## Pacific Island Countries Have Untapped Tax Potential

_IMF Blog, October 20, 2022_

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## Bibliographic details
- Authors: Sanjaya Panth, Todd Schneider, Mouhamadou Sy
- Published: October 20, 2022

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### Overview
- Palau is set to introduce a value-added tax (VAT) in a move next year that will provide a fillip to public finances and set an example for other Pacific governments.
- Palau’s tourism-dependent economy shrank by almost 10 percent in 2020 as the government sealed the borders to stave off COVID infections.
- The national budget sank into deficit equal to 11 percent of gross domestic product.
- The government could raise an additional 1 percent of GDP in annual revenue when it starts to collect the new taxes, including VAT, known locally as the Palau Goods and Services Tax, approved as part of a wide-ranging reform package in September 2021.

### Fiscal needs and spending gaps
- A recent IMF paper shows that the average tax gap—the difference between current and potential tax revenue—is about 3 percent of GDP in the Pacific region.
- Pacific islands must on average spend an additional 6.3 percent of GDP over the next decade to meet the United Nations Sustainable Development Goals.
- Pacific islands must on average spend about 3.1 percent of GDP to build new climate-resilient infrastructure.
- International support on concessional terms, such as through the IMF’s Resilience and Sustainability Trust, should play an important part in meeting these spending needs.

### Tax reforms, revenue trends, and limits
- As a group, the Pacific islands have implemented some major tax reforms and made progress in raising tax revenue in recent years.
- Country examples:
  - Fiji invested in technology upgrades at its tax office and a new website that allows taxpayers to register online.
  - Micronesia made its corporate tax structure more progressive.
  - Vanuatu increased its VAT rate from 12.5 percent to 15 percent.
- In many cases progress has come through windfall gains, particularly from corporate income taxes, with a lack of momentum towards more durable tax-policy and revenue-administration reforms.
- Tax offices are often understaffed, underfunded and work with outdated technology, making it a challenge to raise compliance and collect all the taxes that are owed.
- Policy reforms often languish in legislatures.
- Government relief measures to mitigate the impact of the pandemic and higher prices for imported food and fuel following Russia’s invasion of Ukraine are piling pressure on public finances.

### VAT potential and compliance gaps
- Well-designed VAT systems can encourage compliance and lift receipts from other types of taxation.
- Many Pacific islands do not yet have a VAT system and those that do are not exploiting its full potential.
- The gap between the current VAT collection and what could potentially be collected is on average about 50 percent—pointing to significant room for improvement.
- All VAT rates in the region are below the world’s average, and there are widespread exemptions.
- IMF research suggests there could be significant revenue gains by reforming VAT systems. Key steps should include:
  - A focus on a single broad-based VAT rate.
  - Increasing VAT rates in some Pacific islands.
  - Improving compliance through better enforcement to boost collection.
- Countries such as Marshall Islands without a VAT should consider adopting one.
- Given that poor households tend to spend a larger proportion of their current income, VAT implementation should be accompanied by efforts to support the vulnerable and poor through well-targeted fiscal measures.

### Policy recommendations and strategy
- Make domestic resource mobilization a priority as part of a broader strategy to reduce public debt, restore fiscal space, and finance climate and development spending.
- Pursue a comprehensive approach rooted in a medium-term revenue strategy and supported by technical assistance from the IMF and others.
- Use VAT reform, improved enforcement, and administrative modernization to close the tax gap and create fiscal space for social-development and climate-related spending.

*Source: Pacific Island Countries Have Untapped Tax Potential (IMF blog).*

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## References

- [IMF paper](https://www.imf.org/en/Publications/Departmental-Papers-Policy-Papers/Issues/2022/09/09/Funding-the-Future-Tax-Revenue-Mobilization-in-the-Pacific-Island-Countries-522181)
- [Resilience and Sustainability Trust](https://www.imf.org/en/Topics/Resilience-and-Sustainability-Trust)

_Source: https://www.imf.org/en/blogs/articles/2022/10/20/pacific-island-countries-have-untapped-tax-potential_