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Asia-PacificJuly 21 2021

Asia’s tax issues come into sharp focus

The Asean region has a low tax regime, but as its countries seek to overcome the economic impact of the pandemic, raising taxes may be a speedy route towards recovery. 
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Asia’s tax issues come into sharp focus

New waves of Covid-19, coupled with vaccine shortages, have wreaked havoc on many south-east Asian economies in the second and third quarters of 2021, forcing governments to raise their public debt levels to help combat health crises and succour their desperate populations. Once the pandemic recedes, the region will find itself in a much more fragile fiscal situation than it was before the pandemic, and governments will face the difficult task of easing off stimulus and relief measures while trying to achieve infrastructure and social development goals. To do so, most governments will need to resort to domestic resource mobilisation — namely, raising taxes. 

The 10 countries of the Association of Southeast Asian Nations (Asean) have long comprised one of the fastest growing regions in the world, their economies fuelled by hefty foreign direct investment (FDI) inflows, ever-rising exports and consumption booms as middle classes emerged in their home markets. The region also stands out for its relatively low tax-to-gross domestic product (GDP) ratio.

“If you compare tax-to-GDP ratios with the rest of Asia-Pacific, Asean is lagging behind, and Asia-Pacific is lagging behind the Organisation for Economic Co-operation and Development (OECD) countries,” says Ramesh Subramaniam, director-general for the south-east Asia department of the Asian Development Bank (ADB). The average tax-to-GDP ratio for Asean in 2018 was 14.8%, compared with 24.9% in the richer OECD countries, according to data compiled by OECD, ADB, World Bank and International Monetary Fund (IMF). 

As a general rule of thumb, economists deem a 15% tax-to-GDP ratio to be the minimum needed to maintain sustainable growth. This means not only strong GDP growth, but also improvements in such vital areas as health, education, poverty eradication, income and gender inequality — all of which are pillars of the 17 UN Sustainable Development Goals targeted for actualisation by 2030. Covid-19 has set those goals back across the entire Asia-Pacific region. 

Tax hike

Given its historically low tax-to-GDP ratio, Asean should have plenty of room to grow its tax base in the post-pandemic era. In May 2021, ADB launched its Asia-Pacific tax hub, with the secretariat based in Manila, designed to provide advice and technical assistance in this politically sensitive area. “Clearly, the timing could not have been better,” says Mr Subramaniam, one of three senior ADB staff manning the secretariat. Initially, the new tax hub will be working closely with Indonesia, the Philippines, Pakistan (which is not part of Asean), Cambodia and Laos on taxation plans. “The hub has two parts to it: the first is the domestic resource mobilisation and the second is on international tax co-operation,” Mr Subramaniam says.

On the international tax co-operation front, the ADB hopes to play a role in preparing the Asean region for the implementation of a 15% global corporate tax rate proposed by the US president Joe Biden at the G7 annual meeting in June 2021. A blueprint of the proposal has since been supported by 130 countries worldwide, with the G20 leadership offering their support for the idea at their annual meeting on July 9, 2021. “With a global minimum tax in place, multinational corporations (MNCs) will no longer be able to pit countries against one another in a bid to push tax rates down and protect their profits at the expense of public revenue,” Mr Biden said of the proposal.

While more details on implementation are expected in October, it is already clear that implementation of such a scheme would be good news for some, but bad for others in south-east Asia. 

Singapore has long billed itself as an oasis of political calm with international-standard regulations, a liberalised financial system and a low-tax location for MNCs — and has done so to great success. Even in 2020, when FDI inflows to Singapore fell 21% to $91bn, it continued to attract the lion’s share of investment into Asean, soaking up 67% of the $136bn in total FDI reported in the 10-country bloc. Much of that FDI is parked safely in Singapore, where MNCs are wont to set up their regional headquarters and pay their taxes, while they invest and trade elsewhere in the region. 

Ramesh Subramaniam

Ramesh Subramaniam, ADB

Although Singapore’s corporate tax rate is actually 17%, the government offers many tax incentives and waivers to MNCs opting to station themselves in the city-state. Elsewhere in south-east Asia, local corporate taxes vary — for instance, they stand at 18.5% in Brunei, and 20% in Thailand and Vietnam, according to Fitch Solutions’ country risk and industry research arm. But most governments in south-east Asia offer corporate tax waivers as a key incentive for choosing to base their manufacturing or headquarters in these countries. This might be a good time for Asean to reassess its FDI incentive schemes.

“The IMF encourages countries to regularly review the effectiveness of their tax-incentive policies, including by publishing data on forgone revenue through tax expenditures,” says Katherine Baer, deputy director of the IMF’s fiscal affairs department. “For countries that see value in maintaining tax incentives, there can be revenue gains over the medium term by replacing less well-targeted incentives, such as tax holidays, by incentives better targeted at new investments, such as accelerated depreciation,” she says.

Overall, the more populous south-east Asian economies, such as Indonesia, the Philippines, Thailand and Vietnam, stand to gain from the global corporate tax scheme in terms of earning more tax revenue from e-commerce giants, such as Amazon, Google and Alibaba. Under the proposed scheme, they would be forced to pay tax at the point of sale, rather than at the home base of the MNC, which is usually in a tax haven country. “As a result, despite economic activities taking place in the origin countries, the profit gets shifted,” says Mr Subramaniam. “That’s why the tax base is eroded, and hence the need for the base erosion and profit shifting (BEPS) [initiative].”

ADB is urging all Asean countries to speed up their ratifications of the BEPS initiative and the global tax co-operation on transparency to improve coordinated tracking of such transactions. “You will have data capture in the origin [of sales] countries, as well as in other countries where the MNCs operate,” says Mr Subramaniam. 

