Widen tax base, spend more efficiently

World Bank’s Advice to 9 Pacific Economies

The World Bank says six Pacific Island countries are at high risk of debt distress, and that gradual cuts to government spending are vital for balancing budgets and avoiding sharp cuts to public services in the years ahead.

The authors of “Raising Pasifika: Strengthening Government Finances to Enhance Human Capital in the Pacific: A Public Expenditure Review for Nine Pacific Island Countries,” say Kiribati, Marshall Islands, Federated States of Micronesia, Samoa, Tonga and Tuvalu are all at high risk of debt distress, while Vanuatu is rated medium risk and Palau and Nauru’s debt is rated as sustainable. 

The report says: “the COVID-19 shock, combined with overlapping shocks from natural disasters and global inflation, risks reversing a decade of progress in building human capital across the Pacific.”

It says tax collection “needs to be the foundation” of the countries’ revenue strategies as current tax gaps are estimated to be between 8-17% of GDP, but that revenue reforms should be introduced once post-pandemic recovery is underway.

“These large tax gaps are from a combination of low compliance and tax bases that are narrow due to high thresholds and costly exemptions. In a few cases, the absence of a general consumption tax (Nauru), a corporate income tax (Palau), or any income taxes (Vanuatu), represents the most significant case of narrow tax bases.”

It suggests lowering Value-added taxes (VAT) thresholds in Kiribati, Palau and Samoa and rationalising VAT exemptions in Tonga and Kiribati. It also observes that timely VAT refunds would help improve trust and voluntary compliance with the systems, as might digital filing options.

The report suggests that in Marshall Islands and Kiribati, some of the funds spent on copra subsidies should be reallocated to poverty-targeted social assistance programs, and that for FSM and Marshall Islands: “moving from a gross-revenue regime to a VAT regime is a critical reform, which can improve horizontal and vertical equity, and increase revenue.”

It flags that implementation of the PACER Plus trade agreement will lead to losses in trade taxes, but that these could be offset by higher taxes on tobacco, alcohol and sugary drinks.

To offset the burden that tax reform would place on vulnerable groups, the Bank suggests strengthening direct taxes so those on higher incomes pay more, and ensuring that spending supports the poor and vulnerable, including through targeted cash transfers.

The report notes that spending on health and education in the nine countries is already high as a proportion of total budgets and that more efficient spending of allocations within those sectors is advised. It notes that property taxes are low across the nine economies and suggests that “higher taxes on immovable property can be a useful instrument to raise local revenue to finance local services” and strengthen accountability between revenue, spending and local governance.

The authors believe maximising the long-term benefits of fishing revenues related to the Parties to the Nauru Agreement (PNA) Vessel Day Scheme (VDS) for purse-seine tuna vessels is “crucial to fiscal sustainability” as they account for between 8-75% of domestic revenues, and says reforms that provide greater flexibility and transfer of VDS days could increase this revenue.

Education

Spending on public education is relatively high in the nine countries examined when compared to peer countries.

Speaking at the report’s launch, World Bank Macroeconomist, Lars Sondergaard, noted that: “Two things stand out: when we look at most countries around the world, when we look at education spending, a large share of that spending is usually on teacher salaries.

“Now this isn’t the case in the nine Pacific Island countries; in part, it is due to their smallness, which means that a much larger share of their budget ends up being spent on overhead costs such as administrative or support costs.”

Spending on scholarships and food provisions is also high.

So what are the countries achieving for that spending? The report looked at two measures; access to education and quality of education measured by student assessments.

“There has been improvement over time, but it is still the case that when you look at primary school students reading comprehension and numeracy skills, a large proportion of children in grade six are still not able to understand what they are reading,” Sondergaard said.

He said to overcome this problem, the most important thing is to recognise “you have an unfinished agenda and make it a national priority to make improvements in early grade reading skills,” then set targets for improvement and launch a cost-effective and evidence-based plan to implement it.

The report notes that access to secondary school is limited, especially for youth and boys. “The limited number of secondary schools is a bottleneck” it states, while observing that access is likely to improve as entrance exams for secondary schools are being lifted and repetitions are declining.

It says savings in the education sector are likely to be feasible in “overseas scholarships, school operational costs, and private subsidies and school grants.”

“Learning outcomes were already very poor and worsened during the pandemic” the report notes. It says while the countries have been participating in a regional assessment for more than ten years, “the data has not been made public, contrary to common practices. This hinders public debate about the quality of education provided and many contribute to an education crisis going unnoticed.”

It recommends making improved leaning outcomes for all children a national priority, introducing strategies such as targeted instruction, structured pedagogy, tutoring, and self-guided learning; publicly releasing the data collected through the Pacific Islands Numeracy and Literacy Assessment and gathering data on teachers’ content knowledge and teaching practices to help design plans for improvement.

It also recommends finding ways to reduce overhead costs, improving access to Early Childhood Education from the age of three, and developing policies to improve access to secondary schools for children in the most remote areas.

Health care

Similarly, spending on health (both as a share of GDP and share of total government spending) is high across the nine countries, compared to peer countries. The Bank says this reflects governments’ prioritisation of health, but also the substantial support external partners have provided to the sector (especially through the pandemic).

It recommends the strengthening of health sector governance, and that development partners improve the transparency of their funding to assist governments to better track, coordinate and effectively use resources for health.

The report says resources are currently concentrated on hospitals and urban centres, and governments are urged to review and adopt service delivery models that focus on primary health care and adapt to crises by taking advantage of digital tools and telehealth opportunities.

It recommends strengthening corporate and clinical governance and improving technical efficiency through better management and coordination of patient medical referrals, improved supply chain management, and more adaptative design of infrastructure and management of utility consumption.

And it says more resources into areas like primary and secondary prevention (child health, nutrition, sexual and reproductive health) could avoid disease progression and costly hospitalisation.

Tonga responds

At the virtual launch of the study, Tonga’s Finance Minister Tiofilusi Tiueti said: “We welcome the launch of this timely report, and while some of the findings present challenging messages for the region, they are important for Tonga and the other eight Pacific nations to consider.

 “I was particularly pleased to see the consideration into how we can more effectively build the potential and opportunities of our people, so they are best prepared to seize the opportunities of the future.” 

The launch of a similar report in Fiji earlier this year was polarising, particularly around suggested changes to the VAT regime and income tax thresholds. Ultimately, governments will need to consider whether they have the political appetite to take on wide ranging reforms, particularly when many stakeholders will be scrutinising the potential hardships they could cause the region’s most vulnerable people, if not offset by strong social protection measures.