Summary

Newly formulated tax capacity estimates, which benchmark revenue against key economic features, indicate that economies in developing Asia could increase tax revenue from a pre-pandemic average of about 16% of GDP by, on average, 3–4 percentage points. However, this potential varies within the region and is generally higher in Southeast Asia, where revenue is often lowest.

Tax expenditures—or tax not collected—are widely used in the region, including to support households and businesses hard hit by the pandemic. Some tax expenditures lack any clear policy justification, however, while significantly reducing revenue. Government reporting of tax expenditures is often lax, but estimates suggest that on average they curtail tax revenue in the region by about 14%. Tax incentives to lure businesses are often ineffective and can undermine healthy competition. Governments should weigh costs and benefits and consider ways to promote investment that are less expensive and more effective. Meanwhile, most governments need to improve tax expenditure transparency and regularly report costs.

Low tax efficiency and comparatively low tax rates indicate that potential exists to increase VAT revenue in some economies. Tax authorities need to ensure appropriate taxation of imported digital products to ensure that online commerce does not erode VAT revenue. Increasing personal income tax revenue is a challenge, especially where collection capacity is weak, and it may undermine work incentives. However, personal income tax can make tax systems more progressive and thus societies more equitable. More revenue can be raised as well from property taxes, which can bolster local government finances and are readily efficient and progressive.

The two-pillar solution developed under the Inclusive Framework on Base Erosion and Profit Shifting enables economies to share corporate income taxing rights, and it proposes a global minimum tax rate. This initiative is welcome, but few economies in developing Asia will likely see significant revenue impact in the near term. The economies that stand to benefit most from reallocated taxing rights are likely to be resource exporters and those with large domestic markets. Investment hubs may lose revenue. Similarly, the revenue impact of introducing a 15% global minimum corporate income tax rate is likely to be small in developing Asia, as most economies in the region already meet it.

Generally relaxed regulatory barriers and low tax burdens in the region have helped keep unemployment low and growth rapid. However, the high cost of business registration is an exception, which partly explains the region’s large informal sector. Policy simulations using a simple two-sector model, both formal and informal, indicate that lower registration costs are particularly effective at reducing informality and increasing tax revenue, productivity, and wages. Stronger enforcement of existing laws and regulations can also reduce informality and increase tax revenue.

Governments often attempt tax reform but then fail, leaving them stuck with low revenue. However, experience from around the world demonstrates that it is possible to implement policies that lift tax revenue by the equivalent of several percentage points of GDP or more. Successful tax reform requires strong leadership with clearly articulated priorities toward feasible policies. Also helpful is a reform road map supported by international cooperation and technical assistance. As major crises sometimes pave the way for tax reform, the current period of pandemic recovery may be an opportune time to embark on ambitious tax reform.

While the impositions of tax compliance have eased across the region, they remain substantial in some economies. Tax administrators can harness technology more effectively to reduce their own administrative costs, improve access to information, and so facilitate compliance. Organizational reform to improve utilization of scarce resources, enhance administrative autonomy, and incentivize performance promises to strengthen tax administration. Tax reform is best accompanied by efforts to strengthen the social contract and tap intrinsic willingness to pay taxes, most notably by improving the quality of government spending. Empirical evidence informed by behavioral insights suggests that significant opportunities exist for governments to experimentally apply sticks as well as carrots, including deterrence messages.