International Monetary Fund (IMF) concluding statement of 2018 Article IV Mission recommends tax reform as the first “pillar” in addressing Palau’s fiscal sustainability.
The report states that a tax reform should aim “to increase efficiency and fairness of the tax system, while raising revenue.” It recommends a Goods and Services Tax (GST) with a single rate to replace Gross Revenue Tax (GRT) and import tax. It also calls for a net income tax to cover all goods and services businesses with no exemptions. It estimates that this comprehensive tax reform will raise revenue by 2.4 to 4% of the GDP over five-year period.
In order for Palau to reach fiscal sustainability, it needs to prioritize current expenditures and reduce public subsidies. The report states that grants to state governments and other government agencies have been growing rapidly and subsidies to PPUC and Pension have been on-going without “necessarily improving outcomes”. It says that subsidy to PPUC represents about 1% of Palau’s annual GDP. Strengthening management and control of expenditure and public subsidies is another means of reaching sound fiscal strategy.
Furthermore, by implementing a comprehensive tourism strategy, Palau could increase its growth potential. Palau could diversity its source markets for tourism and expand its tourism products thereby reducing “sectoral and macroeconomic volatility”.
Report states that increasing minimum wage to the level of Guam over the next ten years could lead to higher unemployment and loss of competitiveness in the tourism sector. Instead it recommends that structural reforms be implemented aim at improving entrepreneurial opportunities in order to retain young people in Palau.
In addition, promoting private sector growth is vital to sustainable growth in Palau. Since Foreign Direct Investment is becoming a major source of external financing, process governing foreign investment approval process needs to be more streamlined and less cumbersome.
The report states that even though Palau fiscal position has improved over past years despite economic downturn, reaching surplus of 4.8% of GDP in FY 2017, it needs to put in place policies to protect from upcoming fiscal risks and challenges.
Palau needs to address risks related to Compact Trust Funds returns volatility, revenue volatility due to tourism volatility, expected decline in future grants due to Palau’s high-income status and risks from contingent liabilities of Pension Plan, ROPSSA and other quasi-fiscal sectors.
Palau’s “tax revenue is volatile given its reliance on taxes on tourism, country is exposed to natural disasters and climate change, have contingent liabilities in civil service pension fund and SOE debt and COFA Trust Fund Returns are subject to market risks” necessitating the need for fiscal reforms.
Recommendations made on the IMF Report are those of the IMF consultant and not yet official position of IMF Executive Board. (L.N. Reklai)