With Taiwan facing rising public-sector budget deficits and ballooning debt, analysts and some public officials are pressuring the government to consider raising taxes. Given the ease that global capital moves around, especially across the Taiwan Strait, this approach is very likely to backfire. Indeed, raising taxes might be the worst possible solution for balancing government books.
There is no doubt that something should be done to stop the red ink flowing at the bottom of the government's balance sheets. Concern over public-sector debt has caused Taiwan's sovereign credit rating to be downgraded by most ratings agencies and harmed its perceived competitiveness.
This concern arises from the fact that budget deficits have been the norm since 1998 and have been increasing in size each year since. Starting from NT$2.799 trillion in 1998, overall government debt is expected to reach NT$3.4 trillion. This would constitute 33 percent of GNP and would bring per capita debt to NT$153,561.
Not only are there likely to be dire economic consequences from increasing the overall tax burden, there are also political costs. Previous governments are known to have squandered resources while also misdirecting public funds arising from cronyism and corruption, something that the present government promised to end during the election campaign.
Of course, a politically expedient approach would be to raise taxes on foreign companies in Taiwan. Yet countries like Singapore are responding to their economic woes by trying to reduce the overall tax burden, in hopes of attracting more foreign investors.
As it is, most of the arguments for raising taxes ignore the availability of simpler alternatives that are easier to implement and that will yield quicker results. Let's start with the argument that tax collections are too low. Following this reasoning, tax officials should become more aggressive while the tax base would be made broader.
But higher economic growth will bring in more revenues even at lower tax rates. Meanwhile, lower marginal rates decrease the incentive to evade or avoid taxes.
And then there is the quickest method to generate more revenues to staunch the size of its budget deficits, privatization. For exam-ple, despite repeated promises, there has been little movement to sell off state-owned banks.
Privatization provides large amounts of revenues quickly while reducing outflows arising from subsidies or loans to keep government enterprises going. Once these entities become privately owned, they become taxpayers rather than having claims on government financial resources.
Another revenue source would be from charging or raising user fees and prices paid to state enterprises. This step along with privatization would lower the overall tax burden since there would be fewer public subsidies so that government operating costs would be less.
Attempting to use higher taxes to reduce deficits reveals faulty economic logic. A much better way to lower public-sector deficits is to take steps that promote economic growth that brings about increases in revenue. This is what ended the large and seemingly-unmanageable budget deficits seen in the US during the 1980s and early 1990s.
A higher tax burden punishes success in private sector actions. And worse, instead of being available for research and development or seeking market share, the money taken by higher taxes would be diverted into a political culture noted for mismanagement and corruption.
Perhaps lessons can be learned from tax reforms carried out in the 1980s in the US under Ronald Reagan's administration. Many analysts are convinced that the Reagan tax reforms reinvigorated the US economy and set the stage for the long boom of the 1990s.
It is noteworthy that the Rea-gan tax reforms were accompanied by serious efforts to make US markets more flexible through deregulation of corporate and financial activities.
In particular, cuts in marginal tax rates helped boost corporate capital investment that led to a resuscitation of economic activity and eventually caused government tax revenues to increase. The first part of the reforms in-volved reducing tax rates and then a second stage involved simplification of the tax structure.
Under the reform package of 1981, taxes were reduced by US$750 billion over a five-year period. Besides reducing marginal income tax rates, corporate tax breaks were expanded in hopes of encouraging capital investment. While the corporate tax breaks were eliminated in 1986, the basic rate for corporate income taxes was cut to 34 percent from 46 percent and personal income tax rates were drastically simplified.
Restoring Taiwan to a high-growth trajectory requires an implementation of policies and support for institutional arrangements to provide private entre-preneurs with incentives to take risks. If there is a desire for more job opportunities and additional wealth to be created, risk takers must be allowed to keep more of what they earn. Exploring tax reforms should become a top priority as a way to revive corporate as well as individual activities.
Christopher Lingle is global strategist for eConoLytics.com.
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