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OPINION

Mobilizing Fiscal Revenues to Reduce Poverty

Kalpana Kochhar

The Kathmandu Post

October 1, 2012

South Asian countries collect exceptionally low levels of tax revenue and have significant public spending needs to reduce poverty and enhance growth. Afghanistan, Bangladesh, Bhutan, India, Maldives, Pakistan and Sri Lanka are consistent underperformers in achieving the Millennium Development Goals and the governments in the region really need to build up infrastructure and improve social service provision—such as education and health.

The average revenue collection in the region ranges from 10 and 15 percent of Gross Domestic Product (GDP), compared to an average of 20 percent in comparable developing countries, and —excluding  Maldives and Bhutan— even higher rates in more developed countries.

This fact is even more significant when seen against the acute need for productive government spending required to reduce poverty and enhance growth. The average per capita income of the eight countries is US $1,300 as compared with, say, the average of East and South East Asia of more than $4,200 with almost half of the world’s poor living in South Asia (US $1.25 a day).

To improve public services and infrastructure, a significant increase in fiscal spending will be required. Yet, fiscal resources of most South Asian countries are limited, and social and infrastructure spending remains much lower than in other countries—and much less than needed. Additional borrowing to address high expenditure needs is a nonstarter because of the already high debt levels in South Asian countries.

Of course, one might argue that revenue levels are affected by the economy’s structures and that if structural differences are accounted for, South Asian countries may not be such poor revenue performers. For example, on average they have lower per capita income, higher agricultural shares of GDP, and lower international trade than most regions of the world —all of which likely reduce revenue collection. But they have lower revenue collection than countries in the rest of the world—even after income levels and economic structures are taken into account. 

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To improve public services and infrastructure, a significant increase in fiscal spending will be required. Close Quotes

Kalpana Kochhar
Chief Economist, South Asia Region

The gap from the average level of similar countries is around 4 percent of GDP for India and roughly 10 percent for Bangladesh. These gaps have remained broadly unchanged over the past 10 to 15 years. Less corruption, lower inflation, and improved macroeconomic stability are all conducive to collecting more revenues.

Two points are worth highlighting when assessing how revenue can be enhanced in South Asia: the first is that, by and large, tax structures in most countries are moving toward what is internationally accepted as best practice. The second is that yields from existing taxes are very low. That is, actual revenue collection is below potential and far below averages for comparable developing economies and those of East and South East Asian economies.

As for tax structures, South Asian countries either have most of the desired taxes in place or are working toward introducing them, but tax structures in Pakistan and Sri Lanka remain quite complicated. In most countries, the major vehicle for revenue mobilization is a value-added tax (VAT) with a limited number of nonzero rates. Some South Asian countries that lack part of the desired policy features are reforming their tax policies to resemble a good practice framework: India is adopting a goods-and-services tax (GST), Sri Lanka is implementing a comprehensive tax reform, Bangladesh is contemplating income tax and VAT reforms, and Bhutan is considering a possible VAT.

However, the crux of the problem remains low revenue collections both for VAT and income tax. Sri Lanka and Bangladesh show the lowest income tax yields, and Pakistan and Bangladesh, the lowest VAT yields. Tax yields in all major South Asian countries are below the average of low-income countries and below those of most East Asian economies.

Acceptable tax structures combined with low levels of collection imply that tax exemptions bases are narrow and that tax administration is weak. In South Asia tax bases are narrow, in part, because of the high incidence of tax exemptions and holidays. For example, Sri Lanka’s tax holiday scheme has been a major cause of its declining revenue, from 20 percent of GDP 15 to 20 years ago to below 15 percent currently.

Most South Asian countries have outdated tax laws and inadequate institutional arrangements that have not incorporated modern principles and practices to accommodate the growing complexity of their economies. In many parts of the world, organization of tax agencies has shifted away from the type of tax they collect towards the functions they perform, such as registration, collection, audit, and taxpayer services. This shift has been slow in the region.

Another potential source of revenue enhancement is nontax. The dependence on nontax revenues in the region is around 15 percent of total revenues, except for Bhutan and Maldives, where they are much higher. To enhance nontax revenues, governments need to manage state enterprises efficiently and on a commercial basis if they remain in the public sector. Also, there is considerable room to collect more user fees. User-fee collection as a share of government operation and maintenance spending indicates that South Asian countries are still a long way from developing appropriate user charges.

South Asian countries should consider taking different initiatives to increase their tax collection levels in order to improve the lives of millions of people.