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Tax Trends and Tax Reforms in the Developing East Asia and Pacific Region

Posted on May 7, 2018

Tuan Minh Le is a lead economist with the World Bank and is based in Washington.

The author would like to thank Congyan Tan and Philip M. Schuller (senior economists at the World Bank) as well as other economists working on the East Asia and Pacific region for their insightful input and comments.

This article is based on research published in World Bank East Asia and Pacific Economic Update, October 2017: Balancing Act (2017). However, the views expressed in this article belong solely to the author.

In this article, the author analyzes revenue data to explore tax compliance, tax collection, and tax reform trends in the developing East Asia and Pacific region.

Analysis of revenue data for the five-year period from 2010 to 2015 indicates that tax collection in the developing East Asia and Pacific (EAP) region1 trailed behind the majority of other developing regions — namely, Europe and Central Asia (ECA), South Asia (SAR), sub-Saharan Africa (SSA), Latin America and the Caribbean (LAC), and the Middle East and North Africa (MENA). In terms of total tax collection as a share of GDP (almost 17 percent), the EAP region ranks fifth out of the six developing regions, only coming in ahead of SAR (approximately 13 percent) (Figure 1).2 The percentage of tax revenue intake stemming from the VAT — 25 percent of total tax revenue — is lower than any other developing region (Figure 2). On average, collection from trade taxes remains relatively high, at approximately 3 percent of GDP or 16 percent of total tax intake.

Figures 1 and 2

Tax efforts and the drivers of tax collection vary greatly across the developing EAP countries.3 Figures 3 and 4 show the average tax effort and collection results for different types of taxes in select EAP countries during the 2010-2015 period. Some contrasts are noteworthy. For example, while Cambodia’s total tax intake is low, the country manages to obtain sizable revenues from the VAT (4.2 percent of GDP, about 35 percent of total tax revenues). The contribution of the VAT to the total tax intake in Cambodia is comparable to the VAT attained by the small island states of Fiji and Samoa, which have the highest overall tax efforts (about 24 percent and 22 percent of GDP, respectively). In contrast, taxes on income and profits are the major drivers that shape the tax collection pattern in the Philippines and Malaysia.4 China, Indonesia, Malaysia, and Thailand have managed to shift away from trade taxes, while other EAP countries still rely heavily on that revenue source.

Figure 3 and 4

The regional averages mask the vast country-specific differences in terms of total tax or revenue intake as well as the collection by tax type. Even within the sample of countries presented in figures 3 and 4, the coefficient of variation (CV) — a measure of relative variability defined as the ratio of the standard deviation to the mean — is significant for all the major taxes. The CVs reach as high as almost 50 percent or more for the VAT, excise, trade, and income taxes (Table 1). For example, the CV stands at approximately 52 percent for PIT and 54 percent for CIT. This would mean that the respective standard deviations are equal to 52 percent and 54 percent of the means of the respective taxes.

Table 1: Revenue and Major Tax Collection in EAP (2010-2015): Averages and Variation

 

Total TR

PIT

CIT

VAT

Excise

Trade Taxes

Others

Mean (% GDP)

17.070

1.608

3.861

4.969

2.196

1.956

2.480

Standard Deviation

3.706

0.829

2.094

2.340

0.988

1.315

1.780

Coefficient of Variance (CV)

0.217

0.516

0.542

0.471

0.450

0.672

0.718

Source: IMF Revenue Database and author’s estimates.

Note: The statistic summary is calculated from a sample of selected developing EAP countries, especially Cambodia, China, Fiji, Indonesia, Malaysia, Mongolia, the Philippines, Samoa, Thailand, and Vietnam.

Variations in Compliance Costs

Average tax compliance costs are relatively high in EAP, but there is a high degree of heterogeneity. Notably, countries that are top performers and low achievers co-exist in the region. Data from the World Bank’s Doing Business 2018 5 illustrate the contrast in performance between countries. While Vietnam and Laos are not the countries with the highest total tax burden (as a percentage of total profits), they are ranked unfavorably in terms of ease of paying taxes: A typical (hypothetical) medium-size company in Laos would spend 362 hours on tax compliance annually, while the figure for Vietnam is 498. These transaction costs are far higher than any regional average and stand in sharp contrast to the best performers in the region, such as Singapore, where the time required for complying with all taxes is only 64 hours. Overall, the average for EAP is 189.2 hours (the best score for the six developing regions). For comparison, the regional averages are approximately 218.4 for Eastern Europe and Central Asia, 280.8 for Africa, and 332.1 for LAC (the highest).

