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South Asia is grappling with significant fiscal challenges that affect its governments’ ability to provide essential public services. Although its tax rates are often higher than average, the region struggles with low tax revenues. This blog explores the reasons behind these low revenues and discusses potential solutions to bridge the revenue gap and strengthen South Asia's revenue collection.
South Asia’s fiscal challenge: Low revenues
South Asia faces significant fiscal challenges. At the end of 2023, gross government debt averaged 77 percent of GDP in the region—well above the average of 64 percent among emerging market and developing economies (EMDEs). South Asian governments spent 26 percent of their revenues on interest payments—also well above the EMDE average of 9 percent. This heavy debt burden makes it difficult for them to fund basic government services such as healthcare and education.
At the root of South Asia’s fiscal challenges are low revenues. During 2019–23, general government revenues excluding grants averaged 18 percent of GDP in South Asia, the lowest among all EMDE regions.
Are South Asia’s revenues low because of low tax rates?
Although tax rates are often above the EMDE average, the region’s tax revenue is below the EMDE average (figure 1). All South Asian countries, except India and Nepal, collect less tax revenue as a percent of GDP than countries with similar per capita income.
FIGURE 1. Revenue mobilization in South Asia
Our new research indicates that tax revenues in South Asia are substantially smaller than what they could be—by the equivalent of 1-7 percentage points of GDP. To arrive at this finding, we quantify the revenue shortfall by estimating a stochastic frontier, which derives each country’s tax potential for each type of tax (consumption, personal income, corporate income, and trade) based on the tax rate and potential tax base. The “tax revenue shortfall” is the deviation of actual tax revenue from the efficient frontier.
This shortfall is especially noticeable in taxes on goods and services, but are also sizable for personal income taxes and, in the larger economies, corporate income taxes (figure 2).
- All South Asian countries, except India, have had above-average shortfalls in personal income tax revenue.
- Shortfalls in corporate income tax revenues have been above-average in three of South Asia’s four largest countries—Bangladesh, India, and Sri Lanka.
- Five South Asian countries—Afghanistan, Bangladesh, Bhutan, Pakistan, and Sri Lanka—have had above-average shortfalls in consumption tax revenue.
Are South Asia’s revenues low because of the structural features of their economies?
Some of these estimated tax revenue shortfalls can be explained by the features of South Asian economies. About 90 percent of the workforce is informal; about 42 percent is employed in agriculture—both sectors that are typically undertaxed (Baunsgaard and Keen 2010; Dokas et al. 2024). Moreover, financial systems, which can help the tax authorities track income and spending and, thus, raise tax revenues, are less developed in South Asia than in the average EMDE (Lompo 2024).
To quantify the extent to which these structural features impact tax revenue, the stochastic frontier estimation is expanded to include informality, the size of the agricultural sector, and the level of financial development. Our research found that among the four countries with above-average tax revenue shortfalls—Bangladesh, Bhutan, Pakistan, and Sri Lanka—these country characteristics account for one-quarter to one-third of the overall shortfalls. Even so, the four countries still have tax gaps that are larger than the EMDE average.
FIGURE 2. Tax revenue shortfalls in South Asia
What are the policy priorities to raise revenues?
The above-average remaining tax-revenue gaps—after controlling for tax rates, potential tax base, and economic structure—point to two priority challenges. First, tax exemptions reduce the amount of taxable income; and, second, the systems for collecting taxes in most South Asian countries are less effective than in the average EMDE.
A review of a large literature of randomized control trials suggests that simple, low-cost tax administration efforts—such as sending reminder letters to taxpayers with delayed payments—can nearly double the revenues collected. Efforts to identify taxpayers tend to be less effective than enforcement measures, suggesting that both are needed for a significant revenue impact.
In addition, because of its exceptionally high levels of pollution, South Asia could also benefit substantially from taxes on pollution. Such policies have been successfully implemented globally through pollution taxation or pollution trading schemes and have generated 0.7 percent of global tax revenue worldwide in 2023.
To address South Asia's fiscal challenges, the region needs to close tax policy loopholes and enhance tax administration, while exploring new revenue sources like pollution taxes.
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