Taxation in Nepal: A Critical Analysis of Composition and Contribution of Direct Tax and Indirect Tax to the Tax Revenue, with Extensions to Health Sector Financing and Natural Resource Taxation

Abstract

The main objective of this study is to examine the composition and contribution of direct tax and indirect tax to the tax revenue of Nepal, and to extend the analysis to the critical linkages between tax revenue, health sector financing, and natural resource taxation. The revenues of the government come from two sources as tax revenue and non-tax revenue. Among the different sources of revenue of Government of Nepal, tax is the most important source. Tax revenue includes direct tax revenue and indirect tax revenue. As tax has a high potential to yield revenue for the government, developing countries like Nepal are engaging in the study of composition and contribution of direct tax and indirect tax.
In this study, an attempt has been made to assess the composition and contribution of direct tax and indirect tax towards tax revenue of Nepal, employing both descriptive statistics and mathematical modeling. This study uses descriptive and analytical research design. This study is mainly based on secondary data collected from Economic Survey 2081/82 published by Ministry of Finance, Government of Nepal. The last 10 years of data (from B.S. 2071/72 to 2080/81) have been taken for the study. To assess the contribution of direct tax and indirect tax towards tax revenue, percentage analysis, trend decomposition, tax elasticity coefficients, Laffer curve analysis, and fiscal multiplier models have been employed. The study found that direct tax contributes around thirty percent and indirect tax contributes around seventy percent to tax revenue of Nepal.
Beyond the descriptive findings, this paper develops a mathematical framework connecting tax revenue composition to health sector allocation through a constrained optimization model, derives the Laffer curve for Nepal’s tax system, computes tax buoyancy and elasticity coefficients, and models natural resource taxation (hydropower royalties, forestry, mining) through a resource rent taxation framework. The study concluded that Nepal’s tax system remains heavily dependent on indirect tax and there is a narrow direct tax base. The study suggested broadening the direct tax base by strengthening income tax administration, improving taxpayer compliance, and expanding coverage through the formalization of economic activities, while earmarking a quantified fraction of tax revenue for health sector investment to break the cycle of low taxation–low health spending–low human capital.