HONG KONG, CHINA – Widening income gaps are undermining decades of successful poverty reduction in developing Asia, meaning governments should proactively use fiscal policy to close gaps and promote more inclusive growth, says a new Asian Development Bank (ADB) report.

“Fiscal policy can and should play a bigger role in promoting inclusive growth in Asia,” said ADB’s Deputy Chief Economist Juzhong Zhuang. “Asian policy makers must act now to integrate inclusion targets into their budget planning to transition to a path where the benefits of growth are broadly shared.”

Fiscal Policy for Inclusive Growth, the special theme chapter in ADB’s Asian Development Outlook 2014 (ADO), released today, notes that during the 1990s and 2000s, more than 80% of the region’s population lived in countries with worsening Gini coefficients, a common measure of inequality. The same market forces that have enhanced growth in the region — globalization, technological progress, and market reform — now exacerbate inequality.

International experience shows that public spending can reduce income inequality. Government spending on education and health care, for example, broadens access for the poor to these vital services and helps level the playing field. Making infrastructure affordable and accessible allows the poor to take better advantage of the opportunities that come with improved education and health.

However, developing Asia lags other regions in public investment to promote equity. Public spending on education averages 2.9% of gross domestic product (GDP) in the region compared to 5.3% in the advanced economies, and 5.5% in Latin America. The difference is starker for health care: 2.4% in Asia versus 8.1% in advanced economies, and 3.9% in Latin America.

The way funds are used can be as important as the amount. Education policy can promote inclusion by prioritizing basic education or expanding technical and vocational training to give students the practical skills and knowledge they need for work. Public health policy can do the same by directing funds toward rural health clinics, for example, rather than the latest medical machines for urban hospitals, the report suggests.

Many regional economies have scope to direct more public resources toward this type of spending, the report says. But this capacity may not last as rising costs associated with aging societies and environmental pressures will squeeze fiscal space in coming decades. Asia’s revenue base remains small by global standards: During the 2000s, the ratio of tax revenue to GDP averaged 17.8% in developing Asia, well below the global average of 28.6%.

Options to raise revenue include broadening the base for personal income tax and value-added tax, enlarging corrective taxes and nontax revenues, and introducing naturally progressive taxes on property, capital gains, and inheritance, the report says.

Policy actions must support efforts to raise revenue. ADO says these should include systematically incorporating equity objectives into fiscal policy, preferably over a medium-term horizon; upgrading government fiscal data to better track public programs and assess their effectiveness; leveraging information and communication technologies to improve tax administration; and considering public–private partnerships in social infrastructure to help extend the reach of education and health care services.

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