The 2026-27 fiscal budget deserves appreciation for one important reason. Amid competing fiscal pressures and slowing economic activity, it has committed to launching a second generation of tax reforms. The timing could not be more appropriate. Nepal’s tax system has reached a stage where incremental changes are no longer sufficient. What is now required is a comprehensive reform agenda that restores public trust, promotes investment, broadens the tax base, and prepares the country for a rapidly changing economy.

But despite all the promise and hype around tax reforms with the change in government, there are signals of policy flip-flops, unpredictability, loss of trust, and even backsliding of earlier reforms. This is especially true with the probability of introducing multiple Value Added Tax (VAT) rates (for example, a different rate of 5 percent on electricity) and losing the fairness and equity—both horizontal and vertical—elements in the new tax tariffs or administrative measures. Moreover, the government has introduced several new tax concessions and exemptions (as summarised in sections 68 and 73 of the Budget Speech 2083–84) despite the promise of comprehensive application of the tax regime to broaden the tax base.

Nepal is not starting from scratch. The country has already witnessed the first generation of tax reforms in the 1990s. The reforms introduced in that period had three landmark departures from the earlier tax regime. First, self-assessment in income taxation shifted the relationship between taxpayers and the tax administration from official determination to voluntary compliance. Second, the introduction of a single-rate VAT, an input tax credit mechanism, and a built-in self-policing system created one of the most efficient indirect tax structures. Third, self-declaration in customs and excise moved tax administration away from excessive official discretion towards greater trust in taxpayers.

These reforms were guided by a simple philosophy: lower tax rates, a broader tax base, and greater tax equity. Moderate, universally applied tax rates were expected to encourage compliance, reduce tax evasion, and generate higher revenues without discouraging investment and economic growth. For many years, this framework served Nepal well.

The challenge today is not that the original reforms were flawed, but that their underlying principles have gradually been diluted. Over the years, substantive tax laws have increasingly been amended through annual finance acts. Frequent policy changes have depleted trust in the tax system by introducing uncertainty and unpredictability, and have made long-term business and investment decisions difficult. Equally concerning has been the proliferation of tax exemptions and concessions. Every exemption narrows the tax base, creates opportunities for leakage, and often rewards influence rather than genuine economic merit.

At the same time, tax procedures have failed to modernise to meet the needs of a digital economy. Compliance remains costly and cumbersome. Excessive paperwork, multiple reporting requirements, and outdated administrative practices increase the cost of doing business. These weaknesses have adversely affected investment, productivity, growth and employment.

Tax Reform 2.0 must, therefore, begin by restoring trust. No tax system can function efficiently unless taxpayers have confidence that tax laws are predictable, fairly administered and consistently applied. Predictability, policy stability, impartial administration and transparency should become the cornerstones of Nepal’s tax system.

Tax administration itself requires fundamental modernisation. Paperless and contactless procedures should become the norm. Full self-assessment, supported by risk-based audits and digital verification, can significantly reduce compliance costs while improving administrative efficiency. Honest taxpayers should find compliance easier, while deliberate non-compliance should become increasingly difficult through intelligent data analysis rather than excessive physical enforcement.

A comprehensive review of tax exemptions is equally essential. Most concessions should either be eliminated or subjected to transparent public disclosure through annual tax expenditure statements. Tax equity must guide reform once again. Horizontal equity requires taxpayers with similar economic capacity to bear similar tax burdens. Vertical equity demands protection of lower-income households from excessive tax incidence. Where environmental taxes such as carbon taxes are introduced, targeted budgetary compensation should protect poorer households from their regressive effects.

Digital economic activities should be brought under a tax framework by subjecting such transactions to both direct and indirect taxes based upon emerging international practices. Likewise, informal businesses should gradually be integrated into the formal tax system initially at low tax rates and with simplified procedures to formalise the economy and expand the tax base.

Technology should become the backbone of modern tax administration. Integrated databases capable of communicating with banking systems, business registries and other government databases can verify transactions intelligently while reducing unnecessary compliance costs. Artificial intelligence and advanced analytics can improve audit selection, detect fraud and strengthen revenue administration. Such modernisation requires sustained investment in reliable hardware, secure software and skilled human resources.

Tax reform must also reflect Nepal’s federal governance structure. Tax procedures should be harmonised across federal, provincial and local governments to provide an integrated nationwide tax framework to the taxpayers. Double taxation of the same transaction should be eliminated while ensuring fair revenue sharing among all three levels of government. The indirect tax structure also deserves careful review. Preserving a single VAT rate maintains simplicity and minimises disputes, while a modest reduction in the rate, combined with a broader tax base and improved compliance, could stimulate economic activity without compromising revenue.

Revenue reform should extend beyond taxation alone. Better management of non-tax revenues—including market-based pricing of natural resources, fair returns from public assets, improved utilisation of public infrastructure, and modern cash management through short-term treasury instruments—can significantly strengthen public finances.

Ultimately, tax reform is about rebuilding the social contract between the state and its citizens. People are more willing to pay taxes when they see that public resources are managed efficiently, transparently and for the common good.

A second generation of tax reform will undoubtedly demand strong commitment at both the political and organisational levels. There are no gains without pains. Every meaningful reform temporarily disrupts established interests as it realigns resources, priorities and economic and social structures. It therefore requires careful management of the political economy of reform and sustained leadership to overcome inevitable resistance.

Yet, the long-term rewards far outweigh the short-term costs. A good tax system is not one that simply collects more revenue; it is one that releases the productive resources of businesses for greater investment, innovation and employment while ensuring fairness for all. In an ideal economy, investment decisions should be driven by the economic merits of the investment itself—not by tax distortions or preferential treatments. That should be the true objective of Tax Reform 2.0.