Recent research indicates that a tax-GDP ratio above 15 per cent is a “tipping point” that helps countries generate sufficient domestic resources that can be invested in health, education, and infrastructure and fuel economic growth and development levels.

Abdul Muheet Chowdhary

On 8 October 2021, the OECD/G20 inclusive framework (IF) on base erosion and profit shifting (BEPS) came to an agreement on the taxation of the digitalized economy. This agreement was known as the “Two Pillar solution”. BEPS is an influential standard-setting forum that produces rules on international taxation. So, it is important to begin a discourse on this inclusive framework (IF).

Pillar One sought to update the rules through which highly digitalized businesses are taxed and Pillar Two established a global minimum corporate tax. Pillar One in particular was highly anticipated as modern businesses are increasingly moving away from brick-and-mortar operations to online modes. These have created tax challenges, as existing rules require the physical presence of companies in a country for them to be taxed. Thus, in the absence of a global solution, countries began resorting to unilateral measures to ensure that these companies, with famous examples being Facebook, Apple, Amazon, Google and Netflix (FAANGs), paid their fair share of taxes.

However, Pillar One was criticized as being complex to administer and generating minimal to even negative revenues for developing countries. Four countries in the IF, two from Africa and two from South Asia, outrightly rejected the Two Pillar solution. These were Nigeria, Kenya, Pakistan and Sri Lanka. At the First African Fiscal Policy Forum in December 2021 organized by the South Centre and the Coalition for Dialogue on Africa, the finance ministers of Pakistan and Nigeria outlined their dissatisfaction and critiques of Pillar One, with the former saying it had “nothing for developing countries”.

These countries have defied enormous pressure from the developed countries to conform and have taken a bold position to impose unilateral tax measures on the digitalized economy. This shows the importance of increased revenues for them. This article focuses on SouthAsia as a region, the tax revenue positions of its countries and the way forward vis-à-vis the digitalized economy.

Large tax gaps

Development – building schools, roads, hospitals, etc – requires funds. There are many sources of such funds. Of these, the single most important source is tax collection, known more formally as “domestic resource mobilization”. This has been recognized at the international level. Para 20 of the Addis Ababa Action Agenda says:

“For all countries, public policies and the mobilization and effective use of domestic resources, underscored by the principle of national ownership, are central to our common pursuit of sustainable development, including achieving the sustainable development goals.”

A commonly used indicator is the tax–GDP ratio. Recent research has begun indicating that a tax-GDP ratio above 15 per cent is a “tipping point”, which helps “countries generate sufficient domestic resources that can be invested in health, education, and infrastructure.” Countries with such a ratio have seen larger increases in economic growth and development levels.

Where do SouthAsian countries stand in this regard? Data from the World Bank gives a fair clue to this question. According to the World Bank, Nepal (with 19.8 per cent taxes) and Bhutan (16 per cent taxes) are the only two SouthAsian countries that have managed to break out of the tipping point. The remaining countries are all within the 15 per cent threshold, with Afghanistan (9.9 per cent), Bangladesh (8.8 per cent) and Maldives (9.1 per cent) at critically low levels.

The majority of SouthAsian countries need to undertake strong measures to accelerate tax collection such that it reaches and crosses the 15 per cent mark. For comparison, the average for OECD countries, the richest in the world, is 33.4 per cent. This will enable their government’s to channel money into human development.

Clearly, there is work to be done.

Dangerously high levels of external debt

A natural question that may arise is how governments obtain funds if not through taxes. The answer more often than not is debt. The less a country’s tax-GDP ratio, the more it would be forced to rely on debt, which has multiple negative ramifications. A useful indicator in this regard is the ratio of the external debt stock (total amount of money owed to foreign creditors) to Gross National Income (GNI).

The situation of SouthAsian countries in this regard shows that there is wide variation and an even split. Four countries, Afghanistan, Bangladesh, India and Nepal, have low levels of external debt, ranging between 15 and 25 per cent. The other four have high levels of external debt, ranging from 45 per cent (Pakistan) to 132 per cent (Bhutan).

Digital economy – a lucrative source of revenue 

In this context it is understandable why Pakistan and Sri Lanka, both members of the Inclusive Framework, rejected the Two Pillar solution. Both Pillars would have deprived them of badly needed revenues, especially Pillar One.

India, the largest SouthAsian country and also the largest SouthAsian economy, has agreed to the Two Pillar approach, but it simultaneously also championed an alternative solution in the United Nations known as Article 12B, which is much more suitable for developing countries. Further, India (and Maldives) have not yet legally agreed to implement Pillar One and the commitments made are only political and non-binding. It thus remains to be seen whether SouthAsian countries will actually adhere to the OECD’s solution. 

All SouthAsian countries still have full freedom of action to decide how they want to proceed. The digitalization of the economy continues to grow, accelerated by COVID. Thus, effective taxation of these businesses will become an increasingly important source of revenue in the future.

SouthAsian countries, amongst the poorest in the world, must conduct a careful cost-benefit analysis if they are considering proceeding with Pillar One. Agreeing to this means foregoing unilateral measures on all companies, including those out-of-scope and losing vital policy space. Further, the agreement will have a long shelf-life and likely last for the next 30-40 years. Thus, countries should be clear about what they are ‘getting into’. 

There are many easier to implement alternatives which can bring these countries much larger revenues. Any cost-benefit analysis must also provide assessments of revenues available through alternative policy options and this must be publicly available. Policy makers must ensure that this critical decision is one that will bring South Asia, one of the cradles of human civilization, the needed resources to come out of extreme poverty and achieve the Sustainable Development Goals.

Abdul Muheet Chowdhary is a Senior Programme Officer with the South Centre Tax Initiative, part of the Sustainable Development and Climate Change (SDCC) Programme at the South Centre, Geneva, an intergovernmental organization of developing countries.