IMAGE: ASHISH KOIRALA
Walk into a mid-sized garment factory on the outskirts of Biratnagar and you’ll hear a familiar grievance. “We don’t mind paying taxes,” says the operations manager, “but we never know when we’ve paid enough.” The factory employs 120 workers, exports to India and the Gulf and meets the standard 25% corporate tax rate. What it cannot anticipate are the monthly visits from inspectors, ambiguous circulars from the Inland Revenue Department and last-minute changes to VAT rebates. “Planning for expansion?” he scoffs. “We plan for audits.”
In theory Nepal’s tax regime is not so harsh. The top personal income tax rate is 39%, lower than India’s 42.7% but higher than Pakistan’s 35% or Sri Lanka’s 36%. Corporate profits are taxed at 25%, with banks and petroleum companies facing 30% and priority sectors such as hydropower eligible for rates in the low teens. These figures place Nepal squarely in the middle of South Asia, and not far from the global norm. Ireland is at 12.5%, Germany 30%. By international comparison, Nepal is no outlier.
And yet the system feels unusually heavy to taxpayers. The problem is not the rate. It is the experience. Ranked 175th out of 190 in the World Bank’s ease of paying taxes, the country demands 46 separate payments a year and devours 377 hours of a firm’s time. The effective rate—nearly 42% of profit—might not frighten off capital on its own, but the sheer complexity of compliance does.
Structurally, Nepal’s regime is typical of emerging markets: mildly progressive with exemptions and neither extractive nor especially generous. The income tax starts at 1% and rises to 39% for income above NPR 5m (about $38,000). Corporate rates sit around the regional average. Nothing dramatic.
But enforcement gnaws at business confidence. Compliance is labour-intensive. Budget cycles bring shifting rules. Local officers exercise wide discretion. Refunds, when they come, are delayed. For firms without accountants or lawyers, compliance becomes a guessing game.
That mismatch—moderate rates, high friction—creates a tax system that looks manageable but feels burdensome in practice.
Over the last decade Nepal has raised its tax-to-GDP ratio to some 20%, up from 7% in 2000. For a low-income economy, this is impressive: higher than Bangladesh or Pakistan and near India’s level. The gains have come through enforcement rather than simplification. Audits have multiplied and digital filings introduced, alongside expanded mandatory registration and fines.
But stronger enforcement without stronger institutions saps trust. Businesses complain that enforcement agencies are more robust than service centres. Small firms, lacking buffers, retreat into informality. Those in the formal economy feel unfairly targeted, whereas big informal actors (rural traders, politically connected firms) slip through the cracks.
The World Bank estimates nearly 80% of Nepalis still work outside the formal sector. That leaves a narrow slice of firms and employees carrying a disproportionate load. The more visible you are, the more you are taxed, not because you earn more but because you are easier to find.
Beyond perception stands another issue: the economy may already be overtaxed relative to its capacity. A 2019 study by Keshav Raj Panthee applied the Scully model, an economic framework that identifies the tax level which maximises growth, to Nepal’s data from 1993 to 2015. The finding: the growth-maximising tax burden for Nepal is around 12.3% of GDP.
In 2015 Nepal’s actual ratio was 14.7%, 2.4 percentage points higher. Since then it has climbed. In other words, Nepal’s fiscal authorities may already be leaning more heavily on taxpayers than the economy can productively sustain.
International comparisons bear this out. Pakistan’s optimal rate is around 21.5%. Tunisia’s is 14%. The United States sits at 22%. Nepal’s optimal level is strikingly low, reflecting its big informal sector, low productivity as well as narrow base. That makes its current burden appear all the heavier.
The consequences are corrosive. A high tax burden means firms invest less and retreat into informality, leaving an ever-narrower base to shoulder the load. Entrepreneurs divert capital into tax-favoured sectors rather than the most productive ones. Trust in the state weakens as enforcement feels arbitrary. And what looks like short-term revenue success could become fiscal fragility, with a narrow set of taxpayers carrying the budget while growth and investment falter.
Other countries have faced similar dilemmas. Georgia in the 2000s simplified its tax code, cut rates as well as automated compliance. Revenue rose and evasion fell and investor sentiment improved, too. Rwanda digitised early and made compliance service-oriented rather than punitive. Both raised more money with less friction.
Nepal has digitised filings but left discretion intact. Hydropower developers, promised decade-long tax holidays, tend to spend as long waiting for approvals. Refund delays and circular ambiguities are normal. Incentives exist in theory but are undermined in practice.
A tax system built on fragile institutions can become self-defeating: it relies on compulsion to raise compliance, but compulsion without trust only pushes more actors out of reach.
Nepal has achieved what reformers in other countries strive for: revenue ratios striking 20% of GDP. Yet its taxpayers are unconvinced. For fiscal policy to sustain growth, the state will need to shift from chasing revenue to cultivating legitimacy: simplifying rules and standardising interpretation.
The operations manager in Biratnagar has little quarrel with rates. His gripe is with uncertainty. Tax, like production, is tolerable when predictable. Without that, firms plan for audits, instead of expansion.
Revenue can be collected by force. But trust, the true foundation of a modern tax system, cannot. It has to be earned. ■
