Tonga E-commerce Incentives Study

Unlocking Tonga’s Digital Potential:  A Realistic Approach to Tax Exemptions and Incentives.

BA recently conducted a study to examine how targeted tax and non-tax incentives can drive the growth of Tonga’s e-commerce sector. Commissioned by the UN Capital Development Fund (UNCDF) and led under the auspices of the Ministry of Trade and Economic Development (MTED) in Tonga, The study was led by a BA team comprising of Rahul Bhatnagar and Aleksandar Zaric.

The Context

A pre-covid IMF study conducted in 2020 identified a range of fiscal challenges facing Tonga, including ongoing spending requirements, managing debt obligations, and revenue losses stemming from PACER Plus, estimated at 1% of GDP annually. This has prompted urgent efforts to identify new drivers of economic growth while strengthening domestic revenue mobilization (DRM) through tax revenues, customs duties, and licensing fees.

On the economic expansion front, Exports led growth is increasingly seen as a priority, particularly digital trade. The E-commerce sector however is relatively new, and there are significant challanges in terms of infrastructure, business-environment and enterprise-capacities. The sector remains small and under-developed despite launching a National E-commerce Strategy three years ago. Particularly given the small domestic market size, it is likely that E-commerce in Tonga will remain a fledging sector without handholding support.

The policy and fiscal space for providing this support is currently limited. Policymakers in Tonga, like their global counterparts, have been suffering from acute 'exemptions fatigue' due to inefficient implementation and weak monitoring and evaluation. On the DRM side,  a review on the wide array of active exemptions is ongoing with the intention of  phasing out inefficient tax exemptions. Some exemptions -such as those for the construction and Tourism sectors - were considered necessary after the slew of natural disasters that have impacted Tonga in recent years, including the 2022 Hunga Tonga-Hunga Ha'apai eruption. The effectiveness of these exemptions and options for expanding exemptions in further areas is under scrutiny.

Objective of the Study

Two primary goals were identified:

●      Identify policy incentives that could support growth in Tonga's fledging E-commerce sector, while ensuring minimum fiscal burden.

●      Assess the impact that adjustment to import tariffs and taxes on ICT equipment could have on the broader digital economy.

While primarily focused on ICT-related goods and services, the study framed recommendations in a way that supports the broader digital economy and sustainable e-commerce growth.

Key areas of evaluation included:

●      The effectiveness of import exemptions in stimulating business investment

●      Whether tax exemptions alone can drive e-commerce growth

●      Alternative incentives beyond tax exemptions to support e-commerce expansion

●      Lessons from comparable economies

●      Potential economic impact of a mix of exemptions and incentives

●      Steps forward and responsible stakeholders

The Approach: Data, Best Practices & Real-World Impact

We  employed a mixed-method approach, incorporating both qualitative and quantitative analyses:

Qualitative analysis: Desk research, stakeholder interviews, and benchmarking against comparable economies.

Quantitative analysis: Tax implication research and economic impact assessment.

Specifically, the following elements were included:

✅ Global Benchmarking: Examined the experience of Small Island Developing States (SIDS) such as Fiji, Mauritius, Singapore, Solomon Islands and other comparator economies.

✅ Impact Modeling: We developed two quantitative models to 1) assess the fiscal (DRM) impact -on key macroeconomic indicators - of adjusting import duties and consumption taxes (CT) on ICT equipment, and 2) identify key bottlenecks for e-commerce firms based on their 'bill of expenses', and assess the economic impacts of broad subsidies/incentives for MSMEs entering the e-commerce sector if broad incentives are provided.

✅ Stakeholder Insights: Engaged policymakers, and businesses via bilateral interviews and Focus Group Discussions with staholders cross the E-commerce ecosystem.

✅ Alternative Incentives: Explored SME-focused subsidies, digital payment reforms, and logistical solutions beyond simple tax reductions.