Taxation goes digital 

Digitalisation of countries’ revenue departments is vital to improved data capture and the move to digital has been hastened by the Covid-19 pandemic — something that fuelled an explosion in e-commerce, digital banking and online tax payments as part of the worldwide lockdowns and work-from-home trends.

Many Asean governments are well on the way to digitalisation. Thailand, for instance, has undertaken a medium-term revenue strategy (MTRS) since 2018 with technical assistance from the IMF. “This strategy is to transform the Revenue Department into a digital and data-driven organisation with an innovative culture, and to value our peoples’ integrity and competency,” says Phensuk Sangasubana, head of international tax division at Thailand’s Revenue Department. “The focal point of the tax administration in digital reform is on the taxpayer, in order to serve them better, and make tax compliance simple and convenient through new technologies and partnership with the private sector,” she said in a recent webinar. 

Other countries in the region that are considering undertaking a MTRS include Papua New Guinea, Indonesia, Laos and pre-coup Myanmar. MTRSs are seen as an important tool in building public awareness and acceptance of taxation as a means of financing national development — a link that has been undermined in the past by a lack of transparency and corruption. “Preference for increased public spending on healthcare, education, social safety nets or infrastructure, especially in the current post-pandemic environment with strained public finances, needs to be based on a social contract,” says Ms Baer.

“In return for the public paying taxes, the government commits to funding development, which also helps with accountability and transparency. The MTRS approach does exactly that by developing a detailed roadmap of tax system reform, ensuring transparency and broad public support, and offering a public discourse on development and financing, rather than simply the tax angle,” she argues. 

Taxing the rich

Another distinctive feature of the Asean region is the high levels of income inequality, with Thailand ranking seventh and the Philippines ranking ninth on the World Bank’s 2019 Gini Index — a measure of social inequality. The Covid-19 pandemic has thrown more people into abject poverty, while the affluent have fared better. “The costs of the pandemic have fallen most heavily on those least able to bear them,” Ms Baer says. “With rising inequality and mounting public debt, countries will have to find innovative approaches to raise money to pay for it all.” Indonesia’s parliament has already mooted a tax overhaul proposal that, among other things, would raise value-added tax from 10% to 12%, while imposing a 35% income tax on individuals earning more than $345,600 a year. 

One area that all south-east Asian tax authorities could start looking more closely at is taxing property — the source of much of the new wealth and income inequality in the region, according to the ADB. “Wealth tax, inheritance tax, estate tax — they are all part of the overall tax framework, but property tax is all inclusive,” Mr Subramaniam says. In particular, he is advising countries to improve their property tax collection at the local government levels. “Our assessment is that when governments start to have a property tax regime and good property tax collection mechanisms at the local government level, the tax-to-GDP ratio will start increasing. In [the Asean region, the ratio] is very low when compared with China or OECD countries. The ratio is as low as 1% — maximum 4%,” he says. 

When governments start to have a property tax regime and good property tax collection mechanisms at the local government level, the tax-to-GDP ratio will start increasing

Ramesh Subramaniam, ADB

Another growth area for Asean’s revenue departments would be broadening their tax bases. “Part of tax inefficiency is that you have large chunks of the economy that remain informal. In [the region], the ratio is about 20% of GDP,” says Mr Subramaniam. “That has been a major source of inefficiency in the tax system and the revenue mobilisation system.”

One of the best means of transforming the informal to the formal sector is through regulatory reforms that make it less painful and easier to join the legal fold. “Pushing through structural reforms to boost private investment and bringing in the informal sector will be important for Asean countries to achieve their development goals,” says Ms Baer. “Strong, private investment is needed to maintain the impressive track record of economic growth that has lowered poverty, boosted incomes and improved welfare. But if this development progress is to continue, tax revenues will need to rise so that spending on health, education and social safety nets can increase. An important part of this will need to come from bringing in the informal sector into the tax-paying formal sector.”

Future sovereign ratings 

Most Asean countries entered the Covid-19 crisis with fairly good fiscal buffers — relatively low public debt, current account surpluses and high foreign exchange reserves — resulting in comparatively few sovereign credit rating downgrades last year, compared with other regions. Fitch Ratings, for instance, only downgraded its sovereign credit rating on Laos and Malaysia in the region. “What these countries have in common is that they are facing severe external financing pressure as a result of the pandemic, with very limited options for new finance,” says Stephen Schwartz, head of Asia-Pacific sovereigns at Fitch Ratings. “That’s the key driver behind our downgrades of these sovereigns.”

Moving into 2021, with the Covid-19 pandemic still claiming lives and forcing lockdowns, Asean has lost much of its fiscal fat. Public debt has risen across the board, except in Vietnam where the government has been thrifty with its relief programmes and the debt-to-GDP ratio has been kept steady, aided by a growing GDP denominator. Vietnam was the only country in the region to enjoy a rise in GDP last year, albeit at a modest 2.8%, and a sovereign upgrade by Fitch. 

As for the rest of Asean, credit agencies are increasingly looking at how these governments are going to finance their growing debt.

“Revenues are an important consideration in our ratings and what we typically look at are countries’ revenue ratios, relative to GDP, and relative to their interest debt service burdens,” Mr Schwartz says. “For countries that lack favourable revenue ratios, it undermines their credit-worthiness and is an important variable in our ratings model.”

Some countries, such as Vietnam, may very well grow their way out of debt, but for others the challenge may be greater. “So, the question is increasingly turning to how countries are going to finance the build-up in debt,” Mr Schwartz adds. 

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