Pension and tax reforms are working in tandem. After completing a pension reform on July 27 last year, the Democratic Progressive Party government also announced a tax reform on Sept. 1 and the Legislative Yuan passed amendments to the Income Tax Act (所得稅法) on Jan. 18.
The tax reform measures take effect retroactively on Jan. 1 this year.
Key features of the tax reform include: an increase in the corporate income tax from 17 percent to 20 percent; a decrease in the undistributed earnings tax rate from 10 percent to 5 percent; and a reduction of the highest personal income tax rate from 45 percent to 40 percent.
An increase in the corporate tax from 17 percent to 20 percent is the right thing to do, because it is expected to increase total tax revenues.
Over the past 10 years, the corporate tax rate been reduced from 25 percent to 20 percent and then to 17 percent to attract more foreign direct investment (FDI), but it appears to have been ineffective.
The total inward FDI stock increased from US$46 billion in 2008 to US$69 billion in 2016, indicating an average annual net FDI inflow of only US$3 billion. This is significantly lower than US$74 billion for Singapore, US$12 billion for Thailand, US$11 billion for South Korea, US$23 billion for Indonesia, US$8 billion for Malaysia and US$5 billion for the Philippines during the same period.
It was time to restore the corporate tax to 20 percent — which remains competitive with other Asian countries: 17 percent for Singapore, 20 percent for Thailand, 25 percent for China, South Korea and Indonesia, 30 percent for the Philippines and 30.8 percent for Japan.
However, it is not right to reduce the undistributed earnings tax rate from 10 percent to 5 percent, as it will not only reduce total tax revenues, but also increase income inequality in the country.
The Chinese-language Liberty Times (the Taipei Times’ sister newspaper) reported that Taiwanese firms are sitting on about NT$4.6 trillion (US$150.8 billion) in undistributed earnings, and a reduction to 5 percent of the tax rate is expected to generate NT$230 billion in windfall profit for investors, which are in turn likely to fuel more speculation in the real-estate market, driving up housing prices, which are already higher than average citizens can afford.
According to the Directorate-General of Budget, Accounting and Statistics’ Report on the Survey of Family Income and Expenditure 2016, personal income consists of wages and salaries, entrepreneurial income, property income and transfer payments.
Of these sources, wages and salaries have been stagnant in recent years; entrepreneurial income has been declining since 1991, while property income, including rent, capital gains, dividends and transfer payments, have steadily increased.
The nation’s Gini coefficient, a measure of the degree of income inequality, increased from 0.30 in 1991 to 0.34 in 2016 and is approaching the critical value of 0.40.
Arthur Laffer, who was an economic adviser to then-US president Ronald Reagan’s administration in 1980s, developed the Laffer curve, which shows the relationship between tax rates and tax revenue. When the tax rate is very high, decreases in tax rates will increase tax revenues.
The new law reduces the highest tax bracket for personal income from 45 percent to 40 percent, which is expected to increase tax revenues. However, a top tax bracket of 40 percent is still too high when compared with the US’ 37 percent; Canada’s and New Zealand’s 33 percent; and Singapore’s 22 percent.
As the personal income tax is a levy on profits, wages and salaries, and capital gains, a relatively high tax rate can be expected to affect people’s work motivation, investment and other business activities. There is room for further reduction of the highest tax bracket, as lower marginal tax rates boost the incentive to engage in productive work relative to leisure and tax-avoidance.
As for total tax revenues as a percentage of GDP, Taiwan’s tax burden is one of the lowest in the world.
Based on the IMD World Competitiveness Yearbook 2016, total tax revenue as a percentage of GDP was 12.3 percent for Taiwan, only slightly higher than 10.6 percent for the Philippines and 10.8 percent for Indonesia, but much lower than 13.9 percent for Singapore, 17 percent for Thailand, 24.6 percent for South Korea, 26.1 percent for the US, 30.6 percent for Japan and 31.0 percent for Canada.
A look at Taiwan’s tax burden over the past half century shows that collected total tax revenues as a percentage of GDP have fluctuated, increasing from 17.1 percent in 1970 to a peak of 19.9 percent in 1990, then gradually declining to a low of 11.4 percent in 2003 before increasing slightly to 13 percent in 2016.
In terms of value, total tax revenues increased from NT$36.7 billion in 1970 to NT$2.224 trillion in 2016 — a 60-fold increase — while GDP increased from NT$215 billion to NT$17.319 trillion over the same period — or an 80-fold increase. This reflects a peculiar situation in which GDP grows while tax revenues decline. Tax revenues did not increase with GDP growth.
Another major reason underlying Taiwan’s low tax burden is growing underground economic activity. It is estimated that about 25 percent of the nation’s GDP, or NT$4.5 trillion, is in the underground economy. That is slightly more than in Canada and the US, where the ratio is 18 percent, but much less than 50 percent in India and Brazil.
Levying an average tax rate of 12.6 percent on this activity would generate additional tax revenues of at least NT$567 billion for state coffers. This is one of the most important issues to be addressed in future tax reform.
The tax reform increased the corporate income tax from 17 percent to 20 percent and reduced the highest tax bracket for individuals from 45 percent to 40 percent. These measures should increase total tax revenues.
However, a decrease in the undistributed earnings tax rate from 10 percent to 5 percent might offset the effects of the personal income tax and corporate income tax amendments.
Thus, the tax reforms could lose their main purpose: creating a fair tax system that collects sufficient revenues, but at the same time stimulates economic growth.
The tax reforms leave room for improvement. The government needs to address the critical issue of a relatively low tax burden as a percentage of GDP.
Lee Po-chih is professor emeritus of economics and former vice president of National University of Kaohsiung.
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