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Having concluded its latest Article IV consultation, the International Monetary Fund (IMF) expects that spending needs, particularly in infrastructure and social services, will put pressure on Vanuatu's fiscal position, and welcomes its plans to strengthen tax administration and to consider new measures to increase tax revenue.
With economic growth in 2012 estimated at have risen to about 2.25 percent on the back of a recovery in tourism, Vanuatu's fiscal deficit is estimated at 1.5 percent of gross domestic product (GDP) in 2012, down from 2.25 percent in 2011, largely due to the maintenance of prudent macroeconomic policies in controlling expenditure.
In 2013, continued growth in tourism is expected to help in raising output growth to 3.25 percent, with a budget targeting zero net domestic financing and net repayments of external debt. It is also envisaged that revenues will rise on account of higher growth and improved tax compliance.
However, according to the IMF, a key external risk stems from possibly weaker-than-anticipated regional growth which might adversely affect tourism, and maintaining strong fiscal buffers is recommended to be a macroeconomic policy priority in light of the economy's exposure to shocks. In the longer run, financing continued public investment while preserving low debt will require additional tax revenue measures.
The Government is already strengthening the audit function in the Department of Customs and Inland Revenue, including the introduction of risk-based auditing. Also, discussions are underway in the Melanesian Spearhead Group (MSG) – composed of Fiji, Papua New Guinea, Solomon Islands, Vanuatu and the archipelago of New Caledonia – to amend the rules of origin in the MSG free trade agreement and reduce revenue losses, while new legislation is being discussed to improve customs enforcement and compliance.
The IMF suggests that any revenue losses arising from trade agreements should be offset through higher excise taxes, but that more decisive tax policy measures will also be required to boost revenue by amounts sufficient to provide the Government with the resources needed.
Vanuatu has previously been attractive as a retirement and investment destination for Australian citizens, largely due to its lack of an income tax, but there has been enhanced oversight in recent times by the Australian Tax Office of Australian citizens' financial assets in Vanuatu. In that scenario, the IMF now proposes that an income tax could now be imposed, as it has been in other Pacific islands.
Vanuatu's domestic revenue, at 18.5 percent of GDP, is low relative to its Pacific island peers, suggesting scope to increase revenue. It is forecast that an income tax, levied on both employees and employers, could yield between 3 and 4 percent of GDP at modest tax rates, and bring greater equity to the tax system.
IMF estimates suggest that additional revenue of this magnitude would allow for sustaining the rate of public investment at a level consistent with higher growth, as well as financing a modest increase in current expenditure. To alleviate the impact on businesses, it is recommended that structural reforms to lower the costs of doing business should be implemented simultaneously.
On the other hand, amongst other options, strengthening compliance would result in continued improvements in value added tax (VAT) collection, but it is felt that the scope for revenue enhancement would actually be relatively narrow. In addition, raising the VAT rate from the current 12.5 percent to 15 percent could yield additional revenue relatively quickly, but would disproportionately hit the poorer segments of the population and would likely generate lower revenue than an income tax (some 1-1.5 percent of GDP).
In conclusion, however, the IMF reports that, while the Government has concurred that boosting tax revenue is critical, it has pointed to the administrative and political difficulties of introducing an income tax, and thought that ultimately consumers would bear the burden of such a tax, as this would be passed on given the limited competition in the economy.
While the IMF says that the Government has stressed that it is still exploring all options, it now seems more inclined to rely for increased tax revenue on a VAT increase, and possibly the reintroduction of a turnover tax (which was abolished earlier when the VAT was introduced) and increases in business licensing fees.
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