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Moody’s: Tax reforms to address revenue woes

Moody’s Investors Service says that tax reforms in developing Asia Pacific economies will help address the narrowness of revenue bases in some countries, but that many governments still face structural barriers to broadening these bases.”

For many sovereigns, measures to broaden the tax base are unlikely to boost fiscal strength unless accompanied by enhanced tax administration and measures that effectively manage expenditure growth,” says William Foster, a Moody’s Vice President and Senior Credit Officer.

Moody’s conclusions are contained in its just-released report “Sovereigns—Developing Asia Pacific: Tax base broadening most likely to be effective in countries with strong tax administration”.

The report looks at the extent to which tax reforms are likely to support the sovereign credit profiles of 11 developing Asia Pacific economies that have underdeveloped tax systems.

The 11 are Bangladesh, Cambodia, India, Indonesia, Maldives, Mongolia, Pakistan, the Philippines, Sri Lanka, Thailand and Vietnam.

By constraining revenue-generation potential, the narrow tax bases of many of these sovereigns increase their fiscal vulnerability, while also limiting the financial resources available to develop the social and infrastructure services needed for greater economic development.Some sovereigns are now seeking to initiate reforms to broaden their tax-generation capacity.

Moody’s expects such reforms will most likely address the narrow revenue bases present in fast-growing economies with improving expenditure and debt management, such as the Philippines (Baa2 stable), India (Baa2 stable), Indonesia (Baa2 stable) and Thailand (Baa1 stable).Conversely, for Mongolia (B3 stable), Pakistan (B3 stable) and Bangladesh (Ba3 stable), Moody’s sees more limited prospects for significant improvements in fiscal strength, given weaker levels of tax compliance and administration, and structural economic factors that limit the potential impact of reforms.”Long-standing institutional and economic constraints—such as small governments, high levels of corruption, large informal sectors and low levels of wealth—will likely continue to constrain the revenue bases of developing Asia Pacific economies,” says Foster.Besides hurdles to tax administration, the relative concentration of the tax base on indirect taxes—such as value-added taxes—leaves governments vulnerable to pressure to grant exemptions for various special interests.And often more difficult to administer, direct taxation—such as income and social security tax—is often hindered by the largely informal nature of the system.