The distance to frontier score — an aggregate indicator of the overall ease of doing business — also reflects this intraregion contrast. It measures the distance of each economy to the “frontier,” which represents the best performance observed on each of the indicators across all economies in the Doing Business sample since 2005. An economy’s distance to frontier is reflected on a scale from zero to 100, where zero represents the lowest performance and 100 represents the frontier. Hong Kong SAR, China, and Singapore are the closest to the efficiency frontier in terms of paying taxes (99 and 92, respectively), while Vietnam performs poorly (49).

Aggressive Intraregional Tax Competition

As a region, EAP is known for aggressive tax incentives and benefits, implemented by governments pursuing multiple objectives. Intraregional tax competition and complex, incoherent tax policies combine to make the tax systems prone to abuse and to deplete the tax base. Further, EAP countries increasingly rely on tax holidays — widely regarded as the most inefficient form of tax incentives — plus an extensive list of generous fiscal benefits (for example, reduced tax rates, investment allowance, and super-deductions).6 A 2016 World Bank survey of the incentive regimes in 12 EAP countries revealed that 92 percent have tax holidays, making it the most prevalent type of tax incentive in EAP.

Globalization and regional integration have a significant impact on taxation everywhere, and the EAP region is no exception. Tax policies in other countries and international business transactions have become increasingly important considerations for policymakers in EAP as they design and implement domestic tax reforms. On one side, rising numbers of multinational corporations engage in profit shifting using aggressive tax planning and transfer pricing strategies. The fiscal cost from inappropriate transfer pricing can be substantial, with estimates suggesting that developing countries lost, on average, $100 billion per year during 2002-2006 as a result of these schemes.7 On the other side, tax authorities in most EAP countries are generally bound by outdated tax laws and treaties. They also face numerous other challenges, including information asymmetries and limited data access; poor knowledge of multinational corporations’ structure and their complex web of international transactions; and constrained administrative capacity.

Perspectives on Regional Tax Reforms

Ongoing and planned tax reforms across EAP countries share the dual objectives of raising revenues and reducing tax-induced investment hurdles. These dual objectives contain some inherent conflicts from the perspective of policy design. Vietnam and Indonesia, for example, have continued to struggle with setting their major objectives as they recognize the need to attain a balance of trade-offs. They are considering a substantial reduction in statutory corporate income tax (CIT) rates, yet are unsure how to streamline the existing complex incentive system and achieve a broader tax base. Policymakers also face the long-standing problem of the trade-off between efficiency and equity — they want to enhance the efficiency of major taxes (largely, CIT, VAT, and excise taxes), but strive to do so in a way that does not excessively affect the poor. For example, extending the list of VAT exemptions or non-export zero ratings to cover specific commodities consumed by the poor would improve equity but reduce efficiency and create additional burdens for enforcement and compliance functions. The political reality separating tax policy from expenditure considerations that benefit the poor — a common problem in EAP — tends to result in further complexity and incoherence in the individual tax regimes.

A World Bank snapshot survey of 14 EAP countries reveals the most commonly perceived challenges in revenue collection and directions for reform. 8 The top challenges reflect concerns about stagnation or decline of tax revenues, administrative weaknesses and high compliance costs (both flagged by 86 percent of the survey respondents), and base erosion as a result of globalization and international tax matters (identified by 71 percent of the respondents). These perceptions drive the way that governments shape reform strategies — which focus on revenue enhancement, improved efficiency, and enhanced equity — that countries hope to achieve by restructuring the tax mix and reforming tax administration.

While most EAP countries focus on revenue raising, there are a few exceptions. Some focus more on equity and the efficiency of the tax system while maintaining revenue neutrality, such as Fiji, which has maintained relatively stable revenue at 32 percent of GDP. Singapore’s tax reforms focus more on growth. The government designed the general sales tax to achieve an overall negative tax revenue; each general sales tax rate increase has been accompanied with a staged reduction in income tax rates.

