Reflections on Taxation of the Digital Economy - Bruno Carrasco

Keynote speech by Bruno Carrasco, Director General,  Sustainable Development and Climate Change Department, ADB, at the Virtual Policy Dialogue on Taxation in the Digital Economy New Models in Asia and the Pacific, 29 January 2021

Introduction

Dean Sonobe, Deputy Dean Kim, Professor Evans, Nella Si Hendriety, Ladies and Gentlemen, a very good morning to everyone.

It’s a great pleasure to participate in this Virtual Policy Dialogue on Taxation in the Digital Economy: New Models in Asia and the Pacific. The importance of this subject cannot be further underscored.

In today's presentation, I would like to share some reflections on this important topic.  

The importance of taxation

In the run-up to the Covid-19 pandemic, most Developing Economies in Asia (DEA) were recording relatively weak revenue performance as highlighted in Figures 1 and 2. Many countries were posting tax yields below the 15% benchmark and tax yields were rather unstable and unpredictable.

Covid-19 has been a devastating crisis in so many ways.  Yet it has served to underscore a critical gap namely the need to bring public finances on to a firmer footing. Given the weak revenue performance and greater demands on public spending including not only Covid-19, but also the Sustainable Development Goals (SDGs) and Climate Change challenges, tax reform is essential to any form of recovery. The status quo in terms of tax policies is no longer an option as a large part of the revenue base has been wiped out.

Singularly relying on the existing revenue collection model will not work as the structure of the economy has significantly changed. For example, a large share of retail trade has been replaced by e-commerce. Similarly, growing segments of economies are increasingly transitioning into the digital space where there is limited tax collection under the former model. In addition, many firms have shut down and others fallen outside the formal economy further weakening the revenue base.

Indeed, the weak revenue base traced to continuing with the existing model of taxation will likely lead to a large increase in public debt that will end up eroding market confidence leading to higher borrowing costs and undermine economic growth. Figures 3 and 4 show case how those countries that have been more severely affected by COVID-19 are not only facing larger public debt but also weaker GDP growth prospects four years out.  

While at relatively low rates of interest and high GDP growth rates, countries’ carrying capacity of large public debt is possibly contained, an increase in interest rates or a declining GDP growth rate can lead to a weakening of “g-r” setting debt dynamics into a destabilizing path and wreaking further havoc across economies. For those more sanguine, I refer them to the taper tantrum of 2013.

These facts imply that there is little room left for DEA to further increase external borrowing, and vividly remind us of the importance of seriously thinking about how we can successfully reform tax policy. The message is clear, there is an urgent call to revisit tax policy as part of the “next normal”.

Fundamentals of tax reform

This brings us to the question of how can DEA successfully implement tax reform?

Within ADB we have established a Task Force to review this matter closely. Broadening the revenue base is a key policy reform that through stronger compliance and improved enforcement could mobilize additional revenues, even in the absence of an increase in tax rates. Stronger collaboration and coordination between the tax policy department and the tax administration is key (see Figure 5). In conjunction with broadening the domestic tax base, DEA need to enhance tax compliance with a greater use of Information Communication Technology, as most tax systems rely on a system of voluntary tax compliance. Tax policy structure is also an area that requires tightening to address many of the potential risks of leakages including too many tax bands, ad hoc tax holidays, and loopholes on VAT. As highlighted in Figure 5 the combination of compliance and policy gaps leads to sub-optimal arrangements in terms of revenue collection. Part of the solution for improved compliance is traced to the imperative to build confidence in the fiscal contract and trust in government to ensure that tax revenues are visibly put to good use. A solid communication strategy is part and parcel of this objective too.

To address these challenges, country-specific, differentiated goals on revenue performance - appropriate to their specific circumstances and level of development - are essential to developing strong ownership of reforms and political commitments across DEA. On the policy side, the medium-term revenue strategy (MTRS) will serve as a tax system reform road map sustained by a medium-term government commitment to reforms.  On the administration side, the roadmap of digitalization of tax administrations will complement MTRS by providing a strong pathway to improve taxpayer compliance. These goals can serve as a foundation for development coordination with development partners.

Another important element to broadening the revenue base derives from taking advantage of existing loopholes in the tax legislation and exploiting differences in taxation regimes across countries. Every year approximately $100 – $240 billion is lost globally in potential tax revenues as taxation of MNEs and the digital economy is fraught with impediments. There have been important efforts led by the OECD to strengthen international tax cooperation focusing on a coordinated solution to this tax erosion challenge.  

Base Erosion and Profit Shifting (BEPS) is especially relevant. BEPS is an aggressive form of tax planning by some multinational enterprises that exploit gaps in the interaction of different tax systems to artificially reduce taxable income including from DEA. Given their large markets and growing power, DEA are expected to draw large investments, which make them even more vulnerable to BEPS practice, unless proper redress mechanisms are introduced.

Tax evasion is another example of harmful tax practices which operate through the exploitation of the interconnected global financial network and use of tax havens. Joining the Inclusive Framework on BEPS and the Global Forum on Transparency and Exchange of Information for Tax Purposes (Global Forum) are key steps towards protecting national revenue against BEPS and strengthening DRM through the implementation of international standards on global transparency and exchange of information for tax purposes.

Indeed, as presented in Figure 6, out of ADB’s 46 developing members, 27 are not yet participating in the existing Inclusive Framework on BEPS; 19 are not yet members of the Global Forum on Transparency and Exchange of Information for Tax Purposes, and have therefore not committed to the automatic exchange of information, crucial to address tax evasion. DEA must therefore proactively engage with the international community to be part of this global coordinated effort.

ADB’s role in support of tax reforms

Given the challenges ahead, President Asakawa of ADB announced at the last Annual meeting in September 2020 the creation of the Regional Hub on Domestic Resource Mobilization and International Tax Cooperation (see Slide 7). The regional hub will support the formulation of the MTRS and roadmap of the digitalization of tax administrations in partnership with development partners. It will serve to bring together in a coordinated manner initiatives pursued across the development community such as IMF, OECD, World Bank and other bilateral expertise to support DEA to work together in designing and implementing tax reforms tailored to meet their own requirements.  It will seek close engagement with DEA to address some of the many challenges described earlier. The creation of the Regional Hub is an important strategic and operational investment and will be backed by ADB’s commitment to mainstream support for this agenda in our operations including through policy reform programs, technical assistance, and capacity development.

We will be convening a Regional Tax Conference later this year to officially launch the Regional Hub and together, with strong involvement from our DEA, we can make a success of this important initiative.

Thank you very much for your attention.