Implementing federalism is a cost-intensive proposition. As the projected federal budget for the next fiscal year shows, current revenues will cover only half (US $8 billion) of the estimated $16 billion budget. Early indication suggests the government plans to generate an additional $4 billion from foreign aid and domestic borrowing—leaving a quarter of the budget unfunded. That is a sizeable deficit. Finance Minister Yubaraj Khatiwada is already scrutinizing customs collection—instructing officials to follow reference price for import duties to clamp down on the collusion between businesses and officials. This has significantly increased daily collection at key custom points. He is also rolling out an online government payment system to minimize leakages. The new finance minister has assured businesses he would not increase tax rates to fund the deficit; instead he would widen the tax net.
Revenue collection can be increased to a certain degree—particularly by bringing more individuals and informal businesses within the existing tax bracket. But keeping up with increasing public and development expenses in the next few years—including extra-budgetary requests for province and local level infrastructures—would call for a multi-faceted approach.
There is tremendous scope for generating revenues for local governments via a property tax—a sort of an annual levy—based on market valuation. An alternative formula for taxation can be derived from market rates for housing rents. For instance, families that own concrete homes in urban areas can be charged an annual levy of 1/12th of what they would pay if they were renting an equivalent apartment in the local market. This needs to be built upon the current house rent tax that local governments collect. For this to work, an increase in tax will have to result in an increase in municipal services. Even now, in many cases, citizens contribute up to 70 percent of the funds for local development projects that directly benefit them: blacktopping of the alley road, constructing sewage plants, etc.
In any country, the biggest tax contributors are private firms. Naturally, growth of the private sector is central to spreading prosperity and increasing revenue base. Two of the big obstacles to private sector growth in Nepal are high cost of doing business and political uncertainty. While KP Sharma Oli’s overwhelming majority in the parliament hopefully addresses the political uncertainty part, reducing the cost of doing business would require targeted policy interventions.
For starters, the government can reduce the cost of borrowing for businesses through policy banks interventions in the form of a concessional lending and line of credit for select businesses that meet strict criteria. A revolving fund of about $400 million can be established over five years. This facility can be extended to businesses that have high export potential, and thus reduce trade deficit, or to entities that create a certain number of jobs.
For reference, current interest rate on business loans in the US is around 4 percent. Of course, this could foster crony capitalism. Yet if the governance of such policy banks is handed over to an independent party or a foreign equity investor (five percent return should be lucrative), this could work. A separate policy bank for SMEs could also be formed to similar effect. This can also make lending by commercial banks competitive.
PPP for infrastructure
Innovative use of a private-public-partnerships (PPPs) model can address funding gaps in public infrastructure development. This can allow the government to spread available resources to several projects. For instance the hybrid annuity-based model (HAM), a variation of PPP, only requires government to pay 40 percent during construction. The rest is paid annually over 15 years. In this period, the private party is also responsible for project operation and maintenance. In this region, the International Finance Corporation, a member of the World Bank Group, has worked with the government of India and state governments to structure such a model to construct sewage treatment plants along the Ganga Basin.
Done right, PPPs can foster private sector growth while allowing effective mobilization of private capital in public sector infrastructure development.
Parajuli is a Kathmandu-based journalist with an interest in public policy