Table 2. Trending and Major Drivers for Tax Reforms in Developing EAP

Key Challenges

Objectives of Tax Reforms

Ongoing and Strategic Direction in Tax Reforms

Tax Policy

Tax Administration

Insufficient revenue effort or declining tax collection.

Increasing risk of base erosion and profit shifting from international business transactions.

Weak and inefficient tax administration and high compliance costs.

Enhance or stabilize tax revenue collection.

Improve efficiency and equity in taxation by restructuring the tax mix and enhancing the quality and integrity of tax administration.

  • Develop a midterm strategy for tax policy.

  • Introduce new taxes where justified (e.g., an environmental tax); introduce/revise existing efficient type of taxes (property taxes).

INDIRECT TAXES

VAT/Excises

  • Introduce a VAT to replace the existing sales tax regime.

  • With the existing VAT regime, unify the rates while extending the scope of excise for selected commodities; broaden the base with rationalizing the exemption list and/or lowering the VAT threshold.

DIRECT TAXES

Personal Income Tax

  • Reduce or rationalize the top marginal rate with consideration to harmonize with corporate income tax regime.

  • Simplify the rate structure and reduce exemptions.

  • Rationalize the exemption threshold to serve equity purpose.

Corporate Income Tax

  • Reduce the rate. Simplify the rate structure.

  • Rationalize special incentives.

  • Review and reform the micro, small, and medium-size enterprise special tax regimes toward lowering the cost of compliance and making the regime more in line with the standard income tax regime.

  • Increase attention to revise the tax policy and regulations to deal with BEPS (notably, from transfer pricing, controlled foreign company rules, thin capitalization, and extended definition of permanent establishments).

  • Strengthen the capacity of tax administration agency (in certain cases, increase the degree of autonomy of the administration).

  • Enhance transparency, integrity, and efficiency in taxation through an improved legal framework for tax administration.

  • Reengineer business processes with central focus on voluntary compliance through enhancement of both enforcement and taxpayer service.

  • Introduce internet banking and use of third-party information sharing and cross-checking.

  • Design and implement selected actions with regard to BEPS, especially in direct links with establishment, restructuring, or refunctioning of large tax offices.

Note: Table 2 only reports the status of tax-related reforms, but does not reflect the institutional view nor the World Bank’s endorsement for these reforms.

Despite the differences in the breadth, depth, rationale, and timing in country-specific tax reforms, several common trends in revenue reforms can be observed across the EAP region. Policymakers do seem to agree on some goals and ways to achieve them, as reflected in the following regional policy trends:

  • Balancing growth and revenue objectives. The clear path for achieving the (seemingly) conflicting objectives in tax policy design is taxation’s golden rule: Broaden the base and reduce the rates.9 This policy choice has long been part of the tax policy reforms in EAP countries, following the global trend firmly established since the 1990s. The majority of EAP countries try to link this strategy with a list of incentives embedded in major taxes (that is, CIT, personal income tax (PIT), and VAT).10 However, rationalizing of incentives in major taxes is not always easy — politically or economically. Some countries try to establish direct and explicit links between fiscal incentives and targeted investments conducive to growth (for example, upfront cost reliefs or reductions in the operational costs for research and development). Another line of policy development involves the emergence of e-commerce. Some countries have attempted to redesign their major taxes (including VAT and income taxes) to capture this potentially large — and largely elusive — base. In contrast, other countries like China have emphasized equal treatment for taxation of electronic and traditional services.

  • Rationalizing the introduction of new taxes. Some countries in developing EAP want to introduce new taxes. This approach is gaining momentum in countries that face mounting budget pressure and receive donor technical assistance. The list of countries that have introduced a VAT or plan to do so has been expanding on the global scale, including in developing EAP. A VAT was recently introduced in Malaysia and is planned in Timor-Leste. Other plans include introducing a new environmental tax (Vietnam), taxing passive or capital income (Mongolia), designing new mechanisms for an alternative minimum tax, and imposing a tax on inheritance and gifts (Indonesia).

