments should also have come up with the formula of what percentage of total expenditure should be recurrent and what percent of it should be for development works and programs. If we had such formulas, whether the mayors bought expensive vehicles would not have been a big issue.
That may be so but why did local governments have to raise service fees so high? Some of the local governments are charging as much as Rs 1,000 simply for birth registration.
If they have done this in consultation with local people or through their consent, there should be no problem with it. If what the local governments are doing is accepted by the local people, we should not criticize it. But should high service fees have been imposed? They should not have been because vital registrations are the services the municipalities should be providing for free. The municipalities should review such activities. Imposing high fees on registration of birth, marriage and relation certification is totally irrational.
That’s only a part of the problem. Local governments have been found imposing taxes on sale of cattle as well.
Many people criticize that there is tax on buffalos and goats. If a person takes a cow, a buffalo or a goat to the marketplace and sells it and there is a tax on it, this is not new thing again. Such taxes existed even decades before. It has been in existence in the Tarai market place as long as I know. The amount of tax was very insignificant in those days because the economy was very small. Now the sale of a cow or a buffalo runs into as much as Rs 100,000. It should not be painful for a person selling a cow at this amount to pay Rs 100 tax to local governments. But like I said such tax should be imposed in consent of the farmers themselves. Local people will be happy to pay such taxes if they get better services. It is quite a herculean task for farmers to get their produce to the local market in Tarai because there are no reliable bridges and roads are not graveled, nor blacktopped. If the farmers get a better road which enables them to do business with urban centers, they would be happy to pay taxes.Taxes should be in proportion of the services provided to the people.
In your view why did taxation issue become so controversial?
No mayors and deputy mayors who contested the elections last year publicly spoke to people with the proposal of tax policy. They talked about development and infrastructures but nobody spoke about their taxation system. In developed countries, leaders contest the election by making public their taxation policy and expenditure proposal. If the people like the policy, they vote for their leaders and if they don’t they vote them out. In our case, mayor and deputy mayor candidates were basically guided by central party bosses and manifestoes were drafted here at the center. So the center always thought that the revenue is generated by the federal government and then given to the local governments. In the last one and half years, local governments and federal government must have learned lessons and hopefully they will correct these mistakes in the next budget.
Many argue that federalism has made the governance system expensive. Is that the case?
Federalism may have been very expensive in other countries. But based on my studies, I can say that federal structure is not more expensive than unitary structure. The expenses of the government increase because of three reasons. First, when the total areas of the place the government rules increase. Total area of Nepal has not increased. Second, if the population increases drastically. If our population increases to, say 50 million, the government expenditure will definitely increase. Third, when the government scales up its activities or adds more activities into its fold or when the government increases the basic public deliverables. Now the role of providing basic services to the people has been divided among three layers of governments. But the volume of activities remains the same. It has not increased substantially. For example the government has not said that the entire education or health is free. The government expense would have drastically increased if the government provided these services absolutely free of cost. In other words, what the government is doing now is not new. Thus to say that federalism has made governance more expensive or contributed to higher taxes would be illogical.
But there is a strong impression that it has. Many believe federalism is becoming costlier.
But this is far from reality. People are saying this without doing calculations. My calculation does not say so. If you look into it, total number of public offices has gone down. In the past there were around 4,000 local units. There were 3911 village chiefs and same number of deputy chiefs. There were nine ward chiefs in each VDC apart from a number of ward members. Many of them were paid by the state. Those who were not paid salaries were stealing from state coffer.
Let’s compare the expenses of the time when local governments were in full operation years back. At that time, chairman and vice chairman of the district development committee were given salary. VDC chair and vice chairs were given salary and also they were entitled to meeting allowances. Ward chairs and members would get only meeting allowances.
Now we have reduced the number of local governments to 753 from 3911. Number of offices has gone down. The number of municipalities in each district has come down. Practically, their efficiency should also improve. There are signs of improvements. I was reading about some local governments providing the best of services to the people in your newspaper recently.
Private sector business community has complained of double and multiple taxations by different layers of governments. How should the government address their concern?
Some of their concerns are legitimate. Some municipalities have revived the toll taxes on the movements of goods on the highways. Chances are high that a truck traversing from Birgunj to Kathmandu may have to pay toll taxes to several municipalities. It is an aberration. It is increasing cost of doing businesses. The additional costs in this way ultimately pass on the customers. Federal government should ask the local governments not to add taxes that increase the cost of products and services.Collecting integrated property tax is the best option for raising money to materialize the development dreams.
In the last seven months of its implementation, where do we stand fiscally on federal governance?
Based on available facts related to revenue potentials, expenditure needs of the government, overall macro-economic indicators, external sector, monetary sector, I must say that we are not in the risk zone. Again based on these facts, I can say that we will not be in the risk zone for the next couple of years. But if there is serious mismanagement, larger holes in external sectors, trade deficits and balance of payment, if monetary system goes into a problem, if overall financial stability also becomes problematic with non-performing loans, and if the government expenditure management gets poorer and poorer. If some or all of these things happen in the next two years or before, we might be moving downhill. This is why the government should be careful and realize that this is a very critical time. We are not in a risk zone now but we will definitely get there if we become even slightly careless. This is the time to be careful for the government.