personal income taxes and the planned introduction of the GST would alter these distributional impacts. With the reduction in PIT, direct taxes have become slightly more progressive; however, the inequalityreducing impact is slightly dampened than before. The GST as a broad-based tax likely leads to an increase in indirect taxes paid by households across the distribution, including those in the bottom 40 percent. At the same time, the GST is much less progressive than the existing sales tax. While the GST is povertyincreasing as a result, the poverty rate reverts to levels similar to the baseline in 2017.

The rest of the paper is organized as follows. Section 2 presents an overview of taxes and social spending in Bhutan. This is followed by a description of data sources and general methodology in section 3. It will elaborate and further expand on the standard methodology to account for an important limitation in the available data set, i.e., the lack of information on household income. The paper introduces a model which combines a consumption-based model with Mincer-type earnings to derive estimates of incomes. The incidence of taxes and social spending are subsequently presented in section 4, followed by simulations of personal income tax and GST in section 5. Section 6 concludes.

# 2. Overview of Taxes and Social Spending in Bhutan

Fiscal revenues in Bhutan rely on a mix of tax and non-tax revenues. Total revenue collection amounted to 18.6 percent of GDP in the fiscal year 2016-17,<sup>2</sup> out of which roughly two-thirds were from tax receipts. Among tax revenues, direct taxes have a slightly larger contribution than indirect taxes. Corporate income taxes account for a large share of direct taxes while the Personal Income Tax only contributed 0.6 percent of GDP.<sup>3</sup> Sales tax and excise tax accounted for a combined 80 percent of indirect taxes (table 1). Among the different types of taxes whose incidence can be estimated from the household survey, PIT and import duties are particularly overestimated compared to the amounts reported in the national accounts. In the case of PIT, this may be partly due to the fact that the entire value of durable goods is accounted for in the construction of the consumption aggregate, resulting in an overestimation of the consumption flow from durable goods. Indeed, dropping durable goods from the consumption aggregate yields a PIT allocation of 102%, much closer to the value reported in national accounts. A second possibility is that our methodology overestimates the number of formal workers. Our classification of workers (detailed in section 3.3) is closely aligned with the tax/contribution system, and while there may be some informal workers within each category of formal workers, it is impossible to identify them with the available information. The overallocation of import duties is likely because of an assumption related to the condition of the car— specifically, the tax rates differ for new and used cars, but the surveys do not collect information on the condition of the car. The modeling is based on the assumption that all cars were purchased new, likely leading to an overestimation of consumption and therefore, income.

> 2 The fiscal year in Bhutan runs from July to June of the following year. 3 Ministry of Finance. Annual Fiscal Statement, FY2016-2017.

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