  • Modernizing the structure and operation of tax administrations. Countries increasingly recognize the need to ensure that reforms in tax policy and tax administration proceed in tandem. Modernizing tax administration in developing EAP countries tends to focus on enhancing efficiency, integrity, and effectiveness in tax administration with the aim of boosting revenues and reducing both administrative and compliance costs. Some countries have created dedicated large taxpayer offices to handle large taxpayers — taxpayers that are more capable of devising and engaging in various base erosion and profit-shifting schemes. Most reforms aimed at strengthening large taxpayer offices in developing EAP countries are part of the countries’ overall strategy to address BEPS.

  • Countering BEPS. There is an increasing awareness of the BEPS-induced revenue risk. Countries in the region have begun engaging in selective actions from the OECD’s BEPS action plans (specifically, enacting transfer pricing, thin capitalization, and controlled foreign company rules). By taking these actions, the governments are trying to protect the domestic tax base and alter the behavior of taxpayers with a view toward increased productivity and fairness in taxation.

  • Developing regional cooperation in tax administration. Countries around the world are increasingly aware of the need to ensure collective action by regional tax administrations if they hope to reverse the trend toward harmful tax competition. Without effective regional cooperation, EAP countries acting as individual players would be driven toward continued competition and the granting of increasingly excessive fiscal incentives. The countries in the Association of Southeast Asian Nations have made an effort to initiate an intraregional dialogue on improving transparency and the exchange of tax information.

FOOTNOTES

1 The EAP region includes both developing and newly industrialized countries. The developing EAP jurisdictions are Cambodia, China, Indonesia, Lao People’s Democratic Republic (Laos PDR), Malaysia, Mongolia, Myanmar, the Pacific Island countries, Papua New Guinea, the Philippines, Thailand, Timor-Leste, and Vietnam. The newly industrialized economies in the EAP are Hong Kong Special Administrative Region, China (hereinafter Hong Kong SAR, China); the Republic of Korea; Singapore; and Taiwan, China. All geographic groupings in this article are those defined in the report: World Bank, “East Asia and Pacific Economic Update, October 2017: Balancing Act” (2017).

2 Data from the high-income OECD countries are separated out from regional classification as a simple way to deal with outliers.

3 Tax effort refers simply to the share of tax collection in GDP.

4 See also OECD, “Revenue Statistics in Asian Countries: Trends in Indonesia, Japan, Kazakhstan, Korea, Malaysia, the Philippines and Singapore” (2017), which shows similar results for the long-term revenue trend in select Asian countries during 1990-2015. That report also attributes higher tax revenues in Malaysia to significant improvements in tax administration. These include transforming the tax administration agency into a semi-autonomous authority in 1996 and the shift from an administrative to a self-assessment system, with an increased focus on performance and compliance.

5 World Bank Group, “Doing Business 2018: Reforming to Create Jobs” (Oct. 31, 2017) (based on data that is current through June 1, 2017).

6 World Bank Group, “East Asia and Pacific Economic Update: Staying the Course” (Oct. 2015).

7 See Ann Hollingshead, “The Implied Tax Revenue Loss From Trade Mispricing,” Global Financial Integrity (Feb. 2010).

8 The survey was conducted by the respective World Bank country economists. The sample consists of the following countries: Cambodia, China, Fiji, Indonesia, Laos, Mongolia, Myanmar, the Philippines, Samoa, Thailand, Timor-Leste, Tonga, and Vietnam. A copy is on file with the author.

9 See, e.g., OECD, “Tax Policy Reform and Economic Growth” (2010). Each country’s specific tax system and its performance requires a specific policy strategy. For example, Indonesia has been cutting CIT rates while adding incentives (including extending the scope of tax holidays), leading to a stagnant level of tax collection. In that context, rate-cutting policy options should only be advanced when coupled with revenue-enhancing tax measures such as reforming the VAT and restructuring the special tax regime for micro, small, and medium-size enterprises.

10 Some countries, like Fiji and Mongolia, increase the PIT exemption threshold as an integral part of their overall reform strategy. One immediate effect of these reforms is to improve equity by excluding more low-income earners (mostly wage earners) from the PIT regime.

END FOOTNOTES

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