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Dont' believe the tax-refrom hype

`The truth is that Taiwan should cut spending rather than increase the overall burden of taxes to reduce its budget deficit.'

Politicians and bureaucrats use so-called tax reform as a cover for them to raise taxes while avoiding the hard choices involved with exercising fiscal responsibility. So, it is not surprising that the noise out of Taipei is that it is impossible to avoid tax increases to sort out Taiwan's fiscal imbalance. But it turns out that this assertion is based on a logic that places the comfort of politicians and bureaucrats above the interests of citizens and taxpayers.

While a large deficit is against the interests of future generations, raising taxes to offset deficits does not serve them well. It would be far better to end fiscal profligacy and politically-motivated spending that inhibit Taiwan's long-term economic growth potential.

Hoping to increase revenues by almost NT$60 billion (US$1.91 billion) a year, President Chen Shui-bian's (陳水扁) economic advisers propose an increased value-added tax, a minimum tax rate for companies, as well as a tax on capital gains on unlisted stocks and carbon dioxide emissions.

The value-added tax rate would be increased by one to two percentage points from 5 percent and tax breaks currently offered to encourage investment would end, with a minimum tax rate on corporate income.

It would appear that the decisions are based on a presumption that government spending reflects the preferences of the country. The truth is that Taiwan should cut spending rather than increase the overall burden of taxes to reduce its budget deficit.

As it is, economic theory and empirical evidence suggest that spending tends to adjust to available tax revenue rather than the other way around. It turns out that government expenditures are influenced by political battles between taxpayers and interest groups that aim to benefit from higher government spending.

Instead of a borrow-and-spend approach, the move is toward a tax-and-spend approach. However, the real problem is the unwillingness of bureaucrats and politicians to curb spending. Rather than make tough decisions, additional burdens will be imposed on the private sector.

While companies and households have been forced to tighten their belts, there has been scant progress in fiscal reform by central and local governments. And this is the essential source of the problem with deficits and debt.

Although revenues disappear during economic downturns, government spending does not. Governments tend to ratchet up tax rates during downturns while increasing commitments for spending during prosperity. This leads to a tendency to raise taxes when times are bad.

Unfortunately, this is a perfect recipe for ensuring further economic stagnation, since higher tax burdens reduce disposable income and household spending while curbing investment spending.

A better proposal would be to lower tax rates on corporate income so Taiwanese companies will invest more (at home, rather than in China?) and consumers can spend more. In addition, consumption taxes and capital gains taxes should also be lowered. In short, there ought to be a comprehensive overhaul of the entire tax code to reduce the overall tax burden on businesses and households.

These reductions should be across the board and not directed toward special interests or based on the misguided logic of bureaucrats or politicians. And they must be permanent so that economic decision makers will build them into their long-term planning horizons.

As it is, Taiwan's corporate tax rate is 25 percent, while Hong Kong's is 16 percent and Singapore's levy is 25.5 percent. South Korea's average corporate tax rate was lowered to 23.6 percent, down from 28.5 percent, in 1994.

Cutting the corporate tax rate would allow Taiwanese companies to be more competitive and would enhance overall growth prospects. In the first instance, reduced taxes on corporate income and capital gains improve the bottom line for companies while increasing stockholders' wealth so that businesses and households can spend more.

Even better, the pool of savings would increase so there would be a natural decline in interest rates that could encourage long-term commitments of spending in other sectors of the economy.

Of course there will be objections that lower taxes might widen the fiscal deficit. This is nonsense, since the basic problem is a lack of political will to curb spending.

In all events, tax cuts create new growth dynamics that will raise revenues in later periods. In the meantime, Taipei could offset some of the short-run shortfalls by reducing waste and corruption as well as eliminating some of the distorting effects of subsidies. At the same time, additional revenues could be found by privatizing state-owned or controlled financial institutions. Perhaps the best way to "widen" the tax base is to eliminate red tape so that more new businesses can be formed and become taxpayers.

A primary goal of tax reform should be to induce sustainable growth by streamlining the complex taxation system by eliminating earmarked taxes and special-purpose taxes. Complicated tax structures obscure tax neutrality and hinder efficiency.

A reduced tax burden and simplified tax code are the right steps toward inspiring long-term sustainable economic growth. Lower tax burdens allow companies to have greater profitability so they can enjoy an improved competitive position. Lower taxes also encourage corporate managers to take more risks and be more creative to revive Taiwan's economy. And when taxes on gains from capital investment are reduced, international investors are more likely to provide more investment capital.

Christopher Lingle is visiting professor of economics at Universidad Francisco Marroquin in Guatemala.
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