Key Findings

Although we are not at liberty to identify specific recommendations until the report is made public, we can share the following interesting insights that developing countries, particularly SIDS, may wish to consider:

1. Although existing incentives may not spell out ICT/e-commerce, SMEs engaged or seeking to participate in e-commerce can still be eligible for many of the incentives in case they satisfy the existing criteria. Most E-commerce companies in developing economies, including SIDS, will are Micro, Small and Medium-Sized Enterprises (M/SMEs). This is key because most economies already have a range of M/SME incentives available, for agricultural supply chain input financing, new product development, import substitution, capital assistance, export financing support, women owned and operated businesses. and many other areas. Rather than create new incentives for E-commerce firms, why not leverage the existing M/SME incentives? Inefficient administration of the incentive/exemption regimes, weak understanding of e-commerce within policy circles, and lack of mutual awareness on both the public and private sectors is to blame for this opportunity gap.
2. Subsidies and exemptions on imports of ICT equipment will not necessarily translate into private sector understanding of how to leverage the equipment. The key learning is that the subsidies and incentives regime should be tightly linked to to strategic goals (such as export targets) with at least 10 years horizon, and then supplemented with training, after-care services for repairs and other necessities. When deployed based on short-term considerations or without adequate basis, the efficacy of these instruments is weak and contributes to the exemptions fatigue.
3. Incentive regimes- particularly those with DRM implications - need to have regular reviews backed up by a strong M&E framework to ensure that incentives can be adjusted, phased out as per the dynamic needs of the sector.
4. A value chain wide focus is needed along three fronts:
   1. Unlocking digitalization opportunities across high-priority export value chains that will help to make the value chains fit for purpose for e-commerce, develop domestic demand for ICT equipment and services, and help justify exemptions and incentives.
   2. Value-chain integration via B2B e-commerce relationships. e.g. what are the opportunities for tightening supplier relationships between the Agriculture, Light manufacturing and Tourism sector, and how can e-commerce serve as the lubricant facilitating these relationships? If there is a viable case, then incentivising these relationships is certainly valid.
5. E-commerce is dependent not only on physical ICT products but also services (for example cloud based services for hosting websites). Services  are therefore equally important but the lack of data stops any quantitative analysis in the tracks. This is particularly the case in PICS.
6. There is an important need to prioritise e-waste management. A ramp up of ICT and E-commerce activity must accompany enhancement of country’s capacity to repair, recycle, or safely dispose of electronic equipment. This can translate into incentives for the private sector,  development of standards and enforcement mechanisms, as well as necessary infrastructure development for managing e-waste as well as other e-commerce related waste.

Two areas where we innovated:

1) Quantitative modelling to substantiate qualitative inputs: We realized early on that in order to provide a compelling set of recommendations to the Government, interviews and focus group discussions would not suffice. We needed a more rigorous analysis that included quantitative dimensions to substantiate the qualitative findings.

The integration of these quantitative findings with the qualitative data ensures a holistic approach to the study. It underscores the potential multiplier effect of strategic subsidies on MSMEs' ability to engage in e-commerce, as suggested by the qualitative analysis. The quantitative data project how such subsidies could lead to substantial increases in turnover, GDP contributions, and fiscal revenues through enhanced e-commerce activities. As the recommendations are grounded in realistic economic forecasts, this lent a higher confidence in the recommendations that we have proposed to Tongan policymakers.

2) Integrate  average firm level data in the policy analysis: We reviewed the problem space from both an economy-wide perspective but also at the enterprise level. Using the Bill of Expenses (i.e. fixed and recurring costs incurred by a typical E-commerce firm in Tonga) as the basis, we simulated the impact of broader incentives on the bottom line of individual firms, the overall sector and the overall economy. This also allowed us to mimic a Pareto-type analysis which pointed to certain challanges that must be addressed before any e-commerce support package can have an impact (hint: payment gateway and related constraints).

Interested in engaging with us?

Since the completion of the study, we are iteratively enhancing the model to accommodate more complex datapoints and also include benchmarking inputs across a range of comparator economies.  If you are a policymaker or development partner interesting in commissioing a simialr study, contact us at Projects@bhatnagar-advisers.com.

